Accounting and Budgeting

Paper or Plastic

SBOCTeam — Thu, 22 Oct 2009 14:19:00 GMT

When should your small business choose cash versus credit?

by Reed Richardson

The statistics staring at budding entrepreneurs are ugly-nearly two out of three new businesses won't survive past six years. A lack of a rigorous business plan, insufficient marketing, and poor product quality can, among numerous other problems, contribute to this sobering reality, but foremost among the reasons for early failure is a rather mundane and oft overlooked difficulty-poor cash flow management.

"Consumers are not stupid about banking issues, but they often are ignorant about the most efficient choices for themselves," noted E. Thomas Graham in a lengthy article on the FDIC Consumer News website that discusses using cash versus credit (click here to read more). Graham, who is president of the non-profit Personal Finance Employee Education Foundation as well as professor emeritus of consumer economics at Virginia Tech University, argues that many Americans-including many small business owners-are poorly educated about their own finances and, as a result, the choices they make on a daily basis often lead to long-term trouble.

Cash

Despite our economy's perceived obsession with credit, most transactions within our economy-from straightforward purchases like buying a soda at a vending machine to complex transactions like a massive cash-for-stock corporate takeover-still rely on good old cash. The most compelling reason for cash's continued dominance is its immediacy-"I want something now and I want to pay for it now." The buyer and the seller are both satisfied at the same time. This immediacy brings with it no extra transaction costs either, as FDIC Associate Director for Consumer Protection Kathleen Nagle explained in that same Consumer News article. "Cash is usually the cheapest way to go," Nagle noted. "No fees, no service charges, no interest payments."

Cash, of course, is (almost) universally accepted as well, making it the last and best form of payment no matter who is involved in the transaction or what's being purchased. Likewise, the primary hurdle for using cash-its availability-has been eliminated thanks to the vast network of 24-hour accessible ATMs now standing at practically every street corner. For small business owners that might be struggling to keep their head above water, using cash to pay bills and settle debts can offer a welcome oasis of simplicity and acceptance in an otherwise complicated and rejection-happy world. And no business ever fell into too much debt from just using cash on hand. Indeed, perhaps the most effective spending limit around involves looking into one's wallet or purse to see how much cash is left and to plan accordingly.

But cash as a payment method has its limitations and drawbacks as well. Unless you're an established customer or dealing with a public utility, cash won't be of much help when trying to execute most online or phone transactions. Nevertheless, cash is still considered the most liquid of all assets and, as such, it can therefore be the hardest to track in terms of how quickly it flows in and out of your business. Unless you are an inveterate receipt saver, a heavy reliance on cash can therefore easily mask where and how you're spending your money, which could lead to a cash flow disaster that shuts down your business if left unchecked. In addition, cash simply isn't well suited to large transactions or big-ticket capital investments and it offers the least in the way of consumer protections after the point of purchase-there's no way to stop payment or dispute a cash purchase after the fact.

Credit

By contrast, small businesses that rely more on credit get the benefit of time. In fact, credit cards are best thought of as short-term, roughly 30-day, interest-free loans. Putting off these payments for just one month can mean holding onto extra cash-and therefore earning more interest-which can be a boon to a small business's bottom line. But for this plan to work, a small business owner has to be diligent about paying off the entire amount spent at the end of their billing period. As countless examples have shown, if you fail to follow this rule or let spending with credit far exceed your small business's incoming revenue, you're in danger of adding extra costs to your purchases as well as over-leveraging your business. "After adding in the finance charges," the FDIC's Nagle explains, "you have [done] the opposite of buying on sale." Instead, she notes that not paying off your credit cards each month is "like marking up your purchases."

Still, credit and credit cards are only gaining in popularity because they increasingly offer many of the advantages of cash, yet with added consumer protections and built-in tracking mechanisms. Rare is the business that still refuses to accept some kind of credit card or, if you have a steady buyer-vendor relationship, delayed invoicing system, making the acceptance of credit for payment almost as ubiquitous as cash in today's economy. Plus, the Fair Credit Billing Act ensures that a small business can rely upon the consumer protection features of most major credit cards to ensure that the products or services it purchases match up with the quality promised by the seller. And for entrepreneurs looking to closely monitor all their outgoing expenses-no matter how small-over the course of a month, using a business credit card instead of cash is a simple way to ensure all those nickel-and-dime transactions get captured for later review.

Finally, as mentioned previously, credit remains the most popular method for making big-ticket purchases and for financing major capital investments, as it lets a small business spread its payments over time (while simultaneously depreciating those investments, in many cases). Still, using credit requires that someone be willing to lend that money to your small business and as many entrepreneurs have discovered, that can often be a more difficult task than expected. And trying to swear off credit purchases altogether is of little use as even those small business owners with the most modest of aspirations will one day require some kind of credit or lending for a purchase, so starting early and building up a reliable track record for borrowing and paying back is still a wise move.

