When cash is short, consider invoice funding

Is this scenario familiar? Your customers are late in paying their invoices, making you short on cash, and the bank isn’t making any short-term loans. At the same time, your employees expect to be paid on time. What do you do?

You might consider a short-term option called accounts-receivable funding, suggests Chad Todd, regional vice president of AR Funding, Inc. (www.arfunding.com). “Accounts receivable funding is the oldest form of financing in the country,” he explains. “It accelerates cash flow.”

Accounts receivable (AR) funding (also called accounts receivable factoring) provides a line of credit against invoices, and that is what differentiates this source of finance from bank financing. “Traditional bank financing focuses on the business owner’s personal credit, the assets of the company, the kind of business the company is in, and the balance sheet in order to determine if it will lend money,” explains Todd. “Accounts receivable funding does not. Instead, it looks at your customers’ credit. The most important thing in this industry is who you are doing business with.”

What it boils down to is this: If you have good customers, you can get advances on the money they owe you.

How it works

Essentially, in AR funding, a business sells its invoices to the funding company. When a small business works with an AR financing company, it gets a portion of an invoice immediately upon origination. The business, at the same time, advises its customers to send payment to a post-office box. Although the invoice is made out to the business, it actually goes to the finance company. Once the invoice is paid, the business gets the remainder of the invoice amount from the finance company, less the finance fee.

“The value to our customers is that it they perform a service or sell goods today and invoice today, they can receive funding from us today. They don’t have to wait 30 to 45 days for the customer to pay them. In any business, you need money for payroll, rent, insurance, fuel, and other things. You need money; we eliminate the wait to get paid,” says Todd.

Pros and cons

As good as accounts receivable financing seems, there is one disadvantage: Cost. “Compared to traditional bank financing, this type of financing is more expensive,” admits Todd. “I always tell anyone interested in using accounts receivable financing to go to a bank first. If the bank can’t get you approved or will not provide you a line of credit, only then should we talk, because it is more expensive than a bank loan.”

On the plus side, however, is that this type of financing is available for startups. “We fund startups,” says Todd. “The most important thing to us is who you are doing business with. A startup will not have financial statements. But if it can give us a list of customers and how much are it will be invoicing them each month, it can get financing. We’ve gotten deals done with very little. We’ve done deals based on the articles of incorporation and an expected volume of dollars each month.”

Todd says that although AR funding is a very old type of financing, many small businesses have never heard of it. “We are admittedly a stepping stone for small businesses. And, we know we will only have our clients for perhaps up to 24 months, and then they will graduate to bank financing. We’re happy about that.”

By Joe Palermo    

Does the thought of preparing your business tax return leave you with an uneasy feeling? Then do not wait to the last minute to get all your documents organized. Block out time and begin the process of gathering and organizing all of your financial documentation of all business-related expenses.

Some expenses are deductible and are applied in their entirety to lower your tax bill. Other expenses are capitalized, which means a portion of them are recovered over time. And some—personal expenses—do not affect your tax bill. Unfortunately, the IRS does not allow deductions for personal expenses, such as personal living costs or personal use of your automobile. (However, if a cost is both personal and business and can be broken down with documentation, the business portion can be applied.)

Your accountant will need documentation on the following types of expenses:

• Ordinary and necessary business expenses. This is a broad category of costs incurred to run your business. They include a number of different types of expenses, including employee pay; retirement plans; rent expenses for your business property; interest charged on money you borrowed for business activities; various state, local and foreign taxes directly attributable to your business; insurance for your business; and office expenses as part of operating costs.

• Cost of goods sold. If you manufacture products or purchase goods for resale, you must generally value the inventory at the beginning and end of each tax year to determine the cost of goods sold, which is used to figure gross profits for the year by subtracting the cost of goods sold from your business’ gross receipts.

As you prepare for tax preparation, collect information on the cost of products or raw materials (including freight), storage, direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products, and factory overhead expenses.

• Capital expenses. Capital expenses fall into three general categories business start-up costs; business assets; and improvements. Expenses incurred in these areas are not deducted; however, they are capitalized to help reduce your tax bill. In other words, you may b able to recover a portion of the amount you spent on a capital expense through depreciation, amortization, or depletion.

