Balance Sheets
The balance sheet summarizes:
Assets: What the business owns
Liabilities: What the business owes
Equity: The investment of the owners in the business
Assets = Liabilities + Equity
A starting balance sheet states what assets you need to start the business, and how you plan to pay for those assets. You can either borrow the money (liability) or you and others can invest money (equity).
As the business grows, you need more assets, such as inventory and equipment. You need to finance these assets, perhaps with profits, but most often you will need to borrow money or obtain more investment.
Financing Current Assets
Current assets are cash and things you will soon turn into cash: inventory before it's processed and sold, prepaid expenses and receivables. They are the engines of growth. How will you pay for them?
Since most small and growing companies have no spare cash or retained earnings and suppliers are not generally sources of growth funding, most growth is financed by debt. Your company must have enough working capital to make regular payments on this debt.
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Working Capital: Cash or near-cash assets available to pay current debts.
Add: Inventory, accounts receivable and cash (current assets) Subtract: Accounts payable (since you also need to pay these bills)
When growth is planned - products, expansions, new locations - forecast income statements and balance sheets must be analyzed for changes in working capital requirements. This is the additional amount that must be borrowed to continue to run the business.
Maximizing Working Capital
- Factoring: If accounts receivable is the problem and profit margins can absorb the cost, factors will pay an instant cash fee of about 2% for your accounts receivable.
- Timely invoicing: Send invoices twice a month or at end-of-job. If you send invoices monthly on 30-day terms, expect 45 days to collect. At twice a month, this drops to 37 days.
- Defend against bad debts: Growth leads to less attention to slow payment. Have a systematic approach to granting credit.
- Inventory control: Too little inventory results in lost sales. Too much results in cash flow problems. Beware if true value of inventory decreases rapidly, as in computers.
- Take action on poor turnover: Monitor different types of inventory and make decisions based on turnover.
- Review plans with banker: As growth begins, need for capital grows faster than profits. A well-prepared business plan illustrates long-term prospects. Keep your banker informed.
Financing Capital Assets
These are assets you intend to keep, such as equipment, buildings and land. There are primarily two ways to pay for capital assets.
Term loan: Using company assets as security, the lender provides a loan that must be repaid over a period of time (the term).
Lease: The leasing company owns the asset and the lessee pays a monthly fee for using it.
Borrow or Lease:
- Check lease interest rates: The interest rate on some leases - particularly for small items - can be more than 18%.
- Leased assets are not on the balance sheet: Depending on the circumstances, this can be good or bad. It's good, for example, when you are trying to preserve borrowing power, but it's less desirable when you are trying to build the sale value of your company. Carefully analyse your situation to decide which it'll be for you.
- Equipment loans may be guaranteed under Small Business Loan (SBL) program: The guarantee gets you a more favourable interest rate. Check with your financial institution.
- Leasing gets you more asset for your monthly payment: Leasing defers your downpayment to the end of the lease, when you have to buy out the asset. Good strategy for companies with no cash at start of growth program.
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