Newsletter Oct 2011

“The best reason to start an organization is to make meaning - to create a product or service to make the world a better place.”

Guy Kawasaki, entrepreneur, investor, author

Congratulations to the following SEB participants who have successfully completed the business-planning phase of the program!

Need help with your bookkeeping woes? Are you using Simply Accounting, QuickBooks or are you doing your Bookkeeping manually and require help setting up your company’s books. If you answered yes to these questions, then please call us to set up a one-on-one 1-2 hour appointment with Karen Ristanen. Karen will be more than happy to help you with the set-up of your books. Please bring all of your questions with you. Bring your personal documentation.

Self Employment Tips - Stupid Mistakes Entrepreneurs Make

There's one important tip I like to give everyone as they dive deeper into their financials: remember that cash is king. Most people think about their business in terms of profits first instead of cash. But we don’t spend "profits" when we buy supplies or pay our employees. We spend cash. Profitable companies go broke because of cash flow problems, so pay special attention to this component of your plan.

Although cash is critical, people think in terms of profits instead of cash. We all do. When you and your friends imagine a new business, you think of what it would cost to make the product, what you could sell it for, and what the profits per unit might be. We are trained to think of business as sales minus costs and expenses, which is profits.

Unfortunately, we don’t spend the profits in a business. We spend cash. Profitable companies go broke because they had all their money tied up in assets and couldn’t pay their expenses. Working capital is critical to business health. Unfortunately, we don’t see the cash implications as clearly as we should, which is one of the best reasons for proper business planning. We have to manage cash, as well as profits.

How far would we get if we couldn’t pay the rent or the telephone bill while waiting for customers to pay us? Furthermore, what supplier would give us credit when we have no history and no assets? What bank would lend us money in this situation? Banks do lend against inventory and receivables, but only to a certain percentage of total value. What was missing here, all along, was working capital.

Important: In strict accounting terms, working capital is equal to short-term assets minus short-term liabilities. In real terms, however, working capital is the glue that holds your cash flow together. Get it into the bank before you need it, or you won’t survive the unexpected

Important: Every dollar in accounts receivable means a dollar less in cash. Every dollar of inventory is a dollar less in cash. Every dollar of accounts payable is a dollar more in cash.

Now let’s look at the implications in a real case. The real case is a computer store in a medium-sized local market, with sales of about $6 million per year.

The sample company is profitable and growing. It sells about $6 million annually, produces about 8 percent net profit on sales, and is self supporting.

As the cash case starts

The chequebook balance at the end of each month should never drop below zero, because if your chequebook balance is less than zero, then you are bouncing cheques. The mathematics don’t care, but the banks do. Cash flow, on the other hand, can drop below zero without major problems, as long as the balance stays above zero. For example, if a company’s balance was $10,000 at the end of January, and its February cash flow is a negative $5,000, then the balance at the end of February is $5,000 and the cash flow is -$5,000. The chequebook balance stays positive, but the cash flow is negative.

If that same company now waits an extra 15 days, on average, to receive money from customers on invoices presented. The average wait, which is called “collection days” goes from 45 days to 60 days.

Nothing else changes — no new employees, no change in costs, no additional expenses.

Changing collection days only

A single change, from 45 to 60 days, makes a huge difference in the cash flow. No other changes except waiting on average an extra 15 days before receiving money owed, “Accounts Receivable”, from their customers.

Notice here the critical importance of cash, and the critical difference between cash and profits. With this single change in assumptions, the company is still as profitable as it was, down to the last dollar. Now, however, its projected bank balance in January is more than $50,000 below zero. Therefore, the company needs more than $50,000 in additional financing.

This is new money needed, new investment or new borrowing. The problem can’t be solved by reducing expenses or increasing sales.

Companies go out of business for problems like these. Even otherwise-healthy companies can go under for lack of cash. This kind of projection can kill a company if it sneaks up by surprise, but can be easily managed when there is a plan for it. This is an eloquent argument for good business planning.

In the third case, we set the collection days back to the original assumption of 45 days, but change the assumption for inventory. Where previously it kept an average of two month’s worth of inventory on hand, in this changed assumption it now keeps three months of inventory on hand. Accountants call this Inventory Turnover. The changed assumption creates an inventory turnover rate of 4, instead of the previous rate of 5. The collection days are back to 45 in this next scene, but inventory turnover went from 5 to 4, which means keeping more inventory on hand.???

Lock, Stock and Barrel

An entrepreneur attended an auction at which he won the bid on an old safe. With dreams of a large fortune inside, he was told that the business from which the safe originated was so long defunct, that no one had the combination. Undaunted, he called a locksmith to try to get the safe open. The first locksmith told the entrepreneur that it would cost forty dollars to open the safe intact. However, tried as he might, he couldn't open it, and told the wealthy man that he had lost his money in buying the safe.

The entrepreneur then contacted another locksmith, a crusty, bent old man with three days' growth of white whiskers, who took a long look at the safe, noted its manufacturer and retired to his truck. Shortly, he returned with a power drill, a ruler, and a small, bent piece of metal. The locksmith measured a few inches from the dial and marked an "x" at the "2 o'clock" mark. It took more than half an hour for the old man to drill through the safe's door. He then took the bent metal, hooked it through the hole and fished around a few moments until a loud "CLICK" was heard. Turning the handle the door swung open slowly. The safe was empty. Disappointed, the entrepreneur turned to the locksmith and asked the charge for opening the safe.

"A hundred and twenty dollars," replied the locksmith.

"A hundred and twenty dollars?!" shouted the businessman, "That's outrageous! The other man only wanted forty! I want an itemized bill for it!"

"Okay." The locksmith turned on his heel and returned to his truck. A few minutes later, the entrepreneur was presented with a dirty piece of paper upon which the locksmith had written:

Charge for drilling hole: $20

Charge for knowing WHERE to drill hole: $100.

This project is funded by Employment Ontario. “The opinions and interpretations in this publication are those of the author and do not necessarily reflect those of the Government of Canada.”

The JumpStart resource centre exists to provide meaningful, practical and personal support for entrepreneurs on the Self???Employment Benefits program in Thunder Bay, Ontario.

Located at: 102-325 S. Archibald Street, Thunder Bay ON P7E 1G3 -- PH: 807-622-3813 -- FAX: 807-622-3732