A Simple Cash Flow Model
The true measure of the health of any business is cash flow. Long-term planning matters and revenue is critical, but if you have no cash, you have no business. Period. And knowing what your cash position is at any given time is your best reality check. What’s the optimal way to keep your fingers on the cash flow pulse? A solid model.
Your business happens on a daily basis, and staying on top of cash flow can help you when you have those sudden needs—you get a project requiring additional resources, a vendor (or you) decides to change terms, you have a brief window to get an inventory deal, etc. In that case, a “back-of-the-envelope” model can keep you constantly up-to-date regarding your cash on hand.
“A cash flow model doesn’t have to be complex,” says Jennifer Mailhes, CPA, the Consulting Department Partner at CPA and advisory services firm T.R. Moore & Company. “Most business owners are non-accountants, so having an easy system helps. Think of your cash flow model as a ‘cash-in, cash-out’ measurement. You’re thinking about the timing of when cash comes in and when it goes out. Use an Excel spreadsheet to set up half of the equation: your billing to your customers. Just be realistic about it. If your customers typically pay you in 45 days, make sure your spreadsheet reflects that. Segment it into weeks that show when cash will actually be coming in. The second half of the model is your payables or cash out—payroll, utilities, rent, vendor payments, etc. These will be easy to track, as you tend to pay them on a regular schedule during any given month. It’s really just those two numbers. Subtract that cash out from the cash in for each cycle and that gives you a quick, practical look at cash flow.”
Essentially, the model is designed to quickly show you where any gaps might occur in the short term—daily, weekly or monthly. “Having this gauge in place is a great way to keep regular tabs on cash flow,” adds Mailhes. “But if you’re getting into longer-term issues that extend further than 12 to 18 months, like inventory control, you’ll probably need more professional help. But a simple system like this is more about understanding your cash position at any given time than it is about forecasting.”
The review process you implement depends on your business cycle. Mailhes points to one client who has a small staffing service, noting that it pays contractors twice a month, resulting in what she calls “day-driven” cycles. Once you’ve had the model in place and have been using it for a few months, check it against earlier versions so that you can confirm your earlier assumptions and learn where you might have been off. However, once you’ve been using your model and are comfortable with what it’s telling you, says Mailhes, you won’t have to review it against the history.
“Keep it simple and have a cash focus,” she advises. “You may feel that sales mean cash coming in, but it’s more about collections. You need to know what your cash position is when you’re hitting a time of growth. If you’re growing and you have big deals coming in, that’s exactly when you need the cash to support it—not just the potential of the sales you’ve made. A cash gap can be a real problem, and that’s what most people aren’t prepared for. That’s the true value of this simple type of model.”
Once you’ve developed your model, Mailhes adds, it’s a good idea to run it by your accountant or financial advisor to ensure you’re getting off on the right foot and staying on top of your cash flow
Tuesday, August 11, 2009
Budgeting for small business owners
Basic Budgeting as a Management Tool
“Think of a budget as your roadmap,” says Pam Newman, President of small business consulting firm RPPC, Inc., and author of Out of the Red: Management Accounting Concepts to Keep Small Businesses Out of the Red. “If you’re planning for the upcoming year, the budget will help you set expectations and account for potential shortfalls and the impacts of unexpected opportunities. Once you’ve created your budget, it shouldn’t be written in stone, but updated on a regular basis so that you can make the most of it.” A basic budget is just that; a simple document that outlines three key areas of your business: sales, expenses and profit.
On the sales side, it’s all the revenues you generate through the sales of your product or services.
Expenses are twofold, encompassing direct costs and indirect costs, or overhead. “Direct costs are those that include the materials and labor needed to create your product,” Newman says. “If you’re a shoe-maker, for example, it’s the leather, laces and people that put the shoes together. The indirect costs are your rent, marketing, insurance, utilities or any other expenses not directly related to manufacturing or creation of your products and services.”
Profit is broken down into two buckets as well. Gross profits are your sales minus your direct costs, which gives you what you need to cover overhead. What’s left after you take the indirect costs out is your net profit or loss.