Joe Palermo, CPA, is a partner in B2B CFO and can be reached at 925-548-3395 or jpalermo@b2bcfo.com.

 SIDEBAR 1

What kind of documentation do you need?

• Bank deposit slips

• Invoices

• Credit card charge slips

• Form 1099

• Canceled checks

• Account statements

SIDEBAR 2

Prepare for 2010 taxes now

To make tax preparation easier in 2010, take these steps now:

1. Set up and maintain a file for each vendor and file paid invoices.

2. Establish a file for each customer.

3. Complete bank reconciliation for each month; never get behind.

4. Prepare financial statements each month.

5. Review the financial statement each month with your accountant or business advisor

Do you believe paying taxes is voluntary? Or that you don’t have to comply with an administrative summons about your taxes? Think again. These beliefs—and many others—are erroneous, says the Internal Revenue Service, which has released the 2010 version of its discussion and rebuttal of many of the more common frivolous arguments made by individuals and groups that oppose compliance with federal tax laws.

Anyone who contemplates arguing on legal grounds against paying their fair share of taxes should first read the 80-page document, The Truth about Frivolous Tax Arguments.

The document explains many of the common frivolous arguments made in recent years and it describes the legal responses that refute these claims. It will help taxpayers avoid wasting their time and money with frivolous arguments and incurring penalties.

Congress in 2006 increased the amount of the penalty for frivolous tax returns from $500 to $5,000. The increased penalty amount applies when a person submits a tax return or other specified submission, and any portion of the submission is based on a position the IRS identifies as frivolous.

IRS highlighted in the document about 40 new cases adjudicated in 2009. Highlights include cases involving injunctions against preparers and promoters of Form 1099-Original Issue Discount schemes and injunctions against preparers and promoters of false fuel tax credit schemes.

A number of tax laws enacted in 2009 may affect how much you pay in taxes this year. Business.gov, a portal for information on federal regulations affecting small businesses, summarized a few you should be aware of as you prepare for the 2010 filing season:

• Expensing business property and equipment. According to the IRS, many small businesses that invest in new property and equipment will be able to write off most of these purchases on their 2009 returns. This is because the American Recovery and Reinvestment Act (ARRA) extended the bonus depreciation and increased the Section 179 deduction.

Normally, businesses recover these capital investments through annual depreciation deductions spread over several years. But this year a quick write off of up to $250,000 on the cost of machinery, equipment, vehicles, furniture, and other qualifying property place in service in 2009 is now possible. The IRS has more information on this here.

For more information on when and how to take the deduction, go to www.section179.org, which is a free resource for small businesses.

• Cancellation of business debt. The ARRA also enables certain businesses to elect to delay recognition of income from the cancellation of business debt in 2009 or 2010. Income recognition can be deferred until the fifth year after the reacquisition, and then the income is included ratably over the following five years.

• Business credit for COBRA premium assistance to employees. If your business provided COBRA assistance—extension of health benefits—to employees who were terminated in 2009, ARRA gives you a 65% credit against the COBRA amounts paid. The credit is taken against employment taxes on Form 941, Form 944, or Form 943. The credit is treated as a deposit made on the first day of the return period (quarter or year).

• Business energy credits. Credits for making purchases of qualifying fuel cells property, micro turbine property, and solar energy property have been extended through 2016. The business energy credit can be up to $4,000.

These are just a few of the major changes that pertain to small businesses, so be sure to talk to your tax advisor if you have questions about how your small business is impacted.

—Business.gov 

By Cathy Bracken    

A commonsense business rule is “make it easy for customers to pay.” Credit cards do that. So do other non-cash forms of payment, such as debit and purchasing cards. All of these things increase customer satisfaction and contribute to increased business volume.

These electronic non-cash transactions are processed through a merchant account, facilitated through  point-of-sale (POS) solutions,  only offered by merchant services providers.

The goal of a merchant account is to facilitate fast, reliable cash flow. Almost all types of businesses—even nonprofits— can qualify to have a merchant account, provided you have a business checking account and satisfy the processor’s underwriting credit guidelines. The size of your business really doesn’t matter.

To decide what kind of merchant account or POS solution is right for you consider asking the merchant services provider these questions:

• How do you want to process transactions? It is important to select the right POS solution(s) for your business. For example, a brick-and-mortar business may best benefit from a traditional retail POS merchant account—using a swipe terminal. But if that business also conducts transactions on the Internet, through mail order or telephone sales, or on-the-go, it would need additional types of POS  solutions.

