Fish can only be out of water for a few minutes before they stopping flopping around and start to dehydrate. The same holds true for a business without cash. Much like fish need water; your business needs a sea of cash to survive.
Businesses require a steady stream of cash moving in and out of the business in order to function from day to day (ie Cash flow).
Cashflow is used to measure your business' financial performance and is crucial in order to be solvent. Cash doesn't include your inventory, accounts receivable, or property. Even though all three of these can turn into cash, you more than likely can't trade excess inventory or the spare cubicle for goods or services.
Be careful not to confuse cash with profit. Why? Because profit is the money a business makes after accounting for all the expenses (In other words, it's what's left over after you have used the cash to pay the bills) Even if a business can forecast a profitable year, if there's no cash in the short term, the business is in trouble.
It's important that your business doesn't drowned in all the cash that's in the bank. Companies who pay attention to their cash flow statements know that if they have abundant cash on hand they are able to invest the cash back into the business in order to produce more profit.
When you read the phrase "stress test", what thoughts pop into your head? I'll go ahead and assume that they aren't very positive. Most people think that banks and businesses only undergo stress testing when they are on the brink of disaster, but stress test shouldn't be a last resort of your financial plan. Stress testing your business investment keeps you competitive by allowing you to be proactive.
The economy has changed the way we do business and the speed in which we need to adapt. Stress test can be used as financial indicators that allow you to prepare for the worst-case scenarios that your business can come across. It helps to cover the "what ifs" of running a business:
- "What if" our biggest customer goes out of business?
- "What if" customers start demanding lower prices? Can you meet them?
- "What if" customers start taking longer to pay you?
- "What if" sales or production levels drop?
Stress testing your business has its benefits. It allows your business to be more adaptable to changes by providing the financial data you need to make quick and accurate changes to your business. Stress tests also help you formulate plans that address the "what ifs" giving you leverage when dealing with stakeholders and bankers, not to mention making you a stronger competitor.
The market is down and unemployment is up. We all know this; we've been hearing it every day for the past year. Many people are becoming numb to the numbers thrown at us. It's not news anymore; it's becoming the new normal.
Some companies have decided to sit still and wait for the economy to turn around and others have started to recognize that things aren't going to change until someone makes a move.
These companies have stopped asking why and started asking how. They know that in July national unemployment was at 9.7%. They're aware that it's the highest it has been in decades. They know that the GDP is down. They know this stuff already and have turned from focusing on the problem to focusing on a solution. These companies haven't become numb to the numbers; they keep them in mind while driving business forward. They know that in order to fix the problem they can't lose focus on key performance indicators like liquidity, solvency and cash flow.
A solvent company is aware of its performance indicators and are better equipped to not just survive, but also thrive in the economy. They're doing their research looking for new growth opportunities, forging new partnerships, and taking time to focus on what they do best. Don't sit in the corner waiting out the recession. Focusing in on mere survival will make you lose sight of your overall business plan. Keeping track of your financials will give you a leg up in competition and give you time to sharpen your focus.
Small business support has finally arrived in the form of America's Recovery Capital (ARC) Loan Program.
The ARC program, passed with the Stimulus Act, American Recovery Actis aimed to help established small businesses that are currently facing financial hardship. ARC allows small business to apply for a loan worth up to $35,000--with a 100% guarantee from the SBA to cover existing debt.
The interest-free small business loans give borrowers up to five years to pay back the principal, allowing them to increase their cash flow and invest it back into their businesses. In order to be eligible for the ARC loan, the SBA is requiring that businesses show proof of "change in financial condition" including difficulty making rent, payroll, or loan payments, and frozen credit lines. Businesses must have a record of positive cash flow in at least one of the past two years. (For more information on loan requirements, check out the SBA website- ARC Loan Eligibility)
According to CNNMoney.com , lenders approved 72 loans during the first week of the program, totaling $2.4 million.