Regarding the last point, Newman adds that, “It’s critical that you consistently measure the difference between your gross and net profits. If, for example, your gross is positive and your net is negative, it may mean that you’re not managing overhead well or that you’re not marking up your products and services appropriately. It’s not unusual for business owners to set prices using direct costs, but you can lose sight of those indirect costs. A couple hundred dollars a month here or there really adds up and depletes profits, which is why consistent budget review makes such a difference. It helps you spot those patterns and make changes to correct your course.”
As far as review is concerned, Newman recommends that the budget be assessed at least once a month, calling it a “living document.” In addition, columns should be created for your projected numbers vs. actuals each month. If you’re not on target, you need to know why. The budget allows you to develop a history for your business, and can also help you understand where you need to make changes going forward. If your sales are double what you expected in a given month, it may indicate that your business is growing faster than you may have thought. That may be a signal that you need to think about putting more resources into product development, adding more space, hiring or other areas, which then affects those related budget areas.
The budget is also an excellent expense-management tool. “In general, you know where your expenses are, but often, you have the opportunity to do something that makes a difference for your business, like a spot inventory purchase or in marketing through a special advertising buy,” says Newman. “The budget can show you where you can make moves to support that unexpected expense—where you might put off an expected purchase to account for this opportunity.”
Newman acknowledges that creating and monitoring a budget can be daunting for anyone without a finance or accounting background. “You may want to sit down with an accountant, financial manager or bookkeeper to set up your initial budget,” she notes. “Once you feel comfortable with the process, take it over yourself. After you’ve created and worked with your budget, you’ll find you have a document that can help you succeed throughout the life of your business.”
“Think of a budget as your roadmap,” says Pam Newman, President of small business consulting firm RPPC, Inc., and author of Out of the Red: Management Accounting Concepts to Keep Small Businesses Out of the Red. “If you’re planning for the upcoming year, the budget will help you set expectations and account for potential shortfalls and the impacts of unexpected opportunities. Once you’ve created your budget, it shouldn’t be written in stone, but updated on a regular basis so that you can make the most of it.” A basic budget is just that; a simple document that outlines three key areas of your business: sales, expenses and profit.
On the sales side, it’s all the revenues you generate through the sales of your product or services.
Expenses are twofold, encompassing direct costs and indirect costs, or overhead. “Direct costs are those that include the materials and labor needed to create your product,” Newman says. “If you’re a shoe-maker, for example, it’s the leather, laces and people that put the shoes together. The indirect costs are your rent, marketing, insurance, utilities or any other expenses not directly related to manufacturing or creation of your products and services.”
Profit is broken down into two buckets as well. Gross profits are your sales minus your direct costs, which gives you what you need to cover overhead. What’s left after you take the indirect costs out is your net profit or loss.
Regarding the last point, Newman adds that, “It’s critical that you consistently measure the difference between your gross and net profits. If, for example, your gross is positive and your net is negative, it may mean that you’re not managing overhead well or that you’re not marking up your products and services appropriately. It’s not unusual for business owners to set prices using direct costs, but you can lose sight of those indirect costs. A couple hundred dollars a month here or there really adds up and depletes profits, which is why consistent budget review makes such a difference. It helps you spot those patterns and make changes to correct your course.”
As far as review is concerned, Newman recommends that the budget be assessed at least once a month, calling it a “living document.” In addition, columns should be created for your projected numbers vs. actuals each month. If you’re not on target, you need to know why. The budget allows you to develop a history for your business, and can also help you understand where you need to make changes going forward. If your sales are double what you expected in a given month, it may indicate that your business is growing faster than you may have thought. That may be a signal that you need to think about putting more resources into product development, adding more space, hiring or other areas, which then affects those related budget areas.
The budget is also an excellent expense-management tool. “In general, you know where your expenses are, but often, you have the opportunity to do something that makes a difference for your business, like a spot inventory purchase or in marketing through a special advertising buy,” says Newman. “The budget can show you where you can make moves to support that unexpected expense—where you might put off an expected purchase to account for this opportunity.”