Hint: Work with a merchants services professional who will customize a POS solution to meet your unique needs. There is no “one size fits all” solution in merchant accounts.

• Do you want to lease,  or buy your POS solution? Talk with your merchant services provider about the advantages and disadvantages of owning vs. leasing POS solutions.

• What do you get for the money? POS solutions come with fees. Ask questions to get the full picture about the services and their costs. Is there a set-up fee? Monthly service fees? You have a right to understand fully your merchant account services, how the transaction process will work for you, when you will be funded, and who you are paying each month.

• What are your risks and responsibilities? Ask about your responsibilities in having a merchant account, and find out if there are some types of transactions that carry a higher  risk  of chargebacks and what you must do if you process these types of transactions.

• What other services can be added to the merchant account? Most merchant service providers offer other value-added services, such as electronic check processing, as well as gift-card, specialty-card, and loyalty-card acceptance. 

• How much will a merchant account cost? The merchant account pricing options available today allow for you to be custom-fitted for services based on who your customers are and what types of cards you accept. There are three basic pricing programs— flat-rate pricing, break-out rate pricing, and interchange pass-through pricing. All three offer cost benefits, depending upon your business:

Flat-rate pricing is the most traditional type of pricing program. This pricing program is best for low processing merchants that accept only consumer credit cards. The program is the easiest to understand and reconcile on your monthly statement. It is still very popular, and the most widely marketed to date. If you are considering this type of pricing program, ask for rate detail and fine print in this pricing program to make sure it is the best fit for you.

Break-out rate pricing prices each transaction by the basic card-type categories— non PIN debit check cards, credit cards, reward cards, and commercial cards. These categories are cross-bucket into transaction types as well. Those transaction types are called qualified, mid or partially qualified, and non-qualified transactions. Depending on the processor, you may have from three to 12 different rates for Visa, MasterCard and Discover Cards in all the available categories the processor offers. Each card brand can have a different applicable rate for the card and transaction type categories.  Although it sounds complicated, this type of pricing is excellent for most merchants.

Interchange pass-through pricing prices each transaction at its base cost then adds a processing mark-up.  With more than 160 categories a single transaction can bucket into, this pricing program assures the greatest flexibility in processing venues as well as the most accurate lowest per transaction cost versus the standard averaged costing methods traditionally used.  Interchange pricing is the pricing method of choice traditionally reserved for high transaction volume merchants who accept many types of bankcards originating from several card issuing banks.

Work with your merchant services provider to create a win-win in providing the best processing services and POS solutions at a cost that makes sense for your business.

• What kind of commitment is required? Signing up for a merchant account is easy. There will be an application containing a contractual agreement, with some fine print that usually has a length of term provision and early cancellation penalties. Review the fine print carefully before signing the agreement. It’s also a good idea to inquire about the circumstances, if any, under which you may request to have fees waived.

Before your application is accepted, you will be required to provide basic business documents such as a company check, a business license, Web site(s), and marketing materials to support information provided on the merchant account application.

Merchant services are a great value to businesses. With so much uncertainty affecting businesses today, you can better prepare for future growth and prosperity by strengthening all processes within your control that are certain to yield improved cash flow. 

Cathy Bracken is the CEO of Cyberauthorize.Com (www.cyberauthorize.com), a 10-year-old local merchant services provider that services merchants nationally. She can be reached at 904-564 1228, Ext 204.

By Hal Rogers    

In bad economic times, good retirement planning is more important than ever. For personal accounts, one of the best opportunities still available comes from Individual Retirement Accounts, more commonly known as IRAs. 

Provisions for IRAs are found in the U.S. Tax Code Section 408(a).  Traditional IRAs were introduced into law in 1974 with the Employee Retirement Income Security Act (ERISA).  Originally limited to people who were not participants in employer-sponsored plans, they became available to all taxpayers in 1981 with the passage of the Economic Recovery Tax Act.  The Taxpayer Relief Act brought us Roth IRAs in 1997. 

