First Things First
The first thing most new small business owners set as a priority is generating sales. There is an instinctive drive in the entrepreneur to find customers. Part of that drive is the sense that if someone turns over their hard-earned money, it’s a validation of the business concept.
However, those business owners who succeed quickly learn to also make the bottom line a focus. Generating sales is rewarding, but those sales must generate enough profits to survive and grow.
There is yet another step to learn in growing a successful business. When a company has sales and profits, it must also have adequate working capital and cash flow. This final aspect of running a small business is the third essential step to long-term growth and stability.
Spinning the Financial Plates
One popular vaudeville act involved keeping a number of plates spinning on thin poles. To do this, it was necessary to get a plate spinning and keep it spinning, all while adding more spinning plates. If attention wasn’t given to each plate, they would slow down and fall off the pole.
The life of the small business owner can find a metaphor in this process, especially in the balancing act of handling a company’s finances. Once the business owner understands the vital role of adequate cash flow, there is a constant desire to conserve cash.
However, cash is only part of that balancing act. If the attention to cash means shorting the advertising and marketing budget, sales may suffer and profits decline. Likewise, an investment in new equipment may take more cash to generate greater productivity and profits. Again, the challenge is to keep the right plates spinning.
Debt as a Financial Tool
To illustrate how the balancing of these priorities can be challenging and require careful analysis, consider the discounts many merchants offer on their invoices to improve their own cash flow. Vendors will usually submit an invoice with an offer such as “2% ten; Net 30.” Of course, this is saying, “I am willing to knock 2% off this bill if you pay me in 10 days. If not, you owe me the full amount in 30 days.
Since most small businesses seldom have extra cash lying around, few take advantage of these terms. However, this is one of those situations where a desire to conserve cash and/or a dread of debt can cost the company an opportunity to save significant money on inventory and other expenses.
The math is actually quite simple. For example, consider:
- Taking the discount on the tenth day means two things:
- The company saves 2%
- The company loses 20 days of use of the cash (30 minus 10)
- 20 days divided into one year, 360 days, yields 18 turns. This means:
- That seemingly insignificant 2% percent becomes a whopping 36% return (18 times 2=36%) (note that even for a 1% return, the amount is 18 x 1 = 18% return, and ½ percent equals 9% potential savings)
- Those savings go straight to the bottom line
These discounts should be taken if possible. Even if a company pays 5% on a line of credit to take the discount, the savings can be worth the debt. An analysis is necessary at each level of discount offered to make the best decision.
The higher the level of inventory and similar expenses a company pays each month, the more quickly the potential savings add up, making debt a wise decision. While many business owners just can’t get comfortable with the concept of borrowing money to pay a bill early, the math shows it is often well worth the effort.
Jerry Walsh is a Senior Advisor at Meaden & Moore. For over 40 years, he’s been providing small business consulting services to the family business owners. His background covers a broad spectrum of audit, accounting, tax and consulting services in a number of different industries. Jerry helps clients obtain financing and assists them with their growth goals.