Cash Management Essentials of Corporate Finance Chapters 16 & 17 Materials Created by Glenn Snyder – San Francisco State University

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 2 Topics What is a Small Business?  Challenges of Small Businesses Cash is King  Cash Cycle  Cash Budget Financing  Financing / Matching Principle  Banking Relationships  Loan Covenants  Personal Guarantees Career Advice for Owning a Small Business

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 3 What is a Small Business? Small Businesses are typically defined as businesses with under $25 million in annual revenue Characteristics:  Privately owned  Corporation, Partnership, or Sole Proprietorship  Typically under 100 employees  Management typically has significant personal investment in the business

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 4 Challenges of Small Businesses “Build a better mousetrap and the world will beat a path to your door.” – Ralph Waldo Emerson No matter how good of a mousetrap you build, your business will fail if it doesn’t have:  A strong business plan  Financial discipline  Cash management

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 5 Challenges of Small Businesses Strong Business Plan  Understand the market Customers Competitors Personalities of the market players  Set challenging, but achievable goals Sales Growth Profitability Market share

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 6 Challenges of Small Businesses Financial Discipline  Risks and Decision Making Every business has inherent risk, but the riskiness of a business depends on management Focus on core business  A restaurant should not have investments in a hardware store Conservative approach to finances  Be happy with the worst case scenario, but strive for the best case scenario

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 7 Challenges of Small Businesses Cash Management  Most dot coms (.com) went out of business in the early 2000s, not due to lack of ideas, but due to lack of cash.  Managing cash flow and financing needs may be the most critical and most overlooked aspect of managing a small business.

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 8 Cash is King The phrase “Cash is King” is more relevant to a small business owner, than perhaps to anyone else. Without Cash you can’t…  Pay your employees  Pay your rent  Pay your utility bills  Pay your suppliers  Pay yourself

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 9 Cash Cycle The first step to understanding your cash management is to understand your cash cycle Inventory Period + Accounts Receivable Period – Accounts Payable Period = Cash Cycle

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 10 Cash Cycle Example: Cash Cycle = 45 Days Cash is spent on day 30 and collected on day 75 Day 1 Day 30Day 45Day 75 Receives Supplies / Begins Production Payable Due Product Sold Receives Cash

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 11 Cash Budget A small business owner can use a cash budget to:  Determine minimum balances  Understand short-term financing needs  Understand sources of cash Understand significant sources of cash by products and customers  Understand uses of cash Find cash savings and identify cash management efficiencies

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 12 Financing / Matching Principle Between paying the supplier and collecting from the customer, the company has a financing need. Matching Principle  Short term assets (e.g. inventory, accounts receivable) should be financed by short term liabilities (e.g. line of credit)  Long term assets (e.g. equipment) should be financed with long term liabilities (e.g. term loan)

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 13 Financing / Matching Principle Business is an ongoing process, at virtually every moment a business is at every point of the cash cycle. During periods of growth…  Cash financing can become permanent  Permanent working capital should be financed with long-term debt

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 14 Banking Relationships A strong relationship with a bank can help a small business owner  Cash management  Working capital line of credit  Equipment / vehicle financing  Credit card acceptance  International services

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 15 Loan Covenants Banks use loan covenants to ensure the company maintains liquidity and financial strength.  Loan Covenants are typically in the form of financial ratios Minimum Current Ratio Maximum Debt to Net Worth Maximum Accounts Receivable Period  If the company violates a loan covenant, technically, the bank can call the loan

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 16 Personal Guarantees Bank financing of small businesses typically requires a personal guarantee from the owner.  The owner would be personally liable to pay back the loan if the company defaults  This provides a guarantee to the bank that the owner won’t use the funds for personal use, then declare the business bankrupt

February 26, 2007 Materials Created by Glenn Snyder – San Francisco State University 17 Career Advice for Owning a Small Business Work in the industry to learn the ropes Make industry contacts and learn from others’ mistakes Understand your market niche or competitive advantage Develop strong business and financial plans Finance the company with private funds before applying for bank financing