0 Spend

So how can a small business survive in a bad economy?

Larry Rice, CPA, Director of Strategic Consulting of Rodman & Rodman, P.C., Certified Public Accountants and business strategists catering to small and medium sized companies throughout New England, outlines critical cash flow tips for small business owners to help them weather a bad economy and beyond.

Create a cash flow projection or plan. Every small business should measure projected cash flow one year forward. That projection should be updated on a quarterly basis.  A good cash flow projection starts with a good sales projection.  Use historical data and be sure to consider any changes in your environment such as competition, economic change, etc. Once you have that sales projection, then it is a matter of translating those sales into the time frames that you get paid for those sales.  When you place the payment for those expenses along side the receipt of revenues, you’ve created a cash flow projection.

Plan appropriately for capital expenditures. Due to an aversion of debt, many business owners pay cash for significant corporate assets.  This can lead to a cash flow disaster. A good rule of thumb is that all long term assets should be financed over the expected life of those assets. If you are going to buy a machine that will last 10 years, you should seek to finance it over those 10 years. The idea is to match the outflows (the payment for the assets) to the time you expect to generate inflows (sales) from the use of that asset.

Better your credit management.  Eager to make any sales, some owners do not have strong credit policies. The worst of all cash flow problems is to expend all the resources to make a product or provide a service, and then not get paid for it. Small business can not be too eager to have just any customers; they need to have the right customers.  Go after the customers you want, not the customers who will waste your energy as you chase them to get paid.

Manage suppliers. Small business often pays its bills at designated times, which often are too early. Sometimes this is for convenience but can be dangerous to cash flow. Bills should be
paid timely to maintain good customer relations, but as close to the due date as possible.  Seek opportunities for taking the better discounts for prompt payment from suppliers.

Manage inventory. Sometimes owners do not want to rid themselves of stale inventory at a discount, hoping that some customer will appear to pay full price. Sometimes the best course is to get rid of the inventory and use the cash for other more practical purposes.

Maintain a good relationship with a bank/lending officer. Not all credit decisions are objective.  By maintaining positive communications, sometimes credit which might not be available can be secured when you maintain an open dialogue

According to Rice, “The most important financial statement is not the Balance Sheet or Profit and Loss; it is the Cash Flow Statement. Only the cash flow statement tells you how much cash your business is generating from operations.  A very profitable company can still fail if the cash flow isn’t there to sustain that profit. Bottom line: more businesses fail because of poor cash flow than poor profit.  Good cash flow planning is the key to small business success in any economy.”

Rodman & Rodman, P.C.

Founded in 1961, Rodman & Rodman, P.C. provides accounting, tax and business services to small and medium-sized companies throughout New England.  With a focus on strategic planning, Rodman & Rodman goes beyond traditional accounting services and takes a proactive approach when serving clients to increase, preserve and sustain clients’ financial net worth.

From business valuations, taxation, audits, fraud detection and prevention services and succession planning to a variety of accounting IT services including software selection, implementation and training, the team at Rodman & Rodman serves as comprehensive advisors to clients.  For individual clients, the company offers personal advisory services such as planning for real estate transactions, obtaining financing, estate planning and retirement planning as well as planning for college education.  Rodman & Rodman Certified Public Accountants are located at 3 Newton Executive Park in Newton, Mass.  For more information, visit their website at www.rodmancpa.com or contact Jen Reading at (617) 965-5959.

Steve Dubin

Dave Ramseys general advice to work hard, make your marriage a priority and avoid debt is excellent. In fact, any one who religiously followed Daves suggestions would have experienced far less trouble in the recent financial crisis. In far, some people probably side-stepped the whole mess by applying Ramseys ideas.

Nevertheless, in a handful of specific areas, one can find some minor yet important faults with the financial planning advice that Ramsey gives–and in particular with the financial calculations Dave shares in, for example, his books.

Overly Optimistic Rate of Return Assumption

One of the first problems that appear to certified public accountants and chartered financial analysts looking at Ramseys materials concerns the commonly quoted “12%” rate of return used in examples.

Thats way too optimistic an assumption. Yes, some years investments do generate 12%. And some specialty categories of investments (like small company stocks) may return roughly 12% over lengthy periods of time. But a traditional portfolio of diversified stocks and bonds will probably over long financial planning horizons deliver average annual returns of more like 7%-9%.

You will not, sadly, find it possible to consistently earn 12% on a well-diversified, moderate-risk investment portfolio. No way.

Inflation Ignored Only Leads to Future Disappointments

Inflation represents another issue that an accountant or good financial planner will want to include in financial plans but an issue that isnt always thoroughly discussed by Dave. Inflation can be tricky to incorporate. But inflation will probably eat away at the value of the savings you accumulate.

If youre earning 9% on your investments, for example, but inflation runs 3%, youre not really making 9%. Youre making 6%. You can more implicitly recognize inflation in your financial planning calculations, by the way, by using the net-of-inflation return in your financial calculations. To adjust for inflation when you expect a 9% return and 3% inflation, make the computations with a 6% return.

Expense Ratios Matter

One final investment issue (for some investors) needs to be highlighted. While investment expense ratios often dont matter much for people just starting to save money–probably this is Ramseys typical reader in fairness–by the time one accumulates a more size-able investment nest egg, investment costs matter. And they matter a whole lot.

In fact, if an investment pays a 2% expense ratio–and that sort of expense might be pretty normal once all the investment costs are tallied–that amount doesnt sound so bad. But its pretty outrageous in most circumstances.

Consider the situation, for example, where youve got a 9% rate of return from an investment but suffer from a 3% inflation rate. In actuality, youre really only earning 6% on your money. (The inflation thats baked into the return is not really profit to you.)

If out of your net 6% investment return, you pay 2% in investment fees–in other words, if you pay out 2/6ths of your profit for investment expenses–thats equivalent to a 33% income tax. Ouch.

In the end–just to play this sad song to the very end–while you start with 9%, after you subtract 3% inflation and 2% in investment fees–youre left with only 4%. And note that value is a pre-tax return. So if you pay income taxes on your investment profits (and you probably will eventually), youll actually end up with something less than 4%. Double ouch.

Putting These Financial Planning Insights Together

The nit-picking shared in the preceding paragraphs may seem a little unfair. But to illustrate how significant the mistakes become when combined, ponder the following scenarios:

If you and your spouse save $5,000 a year into a retirement fund for 30 years and say youll earn 12% annually, the calculated future value equals roughly $1,200,000.

Note: If you know Microsoft Excel, you can copy this formula into a workbook to double-check the statement: =FV(0.12,30,-5000)

In comparison, if you and your spouse save the same $5,000 a year in an IRA or 401(k) plan for 30 years but admit (sheepishly) that youll really only earn 4% once you adjust for inflation and that friendly financial advisor, the calculated future value equals roughly $280,000.

Note: Again, if you have access to a personal computer and Microsoft Excel, you can copy this formula into a spreadsheet cell to test my math: =FV(0.04,30,-5000)