Managing Your Business Finances
As a small business owner, you’re expected to be an expert on everything
from product management to strategic planning, marketing and finance. But
in today’s changing economy, understanding it all is much harder,
especially when weighing the many financing options that can make or break
When mystery is removed from business finance, entrepreneurs gain the
insight needed to seize opportunities, sustain growth, maintain tight
control over their company’s direction, and avoid setbacks. Financial
planning, essential for success, should include the following tools.
Adequate Financial Information
Surveys have shown that less than half of all small companies have solid,
current financial information. Work with an accountant to develop a
system for generating and tracking basic financial information such as cash
flow and sales projections, inventory turnover and accounts
receivable/payable ratios. This will help you develop good financial
projections, and assist you in better determining your financing needs.
A Cash Flow Budget
Cash flow consists of funds pumping through your business, from cash
receipts deposited in bank accounts to cash paid out to suppliers.
Managing your cash flow effectively can make the difference between success
and failure for your venture. Failure to carefully monitor cash flow can
lead to unexpected cash shortages and potentially serious disruptions.
If your company is profitable, you should anticipate cash outflow
disproportionate to normal expenses if it’s growing quickly. You may need
cash to fund inventory growth, meet temporary or increased operating costs,
or carry the larger quantity of receivables generated by increasing sales.
Your company may keep too much cash on hand for emergencies or other
unexpected situations, which can cheat your business of opportunities to
grow while also reducing the return on your investment. Every dollar
should earn a maximum return, depending on your firm’s priorities. A
banker can recommend investment options to meet your needs — such as money
market accounts, time deposits and U.S. government securities — which
provide both liquidity and safety.
You can manage cash flow by developing a detailed cash budget. Each
month, take your beginning cash position, estimate the cash receipts and
disbursements you expect for the month, and evaluate what your cash
position will be during and at the end of the month. Then regularly check
your estimates against your actual experience as you go forward. Just as
with a personal budget, this process enables you to monitor important
fluctuations or trends.
With a working cash budget, you’ll be able to allocate your available
cash to meet specific requirements. You’ll be ready to pay bills on time
and use cash surplus to finance growth or capital expenditures. And most
important, you’ll be able to invest surplus cash to earn the maximum
possible return on the dollar.
Maintaining a detailed cash flow budget allows you to accurately
monitor cash needs, time cash disbursements to your maximum advantage, and
plan ahead for cash shortfalls. Don’t confuse paper profits with a
positive cash flow. You may not actually have a cash surplus after
tallying such overhead as daily operating expenses, the cost of maintaining
inventory, and periodic expenses such as payroll tax payments.
While daily operating expenses are generally easy to forecast, the
timing of capital expenditures for items such as manufacturing or office
equipment can be more difficult to predict. If cash flow is not sufficient
to cover expenditures or unexpected developments, you may need to arrange
for bank financing.
Credit can play a critical part in helping your business grow. If cash
flow is not sufficient to meet ongoing operating needs, you may need to
consider managing temporary shortfalls by applying for a line of credit, or
funding an infusion of capital by applying for a loan.
In order to get the most out of your banking relationship, investigate
the variety of services your bank provides, and take the time to
understand what it needs from you as the business borrower. Also make sure
your banker is kept up to date with information about your company, such as
your product or service, your overall financial strategy, and your approach
for reaching your market.
Your banker will need other material as well, such as tax returns and
financial statements from the past two to three years; business plan
information that supports your need for credit; and personal financial
data. In addition, keeping your banker apprised about your company’s
progress as it grows and changes, even between loan requests, will pay
dividends over the long term. By maintaining this kind of open and ongoing
relationship, you should receive quicker service with a greater sensitivity
to the needs of your business.
As banking changes, the range of services banks provide to small businesses
continues to grow. In addition to basic services such as checking, savings
and investment accounts, many banks provide payroll and personal
computer-based on-line money management services, automatic payroll tax
deposits, and letters of credit and other trade finance services that
support international sales efforts. Business financing usually includes
some form of temporary or permanent working capital such as U.S. Small
Business Administration (SBA) loans or other business loans or lines of
* Lines of Credit. This type of credit allows you to borrow repeatedly up
to an aggregate amount, and is often structured so you may repay and
reborrow as often as you need. The term revolving line of credit is
sometimes used because of the repeat borrowing and repayment provisions.
