Cash, the King of Finance - Doug Smith
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Doug Smith, a partner in B2B CFO talks about business financing and how cash is king.
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Cash, the King of Finance - Doug Smith
- 2. Presentation to cpa moms™ Doug Smith B2B CFO® December 20, 2011
- 3. What Is B2B CFO® ? Established: Founded in 1987 National : 211 Partners in 39 states, 6,000 years of experience Focused: Privately-held companies with sales between $1 - $70M Affordable: Part-time CFO services
- 4. Who Am I? • 33 Years in Operations, Finance, Administration • COO, CFO, CAO • Government Contracting, IT, Healthcare • M&A experience (seller, buyer) • BS Engineering, MBA
- 6. The CFO’s Main Rule •CASH IS KING – For most small businesses, cash is most of the rest of the royal family also
- 7. What Financial Reports Say About the Business • Income Statement (P&L) – It’s a look at past history, not the present or future – Positive income ≠ More cash • Balance Sheet – It’s a snapshot – Doesn’t show money to be received from invoices sent out but not paid – Doesn’t show the money needed for next week’s payroll
- 8. What Financial Reports Say About the Business (cont’d) • Some non-cash expenses show up in the P&L – Depreciation – Amortization • Some cash expenses don’t show up in the P&L – Outlays to purchase capital equipment – Loan principal repayments – Owner distributions
- 9. Cash – It’s All About the Timing Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total Revenue $5,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $115,000 Expenses $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $90,000 Profit ($2,500) $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $25,000 Cash Income $5,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $95,000 Received Cash Balance ($7,500) ($15,000) ($17,500) ($15,000) ($12,500) ($10,000) ($7,500) ($5,000) ($2,500) $0 $2,500 $5,000
- 10. Cash – It’s All About the Timing (cont’d) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total Revenue $5,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $115,000 Expenses $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $90,000 Profit ($2,500) $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $25,000 Initial Equity $20,000 Cash Income $5,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $95,000 Received Cash Balance $12,500 $5,000 $2,500 $5,000 $7,500 $10,000 $12,500 $15,000 $17,500 $20,000 $22,500 $25,000 Cash Balance ($7,500) ($15,000) ($17,500) ($15,000) ($12,500) ($10,000) ($7,500) ($5,000) ($2,500) $0 $2,500 $5,000 minus Equity
- 11. Cash – It’s All About the Timing (cont’d) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total Revenue $10,000 $11,000 $12,000 $13,000 $14,000 $15,000 $16,000 $17,000 $18,000 $19,000 $20,000 $21,000 $186,000 Expenses $8,500 $9,000 $9,500 $10,000 $10,500 $11,000 $11,500 $12,000 $12,500 $13,000 $13,500 $14,000 $135,000 Profit $1,500 $2,000 $2,500 $3,000 $3,500 $4,000 $4,500 $5,000 $5,500 $6,000 $6,500 $7,000 $51,000 Initial Equity $20,000 Cash Income $10,000 $11,000 $12,000 $13,000 $14,000 $15,000 $16,000 $17,000 $18,000 $19,000 $145,000 Received Cash Balance $11,500 ($9,000) $500 $1,000 $1,500 $2,000 $2,500 $3,000 $3,500 $4,000 $4,500 $5,000 Cash Balance ($8,500) ($29,000) ($19,500) ($19,000) ($18,500) ($18,000) ($17,500) ($17,000) ($16,500) ($16,000) ($15,500) ($15,000) minus Equity
- 12. QuickBooks and Cash Flow • Mapping between Profit and Loss, Balance Sheet, and Statement of Cash Flows
- 16. Forecasting Cash Flow • At a minimum, forecast next 3 months • Forecast each week in the month • For small expense categories, use 3-6 month rolling historical average • Show large cash needs (e.g., payroll, rent) in the week they occur • Don’t forget other extraordinary cash needs (e.g., owner distributions for quarterly tax payments) • Be reasonable and conservative in forecasting income (probability of collecting > 90%) • Learn over time – Keep past forecasts, compare to what actually happened – Adjust forecasting methodology based on lessons learned
- 17. Cash Forecast Example Week (future) 1 2 3 4 5 6 7 8 9 10 11 12 13 Beginning Balance $100,000 $95,000 $120,000 $109,000 $134,000 $129,000 $154,000 $149,000 $148,000 $143,000 $168,000 $163,000 $182,000 Cash Income $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000 Received Payroll (bi-weekly) $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 Rent (monthly) $6,000 $6,000 $6,000 Quarterly Tax $20,000 Payment Other Non-Labor $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 Cash Expenses Total Cash Expense $45,000 $15,000 $51,000 $15,000 $45,000 $15,000 $45,000 $41,000 $45,000 $15,000 $45,000 $21,000 $45,000 Net Cash ($5,000) $25,000 ($11,000) $25,000 ($5,000) $25,000 ($5,000) ($1,000) ($5,000) $25,000 ($5,000) $19,000 ($5,000) Ending Balance $95,000 $120,000 $109,000 $134,000 $129,000 $154,000 $149,000 $148,000 $143,000 $168,000 $163,000 $182,000 $177,000