Between traditional IRAs and Roth IRAs, the traditional IRA, referred to simply as an IRA, is the more popular. However the Roth IRA is generally considered to be the more advantageous of the two. Subject to income limitations, the traditional IRA allows an account owner to take an income tax deduction for the amount of the contribution in the year of the contribution, and then earnings accumulate tax deferred.  All distributions from the account are fully taxable at the account owner’s ordinary income tax bracket. 

The Roth IRA doesn’t have income limitations on tax deductibility; Roth IRA contributions are not tax deductible.  However, in addition to tax deferral during the life of the account, for account owners who are at least 59½ and have held the account for at least five years, Roth IRAs provide completely tax-free income.

So, which is best, an income tax deduction on the contribution, or tax-free income from the entire account?  This is not difficult to determine if you ask the question a different way: “Would you rather pay taxes on the seed or on the harvest?”  The Roth IRA makes you pay taxes on the seed, but the harvest is income tax-free.

Beginning in January 2010, anyone who earns income can contribute to a Roth IRA.  Contribution limits are the lesser of: 

• Your earned income for the year, or

• $5,000 if you are under age 50, or

• $6,000 if you are age 50 or older.

What’s more important for most individuals, however, is the opportunity to convert a traditional IRA to a Roth IRA.  The advantage of the Roth IRA is that at distribution time it allows tax-free distributions for the life of the account owner, the owner’s beneficiary spouse, and even beneficiary children, grandchildren, and other heirs. 

So where’s the rub?  Funds transferred to a Roth IRA are taxable in the year of the transfer—except for funds transferred in 2010. IRS has taxes “on sale” in 2010 for taxpayers who convert to a Roth IRA.  For this year only, there are no taxes on Roth Conversions.  Instead, half the taxes on the distribution are due for the 2011 tax year (paid in 2012) and half are due for the 2012 tax year (paid in 2013). 

So, what happens if you execute a Roth conversion, and the market subsequently plummets? You have now paid taxes on account values that no longer exist.  Not to worry.  Imagine that you are in a game of Texas Hold ’em.  You have been dealt a hand that looks pretty good, and you place your bet.  But, after seeing two more cards, you discover that your hand hasn’t worked out to your liking at all.  How would you like to be able to not only fold your hand, but get your bet back?

This is exactly what the IRS allows you to do.  It is called a Roth re-characterization.  If you act within a prescribed period of time from the time you executed the conversion, you simply return the money from the Roth conversion back to a traditional IRA and file an amended tax return. The IRS will give you your taxes back.  By the way, after a prescribed period of time, the IRS then allows you to start over and do the Roth conversion again, this time at the lower account values, thus permanently reducing your taxes on the transaction.  My kind of poker!

Timing is important in these transactions; check with a financial or tax advisor who is “in the know” for details to make sure you don’t run afoul of the rules. 

Harold J. Rogers, CFP, CSA, president of Retirement Services, is a registered representative with ProEquities, Inc.  Securities offered through ProEquities, Inc., a Registered Broker/Dealer, Member FINRA & SIPC.  Information is for informational purposes and should not be construed to be specific tax, legal, or investment advice. 

Money, money, everywhere, but not a coin to bank—at least that is what it seems to small business owners during hard economic times. “You do have money. However, your money is in accounts receivable,” Brian Barquilla, president of Barquilla Consulting and publisher of Jacksonville Advantage, told a group of small business owners in the October Knowledge Is Power workshop. Barquilla moderated a panel discussion that also included David Marovich of Florida Telco Credit Union, Chad Todd of AR Funding, and Cathy Bracken of Cyberauthorize.

Increasingly, customers are treating small businesses—in fact, all businesses—as if they were a bank. When customers delay paying, they are using your money—for free. But your business is not a bank, said Barquilla, and you need to get your accounts receivables converted to cash. It’s a challenge, he admitted: The entire payables cycle has been pushed from 30 days to 45 or 60 days or more.

Barquilla pointed out four main areas that small businesses can control to improve their financial outlook: expenses, productivity, purchasing, and collections.

“The name of the game is converting sales into cash—as fast and as easily as you can,” said Barquilla. He also reminded the group that the conversion process has a cost associated with it. “If you are paying your bookkeeper to call customers, you pay for that time. Even if you make the calls yourself, it is costing you. Time is money. Don’t let debt get a day past 30 days.”