Newman acknowledges that creating and monitoring a budget can be daunting for anyone without a finance or accounting background. “You may want to sit down with an accountant, financial manager or bookkeeper to set up your initial budget,” she notes. “Once you feel comfortable with the process, take it over yourself. After you’ve created and worked with your budget, you’ll find you have a document that can help you succeed throughout the life of your business.”
Preparing for an SBA Loan
Preparing for an SBA Loan
The U.S. Small Business Administration (SBA) grants millions in loans each year for small businesses.
The SBA’s loan program is in the spotlight right now because the stimulus package expanded the program in a number of ways. First, there is now a guaranteed fee waiver, which can save small businesses thousands of dollars. In addition, the 75% guarantee has also been raised to 90%, which makes it more appealing for lenders to make loans. Lastly, America’s Recovery Capital (ARC) program helps stabilize small businesses at risk by providing cash to businesses that need assistance paying down existing debt.
These recent changes ultimately mean there are more funds available and greater eligibility for small businesses, including the SBA’s largest vehicle, the 7(a) loan program.
Depending on the loan in which you’re interested, requirements will vary. According to the SBA, common documentation requirements include: purpose of the loan; history of the business; financial statements for three years (for existing businesses); schedule of term debts (existing businesses); accounts receivable and payable aging; projected opening-day balance sheet (for new businesses); lease details; amount of investment in the business by the owner(s); income projections: expenses and cash flow: signed personal financial statements and tax returns: and personal resume(s).
Other necessary documentation may include:
Business profile—A description of the type of business, annual sales, number of employees, length of time in business and ownership.
Loan request—An explanation of purpose, amount and type of loan you’re after.
Collateral—The collateral being used to secure the loan, including business equity, borrowed funds and available cash.
In addition to documentation and other requirements, the SBA wants prospective loan candidates to understand some basic credit factors and the ways in which they influence the loan process:
Equity investment—You should be able to demonstrate a level of equity invested into your business, coupled with a manageable amount of debt. Any loan will involve an examination of your debt-to-worth ratio to correlate the loan amount with the owner’s net worth.
Earnings requirements—This is about cash management and the ability to meet all your debt payments, not just your loan(s). You’ll need to supply a sound cash flow projection, broken down on a monthly basis, and covering the first annual period after the loan is received. All SBA loans must be able to reasonably demonstrate the “ability to repay” the intended obligation from business operations.
Working Capital—Working capital means the excess of current assets over current liabilities. Working capital measures what is available to pay a company’s current debts. It also represents the cushion or margin of protection a company can provide its short-term creditors.
Collateral—Collateral can consist of both assets which are usable in the business and personal assets which remain outside the business. For all SBA loans, personal guarantees are required of every 20% or greater owner, plus others individuals who hold key management positions. If real estate is being used as collateral, banks and other regulated lenders are now required by law to obtain third-party valuation on real estate-related transactions of $50,000 or more. Certified appraisals are required for loans of $100,000 or more. The SBA may require professional appraisals of both business and personal assets, plus any necessary survey and/or feasibility study. One note: SBA will generally not decline a loan where inadequacy of collateral is the only unfavorable factor.
Resource management—Simply put, it’s your ability to manage the resources of your business. Management expertise and capacity—sometimes called character—are important factors encompassing education, experience and motivation.
The SBA offers several loan programs. Learn more about what you need to prepare, loan types and related information at www.SBA.org
The U.S. Small Business Administration (SBA) grants millions in loans each year for small businesses.
The SBA’s loan program is in the spotlight right now because the stimulus package expanded the program in a number of ways. First, there is now a guaranteed fee waiver, which can save small businesses thousands of dollars. In addition, the 75% guarantee has also been raised to 90%, which makes it more appealing for lenders to make loans. Lastly, America’s Recovery Capital (ARC) program helps stabilize small businesses at risk by providing cash to businesses that need assistance paying down existing debt.
These recent changes ultimately mean there are more funds available and greater eligibility for small businesses, including the SBA’s largest vehicle, the 7(a) loan program.
Depending on the loan in which you’re interested, requirements will vary. According to the SBA, common documentation requirements include: purpose of the loan; history of the business; financial statements for three years (for existing businesses); schedule of term debts (existing businesses); accounts receivable and payable aging; projected opening-day balance sheet (for new businesses); lease details; amount of investment in the business by the owner(s); income projections: expenses and cash flow: signed personal financial statements and tax returns: and personal resume(s).