- 18. Getting Information on Cash • From the Bank? – Not a good idea to rely on bank balance • (Although many owners do) – Bank account doesn’t show: • Checks written, but not yet presented to bank for payment • Payments received by the business, but not yet deposited • From the Accounting System? – Good source, AS LONG AS system has been used completely, and kept up to date – Reconcile monthly bank statements against what’s in accounting system as part of month-end close
- 19. Improving Your Cash Position • Retained earnings – keep cash in the business • Shorten A/R days – Close the books as soon as possible after the month ends – Send invoices by e-mail rather than snail mail – Ensure invoices are clear and complete • Write the expected due date on the invoice – Get paid electronically – Use a lockbox at the bank to receive cash payments – Actively work the A/R list, following up on invoices outstanding more than 30 days
- 20. Improving the Cash Position (cont’d) • Reduce inventory carrying costs – Use “just in time” supply chain procedures – only receive parts just before needed for production • Accounts payable – Only pay in accordance with contractual payment terms – For Net 30 terms, pay on day 30, not before • Reduce Bad Debt – Have customers fill out a credit application – Check customer reference, Dun & Bradstreet info, etc.
- 21. Improving the Cash Position (cont’d) • Partner with a collection agency – Use them to collect older, uncollected invoices – There’s a cost, but it’s better than not receiving payment at all – Use a Factor • Use only if you’re in a cash crisis • Factors lend cash through a process where you sell them your A/R – They advance you a portion (70-85%) of the A/R balance • When payment received, you receive the balance of the money not advanced, minus their discount fee – Imputed interest rate much higher than a bank loan (30-40% APR)
- 22. Special Considerations for S Corporations • Many S Corporations file their taxes on a cash accounting basis (even if books are maintained on accrual basis) • To minimize taxes: – Prepay some expenses (e.g., rent) – Stretch some receivables into the next tax year – BUT, you can only do these if you have enough available cash
- 23. Best Practice Example: Dell Computer • Cash conversion time: time between when a sale is made and the cash is received – Dell’s is MINUS 15 days • Dell gets your money as soon as you order • Dell’s supply chain process – Parts are delivered to Dell factory, but placed in a special holding area • Still considered the property of the supplier • Can sit there for a week or more – Parts move into Dell’s inventory only when moved to the computer assembly bench – The computer is built that day, and mailed to the customer within 2-3 days
- 24. Questions? Comments? Doug Smith Partner, B2B CFO® e-mail: dougsmith@b2bcfo.com phone: 703.927.9823 website: www.dougsmithcfo.com
Editor's Notes
- [Have this slide up on the screen as people come into the room]
- INTROI’m happy to be here today. I’m going to be talking about something that happens all to often to business owners and entrepreneurs as their business grows and becomes more successful.First a little on me, and on B2B CFO, where I’m a partner[CLICK]
- B2B CFO is 25 years old, and the largest firm of part-time CFOs in America. We are not as well known in the DC area as some other firms, but our presence is growing.Every company, regardless of its size, needs a Chief Financial Officer. Smaller firms can’t afford to hire an experienced CFO full-time. We bring CFOs within the reach of every firm, by offering services on a part-time basis.Although I am the first Partner in the immediate DC area, I bring a close working relationship with our other 210 partners with me. We have 6,000 years of experience between us. There is no industry we haven’t worked in, and no small and mid-market business issue we haven’t addressed.
- Just to let you know a little bit about my background prior to joining B2B CFO.
- Large businesses often have stores they can draw on to meet their expenses: cash raised through equity, access to substantial debt, retained earnings from having been in business for a number of years. These stores are typically available to small businesses, especially newer ones, and so the availability of cash is a omnipresent factor for many small businesses and their owners.
- The two main financial statements businesses typically review have their uses, but they have limitations as well.
