Tag Archives: Accounts Receivable

7 Financial Facts Every Entrepreneur Should Know

Business Financing, ,

You don’t have to be CPA or MBA to start or run a business. You don’t have to understand debits and credits, or be able to balance your books. But there are some financial facts you just plain need to know. Here’s a list.

  1. Every single dollar in Accounts Receivable (AR) is a dollar less in cash. AR is the standard for business-to-business transactions. You deliver the goods or service along with an invoice, and the client/customer pays you later. That money shows up as sales in the Profit & Loss (P&L), but it’s not in the bank; it’s in AR. This brings up AR aging, collection days, and a flock of related concepts that are all important because a business can die over failing to collect on AR – even profitable businesses choke on AR. Corollary: if you sell to consumers, in cash, check, or credit cards, this is not as important. And if you manage to get business customers to pay you a deposit in advance, that helps a lot too.You_iStock_000014706975XSmall
  2. Every dollar in inventory is a dollar less in cash. As with money you have in AR, money spent on inventory doesn’t show up in the P&L until you sell the stuff and it becomes cost of goods sold. So whatever is in inventory isn’t in your bank account. As with AR, companies that are profitable in the P&L can run out of cash in the bank because they got their inventory constipated. In some extreme cases, expenses get misdirected to inventory, and the system clogs up with inventory that pretends to be assets and creates a fiction that ends up with the reality of no cash in the bank. Corollary: most service businesses don’t have inventory to worry about, and those that do need inventory usually have less of a problem because they need less inventory per transaction.
  3. Every dollar in Accounts Payable (AP) is a dollar more in cash. Most businesses buy stuff on credit, meaning they get the stuff along with an invoice they have to pay in a few weeks. Almost nobody pays bills in cash immediately. Ideally, you finance inventory and AR with the money you owe to your vendors. You have to manage the pull between paying on time, paying late, and stretching AP without getting a reputation for late payments or a bad credit rating. It takes management. That satisfaction you get from paying everything immediately, and not owing anything to anybody – that’s not good financial management.
  4. Debt repayment doesn’t show up in P&L. It costs you money, but you won’t see it if you don’t track cash flow. The interest portion of payments is an expense, so that shows, but principal – debt repayment – doesn’t show up. You have to watch and plan for it.
  5. Buying assets doesn’t show up in P&L. It takes money to buy your assets (equipment, plant, land, furniture, etc.) but those don’t count as expenses, so you don’t see them in P&L.
  6. Fixed vs. variable costs matter. That’s because the trade-offs come up often and matter a lot, and this area is full of choices you can make. Do you hire the person as an employee or contract out for skills? Fixed costs are generally lower than variable costs, but they also increase the risk.
  7. Sunk costs don’t matter. It’s so not intuitive. We so often think we have to continue down some path because we’ve already spent so much money on it. It’s hard to let that go. But the money already spent is a sunk cost. You don’t get it back by spending more. So decide based on whatever decision criteria make sense, in a specific situation; money already spent is never a good reason, by itself, to spend more.

For the record, this post started as one of my answers on Quora: The original question was What are the most important financial concepts an entrepreneur should know?

3 Incredibly Common Credibility Killers in Business Plan Numbers

Business Financing, Business Mistakes, , ,

Business plans are about business decisions. When I read them — and I read hundreds of them every Spring — I’m looking for the concrete specifics, like dates and deadlines and tasks and milestones, that point towards execution. But part of that is reasonable, credible projections. And I am way too familiar, way more than I’d like to be, with these three very common mistakes. 

Credibility killer #1: unbelievable profits

Face it: startups aren’t normally profitable. Existing businesses, once they’re established, rarely make more than 10 or so percent profits on sales (that’s profits divided by sales). Some of the best businesses make 15 or 20 percent. 

Therefore, when you project 30, 40, 50 or more percent profits on sales, you’ve lost all credibility. That doesn’t make anybody think you’ve actually going to generate that kind of profitability. It does make people think you don’t know the real costs. 

