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Principles of Effective Small Business Financial Management

Small business owners are entrepreneurial spirits with a particular talent or trade. While passionate about their craft, the financial aspects of running a business often present new challenges they are unprepared for. Even experienced business owners encounter new aspects of financial management as their businesses grow and expand. In this presentation, we will cover the principles of effective financial management every small business should know.

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Principles of Effective Small Business Financial Management

  1. 1. Principles of Effective Small Business Financial Management
  2. 2. • Financial statements ACT: Accurate, Complete, Timely • Strong personal credit • Understanding the cash conversion cycle • Sufficient working capital • Manageable debt-to-equity • The financial formula for successful vendor management • Employee relations, the two-sided coin: hidden value or hidden costs? THE PRINCIPLES .
  3. 3. Lessons in Business .
  4. 4. • Breakdown expenses and income • Understand cash flows. • As business grows, so does reporting: • Tax returns > internal reports > audited statements • If growth is part of your plan, can’t “worry about it later” – you won’t be taken seriously when it matters. Financial Statements ACT: Accurate, Complete, Timely Watching your checking account balance is not enough!
  5. 5. Financial Statements ACT: Accurate, Complete, Timely Watching your checking account go up and down is not enough!Example YTD sales and projections Expenses with breakdown Payables Receivables Proper inventory accounting Interest payments Depreciation ACT = Balance Sheet AND Income Statement
  6. 6. • Make every effort to protect personal credit. • If you’ve made mistakes, straighten them out and have explanations ready. • Take bills seriously – don’t pay late. • Judgments/lawsuits • Tax liens Strong Personal Credit Your personal credit will be seen as a proxy for how you will handle business credit
  7. 7. Examples Small business owner ready to scale – but late mortgage payments showed on credit report. Small business with two owners denied credit because one had bad personal credit. X X
  8. 8. The Cash Conversion Cycle The amount of time from when you spend your first dollar to when you get it back • Growth kills more businesses than lack of business. • CCC is especially important if you incur costs before payment. • All businesses need to understand: • How long does it take to get paid? • What work will be paid in the near future? What is paid upon completion? • Is there enough regular revenue to cover fixed and variable expenses?
  9. 9. The Cash Conversion Cycle Formula for growth Sales growth x cost of goods # of cash conversion cycles each year • The number of cycles makes a huge difference! • Remember: Growth produces profit in the FUTURE • While you’re growing, it is costing money! • New employees • Office space • Technology • Raw materials
  10. 10. The Cash Conversion Cycle Formula for funding growth Projected growth ($) x cost of goods (%) # of cash conversion cycles each year
  11. 11. Example Company grew from $1.8 t0 4.2 million in sales one year Income statement that year → $500,000 loss. High cost of goods, long time to get paid, few CCCs With advance calculation, could have asked for additional $500,000 from bank up front – not ideal to ask for additional loan when showing losses.
  12. 12. • Why is working capital important? • Temporary working capital – monthly gap between income and expenses. • Permanent working capital – longer-term funding not for real estate, land, or assets. • Hiring, inventory, marketing, etc. • Often small businesses need permanent, but try to solve with temporary • Permanent is more difficult to finance – explore Small Business Administration loans. Sufficient Working Capital Working capital is the money needed for day-to-day business operations.
  13. 13. • Plan for investments required to grow: • Employees, inventory, receivables, • Understand how quickly customers pay, how quickly you pay vendors • Without proper preparation, growing your company could put it out of business. Sufficient Working Capital It costs money to grow your business – make sure to plan for it!
  14. 14. Example $2M in growth with 10% margin = $200k profit? • 70% cost of goods = $1.4M in materials • 5 cash conversion cycles • $300k to fund first cycle • More focus on growth = ordering more from vendors, less focus on collecting receivables • Cash imbalances developed Projected growth x cost of goods # of cash conversion cycles
  15. 15. • For growing small businesses – this ratio can be difficult to achieve. • Even 20% or 25% down payments put you outside of standards • Review balance sheets (another reason for ACT financial statements!) and keep 3:1 as goal Manageable Debt-to-Equity Conventional lending standards: 3:1 ratio
  16. 16. • When your business becomes profitable (or if it already is) – retain some of the earnings. • Resist the urge to spend all profits – even if reinvesting in the company. • Higher leverage = higher priced debt • Higher leverage means you could be denied a loan – even with a good credit history. Key Takeaways
  17. 17. Example Company X is doing well and growing rapidly. They’ve never missed a debt payment – or even paid late. They are a good banking customer, but can’t get a loan. Why? • Franchise restaurant chain with high growth • Open 2-3 new restaurants annually – fund build out with loans. • Profitable, but highly leveraged. • Banks hesitant to lend money. • Small Business Administration loan funded start- up costs without assets.
  18. 18. • Good communication is key • Sync up when you are paid with when you pay vendors. • Can the vendor work with your timelines? • Will they charge interest? • Is this a relationship that can grow with your business? Vendor Management Understand your cash conversion cycle and the appropriate place in the cycle for vendors Vendor Examples Raw materials suppliers Wholesaler Distributor Professional services Marketing/Promotions Subcontractors
  19. 19. Example As a business grows, cash imbalances can develop with increased focus on paying vendors and reduced focus on collecting receivables.
  20. 20. • Resist temptation to: • Hire people who always agree with you • Hire people who will do the job for less • Hire nice people who are underskilled • Hire people who are just like you. Employee Relations Good employees add a lot of value Bad employees cost a lot of money
  21. 21. Good Re-Evaluate • Skilled for the job • Diverse personality traits among employees • Can operate efficiently without you there • Complement business owner strengths/weaknesses • Aren’t sufficiently skilled in their area • Good at “carrying out orders” but can’t work without explicit direction • Always agrees with you • They are just like you ☺ Employee Relations (Management Employees)
  22. 22. Example A Kansas business was doing very well. The owner turned over management of the business to employees while he focused on expanding to Oklahoma. • KS operation began to suffer • Significant costs sunk into new operations • After two years, entire business on verge of collapse • Had to abandon expansion • Rehire and rebuild KS operations
  23. 23. TAKEAWAYS . • Actively manage cash cycles • Understand how growth impacts cash • Plan for growth • Accurate, complete, timely financial statements • Act responsibly and with integrity – both personally and professionally • Surround yourself with the right support
  24. 24. Mike Slater