Striking a balance
For an overwhelmingly majority of small businesses, a mix of cash and credit purchasing will end up being the right solution. Convenience at point of purchase is always a big driver in choosing between cash and credit, but many budding entrepreneurs fail to also consider the convenience factor when it comes to accounting for this spending later on. As managing cash flow is a critical part of a successful start-up, it's important to understand which spending preferences work (or don't work) well with the two main accounting methods. For example, the accrual method of accounting, which counts both debts and revenues on the books as soon the purchase or sale is made, provides a more accurate view of a company's current debt obligations, but can make it hard to judge just how much cash is currently available. A company using accrual accounting, then, might be better off using credit for more of its purchases. Conversely, a small business that follows a cash-based accounting method, where revenues and debts are only recorded once money actually changes hands, might be better suited to use cash or a debit card for most its daily expenses.

In fact, employing a debit card is perhaps the best compromise measure, one that builds in the immediacy and restraint of cash purchases, yet offers the flexibility as well as access to the often-generous rewards programs of a credit card. Linked to your small business's checking or money market account, your debit card, which effectively works as an electronic check, can become a quick and efficient way to combine many of the best features of both cash and credit purchases. For larger purchases you'll still likely need an actual credit card, but if your bank offers online access, a small business owner could then consolidate much of their company's spending within this account, which would allow for monitoring of spending going out, revenues coming in, and remaining cash flow on almost a real-time basis. And anything that gives you a better sense of your small business's cash flow is always a good thing.

Cash Flow and Accounting

SBOCTeam — Thu, 06 Nov 2008 22:18:00 GMT

by MOBI.1

Cash fuel drives you in business just as jet fuel keeps a plane aloft. A pilot is very careful to accurately predict the fuel requirements. You should place the same importance on cash flow control because if, at any point in the future, you run out of fuel, like the pilot, you've got a BIG problem.

Cash flow control is a simple method of projecting your future needs for cash. It is an income statement covering future periods of time that has been changed to show only cash: cash coming in and cash going out and what your balance of cash is at the end of designated periods of time. This is a great tool because you can predict your future needs for cash before the needs arise.

In cash flow control, for each of a number of intervals of time, you make conservative estimates for your future sources of cash (IN) and future expenditures (OUT). Use low, conservative figures for IN items and use high estimates for OUT items. For the initial period, say a month, you start with the cash you now have. To this you add IN items and subtract the OUT items, which results in the cash at end of the month. The cash at the end of month becomes the starting cash for the next month.

The attached cash flow control spreadsheet shows that ending cash for this first period becomes the starting cash for the second period. The ending cash for the second period becomes the starting cash for the third period, and so on. Your projection should be made for an upcoming 12-month period. The projection will be a useful tool for you to arrange financing before it is required by showing your banker that you are sophisticated enough to provide for future cash in order to preserve liquidity.

You can use this simple cash flow format to make up your own cash flow projection for the business you have in mind. It is so simple, yet can be so valuable!
© 2003-2007 My Own Business, Inc. All Right Reserved.

Cash is King

SBOCTeam — Sun, 29 Jul 2007 22:59:00 GMT

Even successful small company can find itself in a cash crunch.
Here’s how to keep the money flowing
By Mike Robbins

You’ve done the work, but when will you get the reward? If you don’t quickly collect the money your company is owed, you’re providing interest-free loans to your clients—and robbing your firm of the cash it needs to flourish. Unfortunately, collecting that cash isn’t always as easy as it should be. A 2006 VISA survey found that receiving and collecting payments is the cash management issue that small business owners find the most challenging.

The key to receivables is understanding the policies of your client’s payables department,” says Ruth King, CEO of BusinessTVChannel.com and author of The Ugly Truth about Small Business (2005). “Does your new client require a supervisor’s signature on all invoices? Do they have special rules for large invoices?”

Make a friend in the client’s accounts payable department. If something goes wrong you won’t have to ask strangers to sort it out. And remember that if you fail to follow a customer’s billing rules to the letter, you might not even get a call warning you there’s a problem—many companies will simply file your flawed invoice and wait for you to figure out that something’s wrong. Their payment process won’t even begin until you resubmit an amended invoice, perhaps delaying your money for months.

Always get invoices out the door as soon as possible. Rapidly growing companies often are so busy getting their jobs done that they treat sending invoices as a low priority. But clients won’t pay your invoice until 30... 60... or even 90 days after they receive them, regardless of when the work was done. Each day that you wait before sending out an invoice brings your company one day closer to running short of cash.

Your invoicing responsibilities don’t end when the invoice goes out your door. If the contract says the client has 30 days to pay, pick up your phone on the 31st day and politely ask the client where your money is. Failing to follow up on overdue invoices won’t just slow your cash flow. It could cripple your lines of credit. Once invoices slip past 60 or 90 days past due, lenders start to question whether these bills will be paid at all, and might not allow you to borrow against this future income. Be particularly persistent about following up on late invoices in the summer, suggests Mills. Invoices are likely to fall between the cracks when employees in clients’ payables department and your own receivables department are on vacation. When invoices are paid, deposit checks immediately.