Other necessary documentation may include:
Business profile—A description of the type of business, annual sales, number of employees, length of time in business and ownership.
Loan request—An explanation of purpose, amount and type of loan you’re after.
Collateral—The collateral being used to secure the loan, including business equity, borrowed funds and available cash.
In addition to documentation and other requirements, the SBA wants prospective loan candidates to understand some basic credit factors and the ways in which they influence the loan process:
Equity investment—You should be able to demonstrate a level of equity invested into your business, coupled with a manageable amount of debt. Any loan will involve an examination of your debt-to-worth ratio to correlate the loan amount with the owner’s net worth.
Earnings requirements—This is about cash management and the ability to meet all your debt payments, not just your loan(s). You’ll need to supply a sound cash flow projection, broken down on a monthly basis, and covering the first annual period after the loan is received. All SBA loans must be able to reasonably demonstrate the “ability to repay” the intended obligation from business operations.
Working Capital—Working capital means the excess of current assets over current liabilities. Working capital measures what is available to pay a company’s current debts. It also represents the cushion or margin of protection a company can provide its short-term creditors.
Collateral—Collateral can consist of both assets which are usable in the business and personal assets which remain outside the business. For all SBA loans, personal guarantees are required of every 20% or greater owner, plus others individuals who hold key management positions. If real estate is being used as collateral, banks and other regulated lenders are now required by law to obtain third-party valuation on real estate-related transactions of $50,000 or more. Certified appraisals are required for loans of $100,000 or more. The SBA may require professional appraisals of both business and personal assets, plus any necessary survey and/or feasibility study. One note: SBA will generally not decline a loan where inadequacy of collateral is the only unfavorable factor.
Resource management—Simply put, it’s your ability to manage the resources of your business. Management expertise and capacity—sometimes called character—are important factors encompassing education, experience and motivation.
The SBA offers several loan programs. Learn more about what you need to prepare, loan types and related information at www.SBA.org
Tuesday, August 4, 2009
Dealing with partners when buying a business
Dealing With Partners When Buying A Business
Years ago, in one of the first businesses I purchased, there were two owners. I initially met the managing partner and he told me from the onset that he made “all the decisions”. Allegedly, the other owner was strictly a silent partner. We had several meetings and negotiations, and things were progressing smoothly.
I tabled an offer that reflected all the deal points we had agreed to. Then, the communications started to slow down drastically. I soon learned that the silent partner was not too silent after all. In fact, he was making his opinion loud and clear – he did not want to do the deal.
I managed to get the two partners back to the table although it was not that easy. They were doing a great job of playing “good cop-bad cop” and I had naively fallen for their routine.
It would have been easy for me to walk from the deal, but I am glad I decided to forge ahead. It turned out to be one of the best investments I ever made. However; getting to the finish line was a “hair pulling exercise”.
A lot was learned from the situation, and so if you find yourself in discussions where there is more than one owner, you will want to do the following:
From the onset of discussions, find out how many owners there are in the company. Always make a habit of getting the company's most recent annual coprporate filings from the local state website just to double-check the company's ownership, the legal structure, and to make sure it is in "good standing".
If any are either not active, or “silent”, you will want a clear understanding of the decision making process in the daily business operations, and also regarding the potential sale of the company.
Ideally, if you will only be dealing with one party, you will want to get a letter from the other owner(s) confirming the other partner’s ability to make binding decisions. If they will not agree to this, then your discussions must involve all owners, at all times. If not, you will drive yourself crazy. One partner will agree, and the other will renegotiate. It will happen with every deal point because the partner who is not present will almost always feel he can get a better deal.
Do not fall prey to the seller’s games. If they are going to play off each other in negotiations, and no point is ever really final, then do not commit yourself to any position until you know the position of both parties on the seller side of the deal.
Make Sure You Know What Each Partner Does
One critically important issue is to really drill down to determine what involvement, if any, each partner has in the business on a day-to-day basis. Far too often, a seller will dismiss the impact of their partner’s role, and you can really put yourself in a bad situation.