Relationships for improving cash flow

In addition to these four areas, Barquilla emphasized the need to demand more from your business-support team—your banker, attorney, CPA, and other key support suppliers. “Your relationship should be such that you have them on your speed dial,” said Barquilla. “You want to be able to call them and ask them quick questions without being worried about being billed for every second. You want a relationship with your support staff so they can grow with you as you grow.”

“The bank should work for you; make your relationship active,” said Marovich of Florida Telco. “You should develop the relationship to the point that you can call your banker directly,” he said. “What you want is to have a bank that will be with you in good times as well as bad and help you through the bad times by deferring payments and modifying loans if necessary.”

Developing that relationship starts at the onset, when you hire the banker. “Interview your banker as if you were hiring an employee,” said Marovich. “Consider how you relate to the individual. Remember that you are the driver; the banker should not talk down to you.” And, once you hire the banker, set expectations about how the two of you should communicate—in person, by phone, or by e-mail.

A merchant services provider falls into the category of “other key supplier relationships.” “A merchant service provider can improve cash flow regardless of the size of your business,” said Bracken of Cyberauthorize. It can set up your business to accept different forms of payment in addition to cash. The easier you make it for customers to pay you, she said, the faster you can get paid.”

For instance, many companies are controlling costs by providing employees with purchasing cards, but you have to be set up to accept purchasing cards in your business to take advantage of this way to get paid instantly (no purchase order or invoice). Also, she said, businesses should be set up to process charge cards in the most cost effective manner.

Another key supplier relationship you may want to consider establishing to improve your cash flow is with an accounts receivable (AR) funding provider. This type of lender finances your invoices, explained Todd of AR Funding. “AR funding is one of the oldest forms of financing,” he said, advising small businesses to visit their banks first. When a business uses a receivables company, he said, it takes invoices to the company, who then gives them the amount of the invoice less a fee. The benefit is that the business gets its money right away.

AR funding companies are not collection agencies, he stressed. “We lend money to businesses to improve cash flow. We help fund your business.”

Brian Barquilla is publisher is Jacksonville Advantage and facilitates Executive Advantage (www.theexecadvantage.com), a group of professional- and business-development group for Jacksonville-area CEOs. Chad Todd is with AR Funding (www.arfunding.com), and Cathy Bracken is owner of Cyberauthorize (www.cyberauthorize.com).

SIDEBAR

More tips on improving your cash flow

• Talk to your banker early—before you run out of cash. Watch your financials carefully. If you anticipate problems, go to the bank early.

• Hire a part-time CFO consultant. Even though your business may not be big enough to have a full-time chief financial officer, consider hiring a part-time CFO or ask your CPA to consult with you in this manner.

• Renegotiate the terms of your lease. But do it early. Because of increasing vacancies, landlords may be willing to drop the cost of rent (or even give free rent for a period of time) in return for an extended lease. However, tenants should not wait until the end of the lease to ask for more lenient terms.

• Change your AR terms. Instead of 30 days, change it to 15 days. Spell out the terms so that the payment period does not begin again if you send a second invoice.

• Know the bureaucracy of your customer. Make sure you send your invoices to the right person. When you call to follow up, make detailed notes concerning the name of the person you spoke with, the time, the date, and the result of the conversation so you can make specific reference to the conversation, such as “When I spoke with you on Tuesday, Oct. 6, at 9:30 a.m., you said the check was to be cut on Oct. 9.”

• Offer a discount to get paid faster. A discount means less cash, but it also means getting cash into your account.

By David P. Barley Sr., CPA    

The economy has not been kind to individuals nor to businesses, and many people have found themselves in dire financial straits. Unemployment is on the rise; earnings are down; and credit is tight. Net worth has plummeted during the economic malaise. And your business may need extra cash.

What are you to do? These are difficult times that are requiring many people to make tough financial decisions.

If you offer and participate in a retirement plan, money is sitting in an account, seemingly locked up for many years unless you are willing to pay penalties for getting your hands on that money. What if you could get to that money? Would you? Or, more important should you?

Let us assume that you have taken every effort possible to improve your current personal economic situation by reducing overhead, trimming expenses, and improving cash flow. Now you see your last resort as invading the funds you put away for retirement.

You may have two options, depending upon your retirement plan: a loan or a hardship distribution.