One reason for the popularity of lines of credit is the ability to take
advantage of opportunities such as trade discounts on merchandise. Another
type of credit line is a seasonable one used by businesses with seasonal
sales. When applying for a seasonal line, determine how much you will need
and, based on past experience, when you’ll be able to repay it. In most
cases, a seasonal line of credit is expected to be repaid within one year.
* Term Loans. Long-term loans are usually granted for three to five years,
and can be used to increase permanent working capital or finance
receivables. Such a loan should also be considered for the purchase of new
equipment, expansion of a store or plant, or an increase in provisions that
limit your firm’s other debts, dividends, or the principals’ salaries.
Collateral for a long-term loan may include the assets you are purchasing,
stocks, bonds, certificates of deposit, and other personal or business
assets. You may also be required to sign a personal guarantee, i.e., your
personal assets may be identified as a secondary source of repayment.
Banks will usually require that the value of the collateral be greater
than the amount of the loan. One factor to consider when evaluating the
worth of collateral is how quickly it can be changed into cash to pay the
loan, and how long it will hold its present value.
* Letters of Credit. A request for opening a letter of credit, which is
often used to facilitate international business transactions, is similar to
an application for a loan and is treated in much the same way. Two types
of letters of credit exist:
Standby letters of credit substitute the bank’s credit for your
company’s credit by obligating the bank to pay a third party if you fail to
do so or if other specified conditions occur.
Commercial letters of credit refer to a specific transaction. Money to
pay for particular goods you are purchasing is held by the bank, and a
letter of credit is sent to the supplier stating that payment will be made
when the goods are satisfactorily delivered.
* Start-Up Financing. If you’re starting up a new business and need
additional funds within the first three years of operation, you can pursue
personal financing options such as cash secured or, if you own a home, home
equity secured (i.e., credit secured by your primary residence). Some
banks provide home equity secured loans in the business owner’s name, while
others allow you to document the credit in the name of the business.
Because these two variations have different tax advantages, it’s advisable
to discuss your options with an accountant.
Applying for a Loan
You will make a better impression on the lender if your loan application is
neat, concise and well organized. It should include an explanation of how
the borrowed funds will be used and a brief history of your business.
It is important to recognize that the bank will always want to know
there are two ways available to pay back the loan. In case your business
does not generate enough money, the bank will want to make sure you have a
viable alternate plan.
Your financial statements are the key item your banker will use to
determine whether to approve or decline a loan request. Because of the
significant weight attributed to them, you should consider consulting an
accountant for assistance.
Lenders ask you to submit financial statements in order to gain an
understanding of the condition and potential of your business. The
following components are of particular interest to them when gauging your
* Liquidity. The amount of cash and working capital a company possesses
is very important because it indicates how efficiently your business
generates internal cash flow which can be used to repay the loan. For
unsecured loans, most banks require that your core business assets (cash +
accounts receivables + a portion of marketable securities) are 1.5 to three
times the loan amount. A quick, simple reading of short-term liquidity is:
(Cash + Accounts Receivables + Marketable Securities)/Current
* Leverage. The amount of debt on a company’s balance sheet when compared
to its net worth (total assets minus total debts = net worth) gives the
banker an idea of how leveraged the business is. This is shown by the debt
to worth ratio which measures how much you rely on borrowed funds, and
provides some indication of your ability to repay a loan. Most banks will
require that your company debts do not exceed three times the amount of
your business net worth.
Total Debt/Net Worth = Debt to Worth Ratio
* Inventory. Your banker will want an accurate count of your inventory,
particularly if you are running a wholesale or retail operation, to help
determine inventory turnover. Inventory turnover ratios are especially
valuable in monitoring internal operations, and can help you achieve the
right balance between overstocking and understocking. Your accountant or
local library should have books that specify the optimal inventory turnover
ratio in your specific type of business.
Cost of Goods Sold/Inventory = Inventory Turnover
* Accounts Receivables Turnover and Collection. Developing a credit policy
is one of your most important marketing decisions. If your credit terms
are too tight, you may lose sales; if they are too liberal, your carrying
costs will be higher than necessary.
