Cash Management

Essentials of Corporate Finance Chapters 16 & 17

Materials Created by Glenn Snyder San Francisco State University

Topics

What is a Small Business?

Challenges of Small Businesses

Cash Cycle Cash Budget Financing / Matching Principle Banking Relationships Loan Covenants Personal Guarantees

Cash is King

Financing

Career Advice for Owning a Small Business

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February 26, 2007

What is a Small Business?

Small Businesses are typically defined as businesses with under $25 million in annual revenue Characteristics:

Privately owned Corporation, Partnership, or Sole Proprietorship Typically under 100 employees Management typically has significant personal investment in the business

February 26, 2007

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Challenges of Small Businesses

Build a better mousetrap and the world will beat a path to your door. Ralph Waldo Emerson No matter how good of a mousetrap you build, your business will fail if it doesnt have:

A strong business plan Financial discipline Cash management

February 26, 2007

Materials Created by Glenn Snyder San Francisco State University

Challenges of Small Businesses

Strong Business Plan

Understand the market

Customers Competitors Personalities of the market players

Set challenging, but achievable goals

Sales Growth Profitability Market share

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February 26, 2007

Challenges of Small Businesses

Financial Discipline

Risks and Decision Making

Every business has inherent risk, but the riskiness of a business depends on management Focus on core business

A restaurant should not have investments in a hardware store Be happy with the worst case scenario, but strive for the best case scenario

Conservative approach to finances

February 26, 2007

Materials Created by Glenn Snyder San Francisco State University

Challenges of Small Businesses

Cash Management

Most dot coms (.com) went out of business in the early 2000s, not due to lack of ideas, but due to lack of cash. Managing cash flow and financing needs may be the most critical and most overlooked aspect of managing a small business.

February 26, 2007

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Cash is King

The phrase Cash is King is more relevant to a small business owner, than perhaps to anyone else.

Without Cash you cant

Pay your employees Pay your rent Pay your utility bills Pay your suppliers Pay yourself
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February 26, 2007

Cash Cycle

The first step to understanding your cash management is to understand your cash cycle

Inventory Period + Accounts Receivable Period Accounts Payable Period = Cash Cycle
February 26, 2007

Materials Created by Glenn Snyder San Francisco State University

Cash Cycle

Example:
Payable Due Day 30 Product Sold Day 45 Receives Cash Day 75

Receives Supplies / Begins Production Day 1

Cash Cycle = 45 Days Cash is spent on day 30 and collected on day 75

February 26, 2007

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Cash Budget

A small business owner can use a cash budget to:

Determine minimum balances Understand short-term financing needs Understand sources of cash

Understand significant sources of cash by products and customers Find cash savings and identify cash management efficiencies
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Understand uses of cash

February 26, 2007

Financing / Matching Principle

Between paying the supplier and collecting from the customer, the company has a financing need.

Matching Principle

Short term assets (e.g. inventory, accounts receivable) should be financed by short term liabilities (e.g. line of credit) Long term assets (e.g. equipment) should be financed with long term liabilities (e.g. term loan)
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February 26, 2007

Financing / Matching Principle

Business is an ongoing process, at virtually every moment a business is at every point of the cash cycle.

During periods of growth

Cash financing can become permanent Permanent working capital should be financed with long-term debt

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Banking Relationships

A strong relationship with a bank can help a small business owner

Cash management Working capital line of credit Equipment / vehicle financing Credit card acceptance International services

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Loan Covenants

Banks use loan covenants to ensure the company maintains liquidity and financial strength.

Loan Covenants are typically in the form of financial ratios

Minimum Current Ratio Maximum Debt to Net Worth Maximum Accounts Receivable Period

If the company violates a loan covenant, technically, the bank can call the loan
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February 26, 2007

Personal Guarantees

Bank financing of small businesses typically requires a personal guarantee from the owner.

The owner would be personally liable to pay back the loan if the company defaults
This provides a guarantee to the bank that the owner wont use the funds for personal use, then declare the business bankrupt
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February 26, 2007

Career Advice for Owning a Small Business

Work in the industry to learn the ropes Make industry contacts and learn from others mistakes Understand your market niche or competitive advantage Develop strong business and financial plans Finance the company with private funds before applying for bank financing
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February 26, 2007