• Loan. A loan is a required step before taking a hardship distribution. And, if your retirement plan offers loans, it would be a more expedient way to gain access to your funds.

Because a loan fails what is known as “constructive receipt”—a financial term used by the IRS, meaning that you do not have unfettered control of the loan proceeds—you are not liable for any tax or penalties on the money. Taking out a loan, however, has its downsides: You have to pay it back, and there are limits concerning how much you can take out of the retirement account. Some of these limitations are specific to the plan in which you participate, so you may need to check with your plan administrator.

Another issue regarding loans is what happens if you were to close your business and effectively separate from your employment. Some plans allow for you to continue paying the loans after you leave, but others require that you pay it back within a short number of days after you leave. If you do not pay the loan back as required by the plan, the loans are treated as a distribution and will be subject to taxes and possibly penalties.

• Hardship distribution.  According to the IRS, a hardship is an immediate and heavy financial need. The need can include the participant’s spouse and dependents. Facts and circumstances are used to determine immediate and heavy and these typically include medical expenses, the purchase of a principal residence, tuition and fees, avoidance of foreclosure on a principal residence, and funeral expenses. This list is not exhaustive, but is indicative of typical needs that meet the standard for a hardship distribution.

The hardship distribution is limited to addressing your needs, and you will not be able to contribute to the plan for at least six months.

Many people have IRA-based retirement plans such as a SIMPLE IRA. Generally speaking, hardship distributions are not allowed from IRA-based plans. That is because IRA owners can take distributions whenever they want to take them. Under certain circumstances, however, early distributions by individuals who are not yet 59½ years old incur a 10% penalty tax (25% for a SIMPLE IRA in the first two years).

If you are younger than 59½ you can avoid these tax penalties, however, if the distribution is to be used:

• To cover medical expenses in excess of 7.5% of your adjusted gross income;

• For the cost of medical insurance;

• Because you are disabled;

• To pay for qualified higher education costs, or

• To buy, build or rebuild your first home.

Times are tough; money is tight. As you try to figure out how to make it through to better economic times, consider taking money from your retirement savings as a last resort. If that is the route that you feel is in your best interests, you can get to get to your money. Exercise caution, though, because you are going to have to pay taxes on the distributed money, plus you are depleting your savings for your retirement years.

Disciplined savings in future years will be necessary to make up for the funds spent prior to retirement. Before taking any distribution from any retirement account, make sure to check with your tax and financial advisor to understand the consequences of your actions.

David P. Barley Sr. is principal of Barley, Martin & Wild, CPA, PL, www.bmwcpa.com, which provides financial planning and tax services to individuals and businesses. He can be reached at 904-694-4CPA (4272).

SIDEBAR 431

If an employee requests a hardship distribution…

A hardship distribution should be a last resort for anyone who participates in a retirement plan. If, however, an employee requests such a distribution, as an employer you should follow these seven steps, according to the Internal Revenue Service (IRS). (Most will be done by your plan administrator.)

1. Review the terms of your plan, including whether the plan allows hardship distributions; the procedures the employee must follow to request a hardship distribution; the plan’s definition of a hardship; and any limits on the amount and type of funds that can be distributed as a hardship from an employee’s accounts.

2. Ensure that the employee complies with the plan’s procedural requirements. For example, make sure the employee has provided a statement or verification of his or her hardship in the form required by the plan.

3. Verify that the employee’s specific reason for hardship qualifies for a distribution using the plan’s definition of what constitutes a hardship. For instance, the plan may limit a hardship distribution to pay burial or funeral expenses and not for any other reason.

By Rick Arthur     

Is your bank a friend—or a foe? The lending practices of banks is a topic of concern to all small business owners—especially during economically trying times. But if you understand how banks do business, you can take steps to make your banker your financial friend, not your enemy.

As providers of the capital small businesses need to grow or expand, banks are cautious about how they lend their money, particularly in today’s economy. How do they determine who gets a loan and who doesn’t? Essentially, bankers follow the guidelines of the five C’s affecting credit:

1. Character. Yes, character counts. The bank checks your business’ credit report. It looks into your past decisions as well as into what results those decisions have yielded. The bank wants to know the personal and professional background of the owners and managers on your team and how well they relate to financial and business management. To assess this, they look into how well you and the team have handled your financial affairs in the past.

