Costs and Funding

As a small business owner, you need to regularly review your company’s performance through financial statements: the income statement, balance sheet, and statement of cash flows. These are shared with lenders, investors, board members, and key employees.

While the income statement and balance sheet provide valuable information, the cash flow statement is crucial for small businesses. Cash is vital for paying employees, suppliers, and taxes. Mismanaging cash can lead to liquidity problems, forcing you to borrow money at high rates.

Here are key strategies to improve cash flow:

• Use a Budget: Forecast cash inflows and outflows for at least three months. If you struggle to meet short-term needs, consider a line of credit.

• Invest Surplus Cash: Use idle cash to earn interest in safe, liquid investments like zero-balance or sweep accounts.

• Manage Accounts Receivable: Ensure timely collection of payments from customers to maintain healthy cash flow.

• Manage Accounts Payable: Pay suppliers on time, but take advantage of early payment discounts if available.

• Control Inventory: Avoid tying up cash in excess inventory. Only buy what you need.

• Explore Alternative Financing: Leasing equipment can conserve cash and provide flexibility.

• Debt Management: Pay down loans when possible to improve your reputation with lenders. Include loan repayments in your cash flow forecasts.

• Make Timely Tax Payments: Use systems like the Electronic Federal Tax Payment System (EFTPS) to handle taxes efficiently and improve cash flow planning.

By focusing on these areas, you can ensure better cash management and financial stability for your business.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}

The statement of cash flows shows where your business's cash comes from and how it is used over a specific period, matching the income statement's period. It supplements the income statement, which includes both cash and non-cash transactions like depreciation.

When you offer or receive trade credit, it creates accounts receivable and accounts payable. This makes your income and cash flow differ. The cash flow statement tracks net cash changes, while the income statement shows revenues and expenses, often using accrual accounting. For cash-dependent businesses, the cash flow statement is crucial.

The cash flow statement relates to the balance sheet. The balance sheet can be prepared at any time, but the main date aligns with the cash flow statement's period end. Changes in cash between two balance sheets match the net change in the cash flow statement.

Cash flow activities are divided into:

1. Operating activities: Cash from regular business operations, including revenues, expenses, depreciation, and changes in accounts like receivable and payable.
2. Investing activities: Cash spent on or received from fixed assets, like buying equipment or selling a business division.
3. Financing activities: Raising capital through equity or debt and paying dividends or interest.

Banks offer various cash-management services to help your business manage its cash flow effectively. Here's a brief overview of these services:

• Lines of Credit: Provides a backup for when your cash flow falls short. It can be secured (using assets as collateral) or unsecured. Interest rates are usually the prime rate plus 2-3%.

• Overdraft and Check-Guarantee: Protects you from bouncing checks when expected deposits are delayed. These services usually come with a fee.

• Lock-Box Services: Securely receive deposits and have funds credited to your account the same day. Useful for businesses that still handle check payments.

• Electronic Bill Payment and Presentation (EBPP): Allows you to pay bills and send invoices electronically, speeding up transactions and reducing float time.

• Sweep Accounts: Automatically invests excess cash overnight to earn interest, as business checking accounts typically offer low or no interest.

• Merchant Services: Enables your business to accept credit and debit card payments, increasing sales and ensuring secure transactions through the Automated Clearing House (ACH) system.

• Payroll Services: Outsource payroll processing to reduce fixed expenses.

• Tax-Payment Services: Use the Electronic Federal Tax Payment System (EFTPS) to make estimated tax payments electronically.

• SBA Loans: The Small Business Administration offers loan guarantees through certified lenders to support small businesses.

• Online Banking: Offers features like electronic funds transfer (EFT), transaction history viewing, and account monitoring.

These services, combined with the convenience of online banking, can help improve your business's cash flow management.

Banks offer many small-business services through branches, but electronic services are becoming more popular due to their speed, reliability, and security.

Traditionally, checks were used for payments, but now electronic data interchange (EDI) is more common. Employers use direct deposit for payroll, and people use electronic funds transfer (EFT) to pay bills.

How Direct Deposit and EFT Work:

• The payee provides a nine-digit routing number (ABA number) to the payer.
• For regular transactions like mortgage payments, the payer instructs their bank to transfer funds using the routing number.

Common Electronic Payment Systems:

• Automated Clearing House (ACH): Overseen by the Electronic Payments Association (NACHA), used for most electronic transactions in the U.S.
• Wire Transfers: Used for large sums, including international transfers. The main systems are:
  • Fedwire Funds Transfer System: Handles a high volume and value of transactions reliably.
  • Clearing House Interbank Payment System (CHIPS): Manages large daily transactions between member banks.

Electronic Tax Payments: Businesses increasingly use electronic services for tax payments, including excise, FUTA, payroll, and federal income taxes withheld from employees. The IRS's free Electronic Federal Tax Payment System (EFTPS) allows individuals, businesses, and federal agencies to pay their taxes online.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}

Merchant services are financial services that banks and other institutions provide to help businesses handle electronic payments. These services make it easier for customers to buy your products, potentially boosting your sales.

Key Features of Merchant Services:

• Electronic Payment Processing:

  • Credit and Debit Cards: The most common form involves processing payments from credit and debit cards. For debit cards, customers swipe their card and enter a PIN, or they can input their information online or over the phone. A data-processing company verifies the funds and authorizes the transaction, usually crediting the payee's account the next day.

• Benefits of Merchant Services:

  • Faster Cash Flow: Instead of waiting for accounts receivable, you get cash quickly from customer sales.
  • Reduced Collection Effort: Less time and effort spent chasing payments.
  • Lower Abandonment Rates: Efficient and secure payment methods reduce the likelihood of customers abandoning their purchases.