- There are some other limitations of the income statement (P&L) if you’re using it to think about the cash needs of the company.When the business buys a fixed asset (e.g., computers, a piece of manufacturing equipment), the cash needed to make the purchase is taken out at the time of the purchase. However, because the asset will support the business for several years rather than being used up in a single month, its value is capitalized and placed on the balance sheet. Each month, a portion of the asset is “used up” and that value is shown as depreciation.If the business has taken out debt, and is repaying a loan, only the interest portion of the loan payments shows up in the P&L. If you have a mortgage, you know that every payment includes both reduction of the loan principal and interest – in the early years, you’re paying mostly interest, in the latter years, you’re paying mostly principal.For many small businesses, owners will pay themselves a salary, but will also take cash distributions from the equity built up in the business. These owner distributions are “below” the net income, the last line on the P&L.
- Here’s a simple business I’ve built to illustrate how on-paper profits and available cash can differ. The business starts in January, with revenue of $5,000 the first month, and $10,000 in subsequent months. It’s a services business, so the primary expense is payroll. The total expenses of the business run $7,500 per month.Revenue is the money we’ll eventually receive for the services the business provides. In this example, the cash doesn’t arrive until two months after the services are provided. When January ends, the books are closed, and invoices are sent out. Even under Net 30 terms, the checks to pay the invoices don’t arrive till March. However, we have to pay the employee payroll in January, when the services are provided.Look at the example. We’ll see that the business “breaks-even” in February, with positive profit. However, notice that the cash balance is negative all the way from January through September. Because of the lag in cash receipts, the business runs a negative cash balance for 7 months AFTER it has turned a paper profit. At the end of the year, the business records $25,000 in annual profit, but it only has $5,000 in the bank.How does the business meet its cash needs from January through October? Let’s look at the next slide to find out.
- We get cash through having the business owner invest some of their own money in the business at start-up. In this case, the business owner puts in $20,000 of their own cash as the business starts up. The business, by drawing on this store of equity, is able to maintain a positive cash balance all year (although the business scrapes pretty close to $0 in March).The “Cash Balance minus Equity” line in the example matches the cash balance shown in the previous example. The initial equity makes the difference, and allow the business to stay in business during that first year.
- Here’s one more example. This business is growing rapidly, doubling its monthly revenue by years end. Expenses also increase. In this case, the business has $51,000 in profits by the end of the year. However, the cash balance at year end, just like the “steady state” model, is still only $5,000 – and this even with the initial equity to help out. The cash has gotten sucked up by “working capital” needs. Working capital covers the gap between cash going out (for expenses) and cash coming in, with the lag cause by normal billing practices.
- Many small business use QuickBooks as their accounting system. Let’s look at how QuickBooks’ reports interact in showing the cash health of the business.
- This is one of the sample businesses that comes with QuickBooks. It’s a wholesale distribution business, where the company primarily holds good for resale to retail businesses. This particular business has a few employees, and an owner.The income statement/Profit and Loss shows a couple of those special situations we talked about the beginning: depreciation (which is not really a cash outlay), and only the interest portion of any loans that are repaid.
- The Balance Sheet has more items related to cash.In our assets, we have the liquid cash the bank is holding for us. Accounts receivable is the money we’ll receive for services already rendered.In some cases, the business may prepay some expenses to reduce taxes. We’ll talk more about this later. The prepaid expenses are shown on the balance sheet, and then are expensed on the P&L during the month they would normally show up.The Fixed Assets line shows the cash paid out for the company’s capital assets. The depreciation we discussed before is accumulated each year to show the “book value” of the assets.Accounts Payable represents bills we’ve received from our vendors, money we owe, that we haven’t paid yet.The business may have short-term loans such as credit card payments or a line of credit form the bank.Toward the bottom, you can see the owner distributions – the “draws” – that the business’s owner, Deborah Wood, has taken out during the year.
- Many owners and bookkeepers are not aware that QuickBooks has a report that focuses specifically on cash flow in the business. Each of the items that add or subtract cash from the business can be mapped to lines on the income statement or balance sheet. [NOTE: show a few examples by stepping from this report back into the previous two slides]
- The Statement of Cash Flows, like the balance sheet, is just a historical snapshot. Since cash is so key for small businesses, the business should also forecast its upcoming cash needs.
- Here’s a simple example, based on the principles from the previous slide. Remember to record large expenses in the week they’ll occur (e.g., the first of the month – when the rent is due – could occur on a Tuesday in a month that has 5 Tuesdays). This particular business has pretty healthy cash flow, but you can imagine a business with large expenses and insufficient income, where the cash flow trend over the next 3 months will be down instead of up.
- Dell Computer is a company that has figured out the cash game to a T.
- Thanks for your time today.[OPEN FOR DISCUSSION AND QUESTIONS]