Even if one has a far lesser role, you need to know whether they plan on leaving the company after the sale as well. If that is the case, then you have to almost certainly adjust the Owner Benefits downwards to account for replacing the second partner’s function. No matter how smart you may be, and regardless of how minimal the sellers may represent one of the partner’s role, if they work in the business at all, you have to replace their function. If there is any cost for you to do so, that must be taken into account.
When Partners Are Fighting
The final point regarding partners is when you come across dealing with feuding ones. This can be a real mess. The points noted above are especially important but more so is that you may have to conduct simultaneous negotiations. I have seen it where the partners no longer talk to each other. You can imagine how much fun that scenario can be. While more time-consuming, if the business makes sense, you can certainly get these deals done. But, you must have each partner sign off (literally) on every deal point.
A word of caution: never get in the middle of their dispute. It does not serve any point. Keep your position and story consistent regardless of which one you are speaking to. If they cannot get along, that is their problem, do not fuel the fire. If the discussions get out of hand, tell them to resolve their issues first and then you will engage in the negotiations.
Richard Anderson
Years ago, in one of the first businesses I purchased, there were two owners. I initially met the managing partner and he told me from the onset that he made “all the decisions”. Allegedly, the other owner was strictly a silent partner. We had several meetings and negotiations, and things were progressing smoothly.
I tabled an offer that reflected all the deal points we had agreed to. Then, the communications started to slow down drastically. I soon learned that the silent partner was not too silent after all. In fact, he was making his opinion loud and clear – he did not want to do the deal.
I managed to get the two partners back to the table although it was not that easy. They were doing a great job of playing “good cop-bad cop” and I had naively fallen for their routine.
It would have been easy for me to walk from the deal, but I am glad I decided to forge ahead. It turned out to be one of the best investments I ever made. However; getting to the finish line was a “hair pulling exercise”.
A lot was learned from the situation, and so if you find yourself in discussions where there is more than one owner, you will want to do the following:
From the onset of discussions, find out how many owners there are in the company. Always make a habit of getting the company's most recent annual coprporate filings from the local state website just to double-check the company's ownership, the legal structure, and to make sure it is in "good standing".
If any are either not active, or “silent”, you will want a clear understanding of the decision making process in the daily business operations, and also regarding the potential sale of the company.
Ideally, if you will only be dealing with one party, you will want to get a letter from the other owner(s) confirming the other partner’s ability to make binding decisions. If they will not agree to this, then your discussions must involve all owners, at all times. If not, you will drive yourself crazy. One partner will agree, and the other will renegotiate. It will happen with every deal point because the partner who is not present will almost always feel he can get a better deal.
Do not fall prey to the seller’s games. If they are going to play off each other in negotiations, and no point is ever really final, then do not commit yourself to any position until you know the position of both parties on the seller side of the deal.
Make Sure You Know What Each Partner Does
One critically important issue is to really drill down to determine what involvement, if any, each partner has in the business on a day-to-day basis. Far too often, a seller will dismiss the impact of their partner’s role, and you can really put yourself in a bad situation.
Even if one has a far lesser role, you need to know whether they plan on leaving the company after the sale as well. If that is the case, then you have to almost certainly adjust the Owner Benefits downwards to account for replacing the second partner’s function. No matter how smart you may be, and regardless of how minimal the sellers may represent one of the partner’s role, if they work in the business at all, you have to replace their function. If there is any cost for you to do so, that must be taken into account.
When Partners Are Fighting
The final point regarding partners is when you come across dealing with feuding ones. This can be a real mess. The points noted above are especially important but more so is that you may have to conduct simultaneous negotiations. I have seen it where the partners no longer talk to each other. You can imagine how much fun that scenario can be. While more time-consuming, if the business makes sense, you can certainly get these deals done. But, you must have each partner sign off (literally) on every deal point.
A word of caution: never get in the middle of their dispute. It does not serve any point. Keep your position and story consistent regardless of which one you are speaking to. If they cannot get along, that is their problem, do not fuel the fire. If the discussions get out of hand, tell them to resolve their issues first and then you will engage in the negotiations.
Richard Anderson
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