If a client is financially unable to pay your bill, keep the conversation friendly and try to set up a payment plan, even if that means you have to settle for a few hundred dollars a month until the client’s company is back on its feet. “This isn’t a perfect solution,” notes King, “but it’s better than calling in the lawyers.”

MAKING PAYABLES AND PAYROLL PAY OFF

The first rule of payables: don’t— until you absolutely have to. If you agreed to pay in 30 days, wait 30 days; if you agreed to pay in 60 days, wait 60. “If you’re late, just be honest,” advises George Cloutier, CEO of American Management Services, a small business turnaround consultancy. “If they call and ask about their money, say ‘We’re cutting your check on Friday.’ Don’t say ‘It’s in the mail,’ if it isn’t.”

Get to know the credit managers at your major vendors, and find out what they need from you to keep your credit terms attractive. Expect most vendors to be more interested in your credit worthiness than whether your checks tend to arrive a day or two late. “Vendors are much more sophisticated about credit than they were even ten years ago,” says Mills. “If you have a bad financial statement, or are just late with a financial statement, some vendors will be very quick to change your terms. Where you once had 30 days to pay, you might now be C.O.D. That can create a severe cash flow problem.”

Payroll is the single largest recurring expense for many small firms, and even successful companies can find themselves without enough cash to make payroll when their receivables vary dramatically from month to month. Cloutier suggests paying employees commissions based on performance whenever possible, to help reduce payroll expenses during stretches when sales and revenues are low. Pay salaries semi-monthly rather than bi-weekly if your revenues come in monthly. “It seems like a small thing, but if you pay every two weeks, there are two months every year that have three pay periods,” says King. “That third one can be a killer if your clients pay by the month.”

A significant number of small companies unwittingly fail to pay all the payroll taxes and overtime wages they’re supposed to, according to Greta Cairns, Vice President of Human Capital Development at SCI Companies, a professional employer organization. Then tax time rolls around or government auditors appear and between the payments and penalties, these companies face major cash crunches.

Should a temporary cash flow problem leave your company unable to pay its bills, contact your vendors as soon as you learn there’s a problem, explain the situation, and try to work out a payment plan. “Ninety percent of vendors will let you do this, if you have a good credit history,” says Cloutier. “It’s a lot better than hiding the problem and surprising them with the news that you can’t pay when your payment is already overdue.”

You might also consider tapping a line of credit from your bank. A good banking relationship can make a world of difference when a generally profitable business suddenly runs short on cash. To build solid relationships with your lenders, get in the habit of sharing all of your company’s financial news with them, even the bad news. If you’re going to have a slow quarter, explain why. And bear in mind that banks don’t just look at your business when deciding whether to loan you money, “They’ll also look at the business owner’s personal credit history,” says Vargo. “If you carelessly make late payments on your credit card, your business will suffer for it.”

EXPANDING YOUR PAYMENT OPTIONS
Providing your customers with easy payment options is an important consideration for small business owners. “The public is becoming comfortable with being able to pay for goods and services with a wide array of different means,” says management consultant Mike Rosen of Rosen & Associates. “Increasingly people expect to be able to use credit and debit cards at pretty much every point-of-purchase.” If your business is restricted to cash or check payments, it will hurt your competitiveness.

Establishing merchant accounts with credit card vendors will cost you in terms of the fees charged for each type of credit or debit card accepted. However, Rose says that those fees must be considered a cost of doing business in the modern marketplace and should be balanced against the potential cost of business lost because of customer inconvenience. “If a customer finds that he or she can’t use the credit or debit card they usually use elsewhere, they may go elsewhere. If you offer your customers few choices in payment, expect fewer sales.”

Rosen notes that cash and checks are declining in use relative to plastic or electronic money, and that small businesses will have to cope. “Setting up a merchant account to receive credit card payments used to be a hassle,” he says. “But today there is great competition among banks and financial services companies to provide such services, so it has become much easier for a small business to set up credit card processing and electronic payment services.” Rosen suggests shopping around for the best fees and array of services. Membership in local small business associations and chambers of commerce can also result in discounts on merchant account fees.

If your business operates a web site, you might consider an online payment service. Opening a online payment account is relatively easy and permits your business to receive payments via credit cards, electronic checks, and direct account transfers. There are merchant fees associated with such payments, but with online sales becoming an ever-more important arena for small businesses, accepting payment online will only become more of a competitive necessity.

KEEPING ON TOP OF YOUR COMPANY’S CASH

Track the cash balance in your corporate checkbook on a daily basis, suggests
George Cloutier of American Management Services. And don’t give check-signing privileges to anyone else. If you sign every check yourself, you’ll always know about every dollar your company spends.

Small business owners must avoid the temptation to treat themselves to luxuries when their businesses appear to be on the road to success.

Mike Robbins is the author of The Smart Guide to Planning for Retirement (John Wiley & Sons) and has written for numerous magazines such as Moneysworth, Mutual Funds Magazine, and the Forbes family of publications.