Focus on the
Fundamentals of Your Business
By Tracy Eden
thing about a recession or economic downturn that most people donâ€™t
think of: It forces most business owners to focus like a laser on
the fundamentals of their business. You know, things like making
sure you deliver quality products and great customer service.
most importantly, tough economic times prompt many owners and
entrepreneurs to take a hard look at how theyâ€™re managing their
business finances. Is inventory being managed efficiently? Are
receivables turns stretching out too far? Is monthly cash flow
positive or negative? Where is money being spent wastefully? Is debt
getting out of hand?
good times are rollinâ€™, it can be easy to let the financial side of
things slip a little. But when times get tough and sales start
slowing down, most companies find it beneficial to go back to the
basics of sound financial management. Here are five key areas you
might want to go back and reexamine if you havenâ€™t lately:
1. Inventory—Think of poorly managed inventory as a pool of trapped cash
that you can see but you canâ€™t put your hands on. Excess inventory
ties up cash in the form of goods sitting on your shelves, as well
as wasted money spent on storage space, insurance and other
overhead. The cost of carrying excess inventory can be as high as 30
percent of the initial value of the inventory per year when you
factor in storage and handling costs, obsolescence and damage.
commitment now to scrutinizing your inventory with a fine-tooth
comb. When you view excess inventory as cash sitting on your
shelves—which is what it really is—it looks a whole lot different.
Itâ€™s especially important to monitor your inventory turnover ratio,
which measures how often your entire stock of inventory turns over
during the course of the year. To find out, divide your average
inventory value by the cost of goods sold.
2. Receivables—Collecting accounts receivable promptly should always be a
priority, but itâ€™s especially important during a slow economy when
everyone is holding onto their money a little longer. The result can
be a domino effect that looks like this: Your customers are getting
paid slower, so they pay you slower—and before you know it, your
cash is no longer flowing, but just trickling.
In order to
stay on top of collections, you must first know the current status
of your receivables. This requires that you create and maintain an
accounts receivable aging report to track the payment status of all
your customers. An aging report will categorize customers by their
payment status—for example, current, 0-30 days, 30-60 days, 60-90
days, and past 90 days. It should also indicate how much each
customer currently owes so you can prioritize your collection
important to establish credit files on all of your customers with
whom you work on open account terms. These customersâ€™ credit should
be monitored on an ongoing basis and their files updated regularly
to reflect their current credit status, which can change quickly and
without warning during volatile economic times like these.
3. Cash flow—Unfortunately, many business owners donâ€™t understand the
fundamental difference between cash flow and profits. So, to recap
briefly: Cash flow is the actual cash (or checks) thatâ€™s
collected by your business each month and deposited into your bank
account. Profit is the cash left over that you get to keep
after youâ€™ve paid all of the expenses incurred in the manufacture
and delivery of your product or service.
that collect cash at or near the point of sale sometimes find
themselves cash-flush. Restaurants are a good example: They usually
receive cash from customers before they leave the restaurant, or at
worse, from the credit card processor within a day or two. However,
expenses must be paid out of this cash—everything from rent,
utilities and labor to the food and ingredients themselves. Not
understanding the difference between cash flow and profit is one of
the main reasons so many restaurants fail.
lots of other companies donâ€™t collect their cash until 30, 60 or
even 90 days or longer after theyâ€™ve delivered a product or service.
These companies may look at their operating statement and see a nice
profit, but the business could fail before itâ€™s ever realized
because cash flow is insufficient to keep operations going.
above, your receivables management will have a direct impact on your
cash flow, which makes improving collections vital to improving
overall cash flow. And never forget one thing: While profits are
always nice, cash is the undisputed King.
4. Expenses—Cost-cutting has taken on a new meaning within most
companies these days as owners and managers look high and low for
ways to shave expenses. A few ideas:
Talk to your
vendors about ways they can help save you money. Remind them
that your success is ultimately their success as well.
renegotiate your office lease with your landlord, if possible.
Itâ€™s a tenantâ€™s market in many regions of the country today.
travel and entertainment expenses and pare them back, where
subscriptions to publications and memberships within trade and
industry associations to make sure theyâ€™re worth the cost.
insurance deductibles, which can cut your auto and property
insurance premiums by 10 percent or more immediately.
5. Debt—Financial ratios can help you determine how much debt your company
should be able to handle comfortably. The main one is whatâ€™s known
as your debt service coverage ratio. Hereâ€™s the calculation:
Net income + amortization/depreciation + other non-cash and
Principle, interest and lease repayments
lenders prefer that a companyâ€™s debt service coverage ratio not
exceed 1:25. One alternative for companies with a high ratio is
factoring, whereby they would sell their outstanding accounts
receivables to a commercial finance company at a discount of usually
between 2-5%. In exchange, the business would receive cash right
away, instead of waiting 30, 60 or 90 days (or longer). Factoring
companies also perform credit checks and analyze credit reports to
uncover bad risks and set appropriate credit limits.
beginning to look like the worst of the economic crisis may be
behind us, itâ€™s always a good idea to refocus on business
fundamentals—regardless of the state of the economy. These five key
areas are a good place to start.
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