Additional tip: nine times out of 10, you’ve underestimated the marketing costs. 

Credibility killer #2: ignoring sales on credit

Businesses that sell to other businesses don’t normally get paid immediately. They send invoices for products and services. They wait. Weeks or months later, they get paid. Sales accompanied by an invoice like that are called sales on credit. They count as a sale, but instead of adding to cash they add to accounts receivable, and then they get into the bank account later, when the receivables are paid off. 

If you don’t allow for sales on credit in your projections, you kill your credibility. So plan your cash to include the additional working capital it takes to support waiting to get paid.

Credibility killer #3: expenses vs. assets

We all use the word asset to refer to something good to have, like a friend, a second language, and a college degree. More to the point, we often refer to business advantages such as a product design, software code, a prototype, brand awareness and so on as assets. 

In financial terms, however, assets are specific. They are entries in a balance sheet. Assets are equal to capital plus liabilities. Cash, inventory, accounts receivable, equipment, office furniture, vehicles … those are assets. 

The most common problem with this is what happens when you pay salaries or project fees for software or web development. That’s an expense. It reduces your profits and lowers your taxes. So it’s a loss. Way too often people show those expenses as if they were buying an asset. Sorry, we hope that your programming expenses generate something good for your business; but they are expenses, not purchase of assets. 

Oh, and that land and those buildings your business owns? Those are assets, yes, but they should be on your books for what you paid for them, not what you think they’re worth. 

Summary: 

Finance and accounting have this annoying thing about them: things have to mean what the standard principles say they mean. You don’t get to redefine them back into what you think they ought to mean. 

(Image: shutterstock.com)

Use Business Lines to Read Warnings in Numbers

Back to Fundamentals, Business Financing, , , , , ,

Are you minding your business? I’ve found through the years of minding my business that most of the important insight in the numbers comes in lines, not dots. I mean that tracking the change in key indicators over time, with lines, is much more valuable than looking at them at any specific point, as a dot.

For example, if your business sells to other businesses, you probably deliver the goods or services along with an invoice that establishes what your customer or client owes you. We call that money your customer owes you Accounts Receivable. The sales you make like that, delivering an invoice instead of getting paid immediately, are called sales on credit.

For business that deal with sales on credit the Accounts Receivable balance can be critical to a healthy cash flow. Every dollar in that balance is a dollar that’s already in sales, but not in the bank. You are waiting to get paid. The higher the Accounts Receivable, the more the danger.

You can’t measure Accounts Receivable with a single number. $32,812 in Accounts Receivable might be way too much or way too little, depending on how long it’s been there, how it’s trending, how that compares to other balance items, and the original sales amounts.

I like to watch the number as a line chart so I can see how it’s trending. Your accounting or bookkeeping software might be able to do this, and if not then any of the leading spreadsheet software applications can. I recommend you generate a line chart showing sales on credit on one line and Accounts Receivable on the other. If sales go up quicker than Accounts Receivable, that’s good. That’s the case in the second line chart here. If Accounts Receivable go up quicker than sales, that’s bad. That’s the case in the second line chart here.

The sales in both line charts are identical, but the behavior of the Accounts Receivable balance is different. In one, there might be reason to worry. You start with the line chart, which is like an alert. Then you go into the details, like who owes your business how much, and how long have they owed it to you. You call, you ask, you investigate, you deal with a problem. In the second case, seeing how Accounts Receivable is behaving, you probably look at the chart and go on to deal with something else.

With most of your business numbers the trends — the line — tell you much more than the specific numbers — the dot — at any one point. If you manage inventory in your business, draw the line of inventory turnover. Every business should watch the lines of the trade payments you have to make (called Accounts Payabe), and of course sales vs. costs, sales vs. expenses, sales vs. profits, sales vs, employees, and so on.

It’s not the numbers you watch as much as the change in numbers. Draw your line charts. Every month.