October 26, 2013Judy's Business Tip of the Week

 

Have you "Mastered your Money"?

For small businesses to succeed, the business owners must master their financial well being. This simply means that they need to understand their financial performance and working capital business needs.

 

This is the first in a series of articles on mastering your business. We will start with financial mastery since this is the foundation of all enterprises.

 

Financial management in a small firm provides a different set of problems and opportunities than those confronted by a large corporation. One key difference is that most small firms do not publicly sell issues of stocks or bonds in order to raise funds. The owner-manager of a smaller firm must rely primarily on trade credit, bank financing, lease financing, and personal equity to finance the business. This results in a more limited number of financing alternatives than those faced by the financial vice president or treasurer of a large corporation.

 

On the other hand, many financial problems facing the small firm are very similar to those of larger corporations. For example, the analysis required for a long-term investment decision such as the purchase of heavy machinery or the evaluation of lease-buy alternatives, is essentially the same regardless of the size of the company. Once the decision is made, the financing alternatives available to the company may be radically different, but the decision process will be generally similar.

 

One area of particular concern for the smaller business owner lies in the effective management of working capital. Net working capital is defined as the difference between current assets and current liabilities and is often thought of as the "circulating capital" of the business. Lack of control in this crucial area is a primary cause of business failure in both small and large firms.

 

The business manager must continually be alert to changes in working capital accounts, the cause of these changes and the implications of these changes for the financial health of the company. One convenient and effective method to highlight the key managerial requirements in this area is to view working capital in terms of its major components:

 

1. Cash and Equivalents
This most liquid form of current assets, cash and cash equivalents (usually marketable securities or short-term certificate of deposit) requires constant supervision. A well planned and maintained cash budgeting system is essential to answer key questions such as:

  • Is the cash level adequate to meet current expenses as they come due?
  • What are the timing relationships between cash inflows and outflows?
  • When will you need the most cash?
  • What will be the magnitude of bank borrowing required to meet any cash shortfalls?
  • When will this borrowing be necessary and when may repayment be expected?

2. Accounts Receivable
Most businesses extend credit to their customers. Key issues in this area include:

  • Is the amount of accounts receivable reasonable in relation to sales?
  • On the average, do you collect your accounts receivable?
  • Which customers are "slow payers?"
  • What action should be taken to speed collections where needed?

3. Inventory
Inventories often make up 50 percent or more of a company's current assets and deserve close scrutiny. Key questions which must be considered in this area include:

  • Is the level of inventory reasonable?
  • How rapidly is inventory turned over compared to your competitors?
  • Is any capital invested in dead or slow moving stock?
  • Are sales being lost due to inadequate inventory levels?
  • If appropriate, what action should be taken to increase or decrease inventory?

4. Accounts Payable and Trade Notes Payable
In a business, trade credit often provides a major source of financing. Key issues to investigate in this category include:

  • Is the amount of money owed to suppliers reasonable in relation to purchases?
  • Is the firm's payment policy enhancing or detracting from your credit rating?
  • If available, are discounts being taken?
  • What are the timing relationships between payments on accounts payable and collection on accounts receivable?

5. Notes Payable
Notes payable to banks or other lenders are a second major source of financing for the business. Important questions in this class include:

  • What is the amount of bank borrowing employed?
  • Is this debt amount reasonable in relation to the equity financing of the firm?
  • When will principal and interest payments fall due?
  • Will funds be available to meet these payments on time?
  • Should you be negotiating a better interest rate or lines of credit?

6. Accrued Expenses and Taxes Payable
Accrued expenses and taxes payable represent obligations as of balance sheet date. Accrued expenses represent such items as salaries payable, interest payable on bank notes, insurance premiums payable and similar items. Of primary concern especially for taxes payable is the magnitude, timing, and availability of funds for payment. Careful planning is required to insure that these obligations are met on time.

 

Please note that these working capital issues need to be looked at together and in relation to each other. To understand the big picture, we need to ask:

  • Is your overall working capital trend healthy?
  • Which individual accounts are responsible for the trend?
  • How does your working capital compare to your competitors?
  • What can be done to correct the trend, if necessary?

Of course, the questions posed are much easier to ask than to answer!! If you want to discuss your working capital situation, I am happy to discuss with you. A brief conversation with me MAY be the difference between your success and failure.

 

Let's get together!

 

Judy Freeman

 

P.S. To learn more about the upcoming New Orleans BEF, Business Excellence Forum, follow this link www.thebusinessexcellenceforums.com.

 

Judy's Picture  

Judy Freeman

Business Coach

703-627-2745

judyfreeman@actioncoach.com

www.actioncoach.com/judyfreeman 

 

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