Although “character” is the most subjective of the five C’s, you can influence this evaluation by reviewing both business and personal credit reports, preparing bios for owners and key managers, and providing both business and personal references.

2. Capacity. The bank looks at your company’s past performance and future forecast to make a determination if it has the capacity to repay the loan within the term requested. As the bank does an analysis of financial statements, it pays particular attention to past, present, and forecasted cash flow and profitability. It reviews all of the numbers from all perspectives and validates figures. Because of their importance, financial statements should be professionally prepared. 

In today’s lending environment capacity has become the most critical component in the lending formula: the ability to repay the loan from future cash flows. The company will need to submit two years of tax returns both company and personal; two years of financial statements plus the most recent financials. Although the bank will prepare its own forecasted cash flow analysis, it is important to include your own version to the bank.

3. Collateral. The bank protects its money by asking for collateral, which are generally assets of the company requesting the loan. Collateral is almost always deemed to be a secondary form of loan repayment and will be based on discounted values of the underlying collateral. Because your bank needs to know the value of the collateral, you will need to provide documentation to support the balance sheet value (for example, accounts receivable—an aging report by customer and inventory—a detailed listing by item for both cost and market value). If the collateral is real estate or machinery, an independent appraisal of value may be requested by the lender. 

4. Capital. The bank wants to know if you, the owner, have risked your own resources by investing in the business. In the process of determining your credit, it validates your business operations to determine if the capitalization currently supports operations and debts and to see if the business has a sufficient buffer to help handle difficult times and/or seasonal variations. 

5. Conditions. The bank prepares a clear assessment of the economic conditions, regional markets, industry situations, and seasonal variations among others that might affect the future success of the business. It is important that the borrower provide their own analysis of trends within their industry and any pertinent local economy information that would influence the banker’s decision. Once this is completed, the bank outlines the terms and conditions under which it will grant a loan.

One of the conditions is almost always the business owner’s personal guarantee. The bank’s business logic is simple: If the owner isn’t able and willing to risk his or her personal assets, why should it put its assets at risk?

Keeping your banker your friend

If you and your business pass muster and the bank grants you a loan, keep it your friend:

• Make the bank your one-stop-shop. In fact, the bank will probably expect more from you than just the repayment of the loan. It will most likely require a depository relationship as well as the opportunity to provide treasury and other value added services. While this is normally a quid pro quo in the banking relationship anyway, it is becoming mandatory in the present banking environment.

• Meet regularly. To keep and maintain the positive relationship you have now developed with your banker, make sure to meet with your banker regularly and keep him or her apprised of the good, the bad, and the ugly concerning your present business position and outlook. If you’re looking to make dramatic changes, make sure your banker is “in the loop.” By keeping constant communication ongoing with your banker, you are assuring him or her that you care about your business, your finances, and their money.

Rick Arthur is a partner with B2BCFO®, www.B2BCFO.com, a CFO firm servicing the needs of businesses with revenues under $75 million. With loans averaging $1.8 million, B2BCFO® partners are helping clients find cash to fund growth and create jobs in today’s economy. He can be reached at rather@b2bcfo.com or 904-477-8957.

Numbers matter. If you have the right numbers—and know how to interpret them—you can manage your business for growth, value, or performance, says Roger Birong of Birong Associates LLC.

Speaking to participants at the first Jacksonville Advantage Knowledge is Power breakfast workshop, co-sponsored by American Enterprise Bank of Florida, Birong explained that small businesses often fail to manage by numbers because they do not have the proper financial information.

That financial information is captured on several different “scorecards”—the income (profit and loss) statement, the balance sheet, and the cash flow statement. By analyzing information from these three sources, you are able to understand four different types of bottom lines: gross profit, operating profit, net profit, and cash flow. “These scorecards are functions of behaviors and management decisions,” he said. “They are the results of your behavior.” He explained:

• The income statement provides a picture of the various types of income (profit) you have— gross profit (total sales minus total direct cost of sales); operating profit (gross profit minus overhead expenses); and net profit (operating profit plus other income, minus interest expenses). Each of these types of profit is a different type of bottom line, and it is necessary to know what each is for your business.