Despite the numbers, many lenders are still hesitant to latch on to the program - with a 60% default rate expected; they are wary of how quickly they will receive payments from the SBA. Still, the SBA encourages potential borrowers to seek out ARC loans from area lenders.
The program started June 15 and will run until September 30, 2010 (or until the funds run out), and the SBA estimates that 10,000 businesses will receive loans in that amount of time.
Just last month, Business First reported that nearly half of business owners have been experiencing cash flow problems these past three months. While the state of the economy can bear some of the blame, the importance of cash flow is something that many business owners greatly underestimate.
So what exactly is cash flow and why is it so important? A company's cash flow is the revenue stream that changes a cash account, or simply, the movement of cash in and out of a business.
Cash flow management is crucial for a business's survival. Sufficient cash flow means that you have enough money on hand to pay creditors, employees, and other emergency bills that might pop up along the way. Having ample cash flow also gives you the opportunity to use the extra cash to expand your business. On the flip side, having little to no cash flow means that your company may be on the verge of bankruptcy.
Cash flow analysis can be classified into three separate areas- operational cash flow, investing cash flow and financing cash flow.
Operational cash flow comes from a company's internal business activities (sales, labor, and purchase of materials). Cash that's received from the sale of long-term assets, or spent on investments is called investing cash flow (purchasing capital). Financing cash is cash that comes from the issuance of debt and equity like loans, loan repayments, and ownership shares.
All three of these categories equal the net cash flows that are necessary to reconcile the cash balance.
Here's a quick example of a positive $550.00 cash flow.
A Cash flow Statement tells a company's story. It helps the owners not only reflect on the financial health, but also allows them to budget for the future. It truly is the lifeblood of every business.
In the world of accounting, ratios give and invaluable amount of information about your company and it's fiscal well being. Accountants use financial ratio analysis on a regular basis. These analyses help to evaluate the financial performance by comparing financial ratios of a business over various periods of time to other businesses in the same industry.
In his book Financial Analysis Tools and Techniques , financial expert Erich A. Helfert defines ratios analysis as
"the use of a variety of ratios in analyzing the financial performance and condition of a business from various viewpoints such as managers, owners, and creditors.
Get out your financial calculator.
There are three different types of ratios:
Liquidity
Profitability
Solvency
Liquidity
Liquidity ratios measure your business short-term ability to pay bills as they are due and let you know if you have the cash to cover and unexpected expenses. Liquidity ratios compare your most liquid assets (assets that are easily turned into cash) with your short-term liabilities. In general, the greater the ratio of liquid assets to short-term liabilities, the better off your company is. These ratios let you know that your company can pay debts that are owed and still continue to operate normally.
Current Ratios
Acid Test Ratios
Current Cash Debt Coverage
Receivables Turnover
Inventory Turnover
Profitability
Profitability ratios measure the operating success of your company for a specific period of time. They give you a better understanding of how well your company made use of its resources to generate profit.
Profitability Ratios
Profit Margin
Cash Return on sales
Asset Turnover
Return on Assets
Return of Equity
Solvency
Solvency ratios measure how well your business can survive over a long period of time by measuring your income after taxes. Solvency ratios take a look at your past financial statement analysis and let you know if your company can continue to pay its debts now and in the future by looking at your income after taxes. A ratio that is higher that 20% means that your business is financially healthy. The lower your ratio, the greater chance your company will default on its debt obligations.
Solvency Ratios
Debt to Asset
Times Interest Earned
Cash Debt Coverage
All of these ratios, liquidity, profitability, and solvency alike can provide you with useful financial information about your company. If you can get so much information from just looking at one type of ratio, imagine the invaluable knowledge you can gain to keep everything on track and guide your company to success.
Business owners really know how to provide quality products and services. But when it comes to simple accounting basics that can make an impact on the success of their business, some business owners are left in the dust.