• Cost Considerations:

  • Debit Card Transactions: Typically have lower fees than credit card transactions. Cardholders might pay fees based on usage.
  • Credit Card Transactions: Fees include a percentage of the transaction (usually 2-3%) and a small transaction fee (1.5-2%). Swiped transactions tend to be cheaper than those processed online or via phone/mail.

• Other Payment Systems:

  • Electronic Cash and Stored-Value Cards: Additional methods to process payments.
  • Point-of-Sale (POS) Systems: Devices used in-store to process payments.
  • Check-Acceptance Technology: For processing check payments electronically.

These services help increase your sales and improve your cash flow by ensuring payments are processed quickly and efficiently. While there are fees involved, they are generally reasonable and can be seen as an investment in smoother financial operations.

Consult with your financial institution to explore available merchant services. The investment in these services often pays off by enhancing your business’s cash flow and reducing the administrative burden of managing payments.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}

To conserve cash, consider using credit cards to pay some of your business bills. Banks typically offer various credit cards, debit cards, and related services to help manage your cash flow.

A small-business credit card can be customized to meet your needs, with features like spending limits for employees and billing cycles that match your cash flow patterns. For instance, during slow months, you might need looser credit requirements, while busier months might allow stricter controls. You can also negotiate longer billing periods to align with your cash receipts at the end of each quarter.

Bonus cards, similar to consumer rewards cards, can improve your cash flow by earning points redeemable for cash or goods. Travel and entertainment expenses paid with a business credit card can help you accumulate these points. Using debit cards can also reduce reliance on petty cash.

When making purchases abroad, you can negotiate a forward exchange rate with your bank to know the dollar-equivalent costs. Ask your bank about the exchange rate they use to convert your expenses. Additionally, your card company may assist with VAT refunds on international purchases.

Using a small-business credit card for certain expenses helps manage cash flow and control cash expenses. Check with your financial institution for available credit card programs tailored for small businesses.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}

Managing your accounts receivable (money owed to you by customers) improves cash flow for your small business. The goal is to convert receivables to cash quickly without upsetting customers. Too aggressive collections can backfire, and not offering credit can limit sales.

To track performance, use ratio analysis:

• Receivables Turnover Ratio: Measures how often you collect receivables in a year. Higher is better. Calculate by dividing sales by average accounts receivable.
• Days Receivable: Measures the average days to collect receivables. Lower is better. Calculate by dividing 365 by the receivables turnover ratio.

Monitoring these ratios helps forecast cash flow and identify improvements.

An aging schedule shows overdue receivables, helping identify problem accounts. For example, if 15% of receivables are over 90 days past due, you might expect some write-offs and adjust cash flow forecasts accordingly.

For persistent issues, consider hiring a collection agency or using a factor, which buys receivables at a discount to manage collections for you.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}

Managing your inventory, like tracking accounts receivable, improves your business's cash flow. Inventory, a short-term asset, is used within a year. For manufacturers, inventory includes raw materials, work in progress, and finished goods. Retailers and wholesalers handle only finished goods.

Monitor your inventory with ratio analysis:

• Inventory Turnover Ratio: Measures how often you sell and replace inventory annually. Higher turnover indicates better efficiency. Calculate it by dividing cost of goods sold (COGS) by average inventory.
• Average Days Inventory: Shows the average days it takes to sell inventory. Fewer days indicate better performance. Calculate it by dividing 365 by the inventory turnover ratio.

Your inventory valuation method affects COGS and gross profit. The two primary methods are:

1. FIFO (First-In, First-Out): Assumes the earliest purchased inventory is sold first. In times of inflation, FIFO results in lower COGS, higher gross profit, and higher taxes.
2. LIFO (Last-In, First-Out): Assumes the most recently purchased inventory is sold first. During inflation, LIFO results in higher COGS, lower gross profit, and lower taxes.

Consult an accountant to choose the best method for your business.

Sometimes, you must write off unsellable inventory. By monitoring inventory turnover and average days inventory, you can manage inventory effectively and avoid these losses.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}

Trade financing means borrowing from suppliers to pay your bills. Just as you might give your customers extra time to pay to boost sales, your suppliers might extend the same courtesy to you.

Trade credit terms are often expressed like "2/10 net 30" or "3/10 net 60." This means you get a discount if you pay early. For example, "2/10 net 30" gives you a 2% discount if you pay within 10 days; otherwise, the full amount is due in 30 days. "3/10 net 60" gives a 3% discount for payment within 10 days, with the full amount due in 60 days.

Businesses use trade credit to buy inventory without immediate cash outlay, incurring a liability called accounts payable. Some businesses delay payments as long as possible, a practice known as "stretching accounts payable."

However, consistently paying late can harm relationships with vendors. Weigh the benefits of delaying payments against the risk of damaging these relationships.

To assess your payment practices, you can use two key financial ratios:

1. Payables Turnover Ratio: This shows how often you pay your accounts payable in a year. A higher ratio means quicker payments. Calculate it by dividing purchases by average accounts payable.
2. Days Payable Outstanding: This measures the average time it takes to pay your bills. Calculate it by dividing 365 by the payables turnover ratio.

Vendors often offer discounts for early payment, which can be beneficial for both parties. Use the formula below to decide if you should take the discount:

Annual Interest Rate = (% discount) / (100% - % discount) * (360 / days early) Example: (.02 / .98) * (360 / 20) = 36.73%

Taking the discount is usually a good financial decision if the discount rate is higher than your borrowing cost. For more personalized advice, consult your accountant.

^{The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.}