Net Sales/Receivables = Receivable Turnover
365 Days/Receivable Turnover = Average Collection Period
These ratios show how many days usually elapse between the time you
bill your customers and when they pay you. If the average collection
period is very short, it might mean your credit policy is too stringent or
your collection procedures are too harsh, or both. If the collection
period is too long, it might indicate that your credit policy is too
liberal, your collections methods are lax, or that you have problem
customers who may not pay you at all. Your average collection period
should show a strong resemblance to your payables schedule.
Value for most companies means saving time and getting more for your money,
not necessarily finding the cheapest deal. As banks offer products and
services with diverse features and varying prices, be sure to shop around
for those that provide real value to your business. Examples include ATM
access for business deposits, or credit lines with optional fixed rate
loans that you can easily initiate without having to reapply or requalify.
Managing the financial side of a business can be a difficult
challenge. But don’t leave financial planning entirely in the hands of
outside advisors or put off giving it the attention it deserves. And keep
your banker in the loop. Increasing your involvement in your firm’s
finances can give you the management perspective that helps ensure
EASING OF THE CREDIT CRUNCH FORESEEN
“Small businesses are especially frustrated right now when trying to borrow
money,” empathizes Bank of America’s Michael Dowlan, vice president of
Asset Product Management, Business Banking Division, in Los Angeles. “It’s
perceived that banks don’t want to lend. In reality, banks are ready to
lend more, but a slow recovery from the recession has made small businesses
reluctant to borrow, and a host of regulations has made it more difficult
for banks to lend.”
As Dowlan explains, a recently enacted law — the Federal Deposit
Insurance Corp. Improvement Act of 1991 or FDICIA — imposed a number of
stringent restrictions on ways banks structure credit and manage risk.
“FDICIA was crafted to protect the bank insurance fund, which was depleted
by the real estate lending abuses of the 1980s and the savings and loan
crisis,” he says. “And while bankers agree that, in some cases, lending
practices went awry then, many feel that the new regulations may swing too
far back in the other direction.
“Worried that examiners will question or criticize what used to be
routine lending decisions, many bankers have more stringent requirements
for credit than in the past,” continues Dowlan.
His point is reinforced by Federal Reserve Board Chairman Alan
Greenspan, who maintains that small business loans now require double the
regulatory paperwork of 10 years ago, making it “prohibitively costly” for
banks to make loans to small businesses.
In fact, according to Arthur Anderson’s Enterprise Group and National
Small Business United, a trade association, 23 percent of small businesses
that tried to obtain bank loans in 1991-92 were turned down. Of those that
did get loans, 10 percent received less money than expected.
“A scarcity of lending capital has troubling implications for the
entire U.S. economy,” emphasizes Dowlan. “With the nation’s recovery in an
early stage, other engines of growth are sputtering. Big corporations
continue to retrench. Hopes for an export boom are fading as the economies
of Europe and Japan slow. That leaves small businesses with the burden of
leading the country out of its economic slowdown.
“Small businesses will play a very significant role in ending the
recession,” he says. “They employ more people than all Fortune 500
companies combined, and fueled much of the economic growth of the 1980s.
But they can’t grow without capital, which they have historically relied on
banks to provide.”
Several other financing options exist through lenders which are
insulated from the new regulatory pressures affecting banks. These
* Commercial Finance Companies. While these lenders make the same
kinds of loans as banks, they don’t take deposits. They may charge higher
interest rates, however, to compensate for the fact that they don’t collect
income on deposits and other bank products.
* Factoring Companies. Factors purchase a company’s accounts
receivable at a discount and assume the credit risk, excluding those that
result from disputes over product quality.
* Government Sources. State and local governments are increasingly
setting up revolving loan funds and loan guaranty programs to keep
businesses and jobs within their borders.
* Credit Indemnity Companies and Accounts Receivable Insurers. If the
credit record of small business owners is brief or questionable, these
companies will insure their accounts payable so large vendors will agree to
do business. As with any other insurer, a fee is charged.
Bank of America’s Dowlan is optimistic that the current lending
climate will improve and that small businesses will benefit as a result.
“Two factors are key. Passage of the Economic and Regulatory Paperwork Act
of 1993, and modifications to FDICIA standards, should help the
entrepreneurial segment more readily gain access to credit and give the
country an important boost,” he concludes. “For the ability of small firms
to get funding from bankers directly relates to full economic recovery.”