Being a business owner isn't for everyone, in fact, most businesses don't make it through their first year. People who don't care to learn all aspects of owning a business especially accounting- probably didn't care about running a successful company in the first place. If you agree with any of the following, you'll probably find yourself in the same category as them.
1. You don't care if your business is profitable.
You should only bother knowing the simple accounting if you care about the health of your company. Accounting provides structure to help business owners keep track of whether or not their business has made any money over time and where that money is coming from. Knowing the nuts and bolts will tell you how profitable your business is by keeping track of how much money is going out and coming in.
2. You don't care about what others think.
As the business owner, you're not the only one who cares if your company is making any money. Banks and investors are very interested in knowing how well your business is doing financially. Banks will look at your business from a fiscal standpoint to determine whether or not they should loan your company money. More importantly, they want to be sure that if they give you a loan, you will be able to pay it back. Investors will also want to know if your company is a solid investment and a financial statement will tell them not only if, but how much they should invest into your company. The better you understand the ins and outs of your company's financial state, the more likely the bankers and investors will give your business the money that it needs.
3. You aren't concerned about employee theft; "they're like family."
This isn't to say that you can never trust your employees - there is no doubt that many employees are hard working and honest - but keeping tabs on your financial accounts can help you keep track of where your money is going. According to Score.org expense reports, payroll, purchasing, and suspense accounts are just a few of the places that disloyal employees are most likely to skim a little off the top. For a complete list of areas where employee fraud is most prevalent and what you can do as an employer to prevent employee theft, read the rest of the article.
4. You like selling products that lose money - you'll "make it up on volume"
Thinking about reducing prices to sell more products? Think again. While it may seem like it might make sense to slash prices to move more product, you are more than likely loosing out. Reducing prices reduces your gross profit margin and create more effort for your company to break even. Then again, if you knew accounting 101, you probably already knew that.
5. Cash flow isn't important to you
Your Cash Flow Statement gives you a snapshot of your company's short-term financial health. Knowing your company's cashflow is crucial, it will help you to determine if you have enough money on hand to pay employees and creditors on time. Companies who pay attention to their cashflow analysis know that if they have abundant cash on hand are able to invest the cash back into the business in order to produce more profit.
6. You don't really need to know if your customers have paid you yet
You don't care your customers don't pay their bills right? Of course you do! If you don't keep track of who has and hasn't paid you, how are you supposed to collect?
7. The IRS doesn't care if you've made your payroll tax deposits
Payroll taxes are the responsibility of every employer. Business' payroll tax responsibility consists of not only the taxes required to be withheld from employees' wages -Social Security tax, Medicare tax and federal income tax- but also that the employer's match their share of Social Security and Medicare taxes. Businesses that don't make payroll deposits can face some major penalties, including jail time.
8. Your suppliers never call you to collect their money
Just like you want to make sure that your customers pay you, the same holds true for your vendors. Keeping track of your invoices will help you stay up-to-date with liabilities and due dates for bills.
9. Your employees donate their time and don't expect to get paid
While satisfaction of a job well done is crucial for your employees to be happy and remain with your company, so is a paycheck. Not very many people can afford to volunteer 40 hours of their week. Knowing the basics, like cash flow, lets you make sure that you have enough money to pay your employees for all of their work.
10. Accounting is too difficult to learn anyway.
You don't need to be a mathlete to have a working knowledge of accounting. Chances are that if you're smart enough to learn how to run a company, you're smart enough to learn the fundamentals of accounting. Monica has put together an easy to understand course, Basic Accounting Structure that helps to explain the makeup of accounting, including the different kinds of accounts and basic financial statements that your business uses everyday.
Hopefully you don't find yourself agreeing with any of the reasons above, but if for some strange reason you might, then don't bother to learn anything about accounting; hire a mathlete to take care of all of your finances. But then again if you don't care about your money, you probably don't have enough to hire someone who does.
Photo credit: Carol Ester