• The balance sheet is broken down into two parts: assets and liabilities. The top section of the balance sheet is devoted to assets—things your company owns. Generally they are categorized as cash, current assets (which can be converted to cash within 12 months), and fixed assets (less their depreciation), which are the “big ticket” items, such as cars and equipment.

The bottom section of the balance sheet identifies the things you pay for—your liabilities. Current liabilities are those things you have to pay within a short period of time, such as rent, salaries, utilities. Liabilities also include long-term debt.

When you add your equity (that is, your net income plus your retained earnings) to liabilities, you should get a number that is the same as your assets—hence, the term balance sheet.

• The cash flow sheet is derived from data from the other two scorecards. It shows the amount of cash “at the end of the day.” Cash flow indicates your company’s liquidity.

Applying metrics

The scorecards give you the bottom lines, but those bottom lines are still data—not information. To turn the data into useful information, Birong said you need to apply some metrics and then make comparisons—against performance for a given time period (for example, year-to-date 2009 compared to YTD 2008) or against industry standards.

A number of different ratios (metrics) can be used to analyze the success of your business. Some work better than others, depending upon the type and maturity of the business. Three common ratios include profitability, activity, and liquidity.

Profitability ratios are called “common size” ratios, calculated from data from your income and balance sheets. Three profitability ratios to scrutinize are your gross profit margin (gross profits divided by total sales); operating expenses (operating expenses divided by total sales); and net profit margin (net profits divided by total sales).

Activity ratios reflect activities involved in the operation of the business. For example, you can calculate the average collection period in days for accounts receivable: accounts receivable divided by annual credits sales/365. This figure shows how fast customers are paying bills, he said. “If your terms of sale are 20 days and customers are paying on average in 33 days, you have a collections problem.”

Liquidity ratios tell you about your cash situation—if your company is liquid or not. To calculate your liquidity ratio, divide your total current assets (from the balance sheet) by your current liabilities. “Common sense says you should have a liquidity ratio of at least 1:1,” said Birong. “Inventory is the least liquid of your liquid assets,” he continued. “If you were to calculate your liquidity ratio by taking off inventory and still have a positive number, you are in good shape.”

A common financial metric is debt ratio (total debt divided by total assets) “It’s not bad to borrow money, but you want your debt ratio to be low,” said Birong.

Making comparisons

Metrics are of particular value when you use them to make comparisons—to your company’s past performance (such as year-to-date and end-of-year comparisons), as well as to industry standards. A number of services provide performance information by industry, Birong explained. An excellent source, available in large libraries, is Financial Ratio Benchmarks, published by the Risk Management Association (RMA).

The benchmarks are useful, but they are not infallible, he cautioned, since many factors influence the operation of your business. To get a better picture, make comparisons against your own performance, he advised. Then you can see if trends are developing or if deviations occur. If you are performing better than you expect, congratulate yourself. If worse, take action and correct it.

Roger C. Birong is a certified business appraiser and a certified management consultant. He can be reached at 904-641-3373 or through his company’s Web site, www.birongassociates.com.

American Enterprise Bank of Florida, www.aebfl.com, is a community bank located at 10611 Deerwood Park Blvd.

Don’t miss the next Knowledge Is Power breakfast workshop. The topic: How to reduce your company’s healthcare costs. Go to www.advantagebizmag.com to register.

SIDEBAR 1

Growth, value, or performance?

Financial statements are tools that allow you to manage your company to achieve your goals. The three broad goals are growth, value, and performance.

• Growth. Companies that are in a start-up phase need to grow fast to get market share.

• Value. This is very important, especially if you planning to exit your business. There are ways to manage your company to increase your equity value in it.

• Performance. Managing for performance optimizes your company.

SIDEBAR 2

3 steps to manage by numbers

1. Hire the right person. There are five levels of accounting sophistication, said Birong: mom-and-pop, bookkeeper, accountant, controller, and chief financial officer. As your business grows, your need for better financial information also grows. “Most companies are one level behind,” he observed. You need the right level of skill and knowledge to assure you have the proper information and reports to make good decisions.

2. Learn the basics. Learn how to read the income statement, balance sheet, and cash flow sheet and be able to apply the basic metrics (ratios) to that information, so that you can assess where you are and if you are doing what you want to do with your business.

3. Develop management systems. One of these critical systems is an operating budget, which then allows you to determine if you are on track—and if not, how to get back on track.