How Working Capital Impacts Your Company Growth

Working Capital is a notion that business owners and managers need to come to grips with and manage effectively in order to ensure sustainability.

Maintaining healthy working capital provides a safety net to absorb possible bad debts, for example, and may be critical if you need to apply for a business loan. It is also critical for maintaining operations if you receive an unusually large order from a client.

As discussed in a previous post, the formula for Working Capital, also called Net Current Asset, is:

Working Capital = Current Assets – Current Liabilities

In other words, it is the sum of Cash at Bank + Accounts Receivables + Inventories + Other Current Assets minus the sum of Accounts Payables + GST & Tax Liabilities + Other Current Liabilities. Read more

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Working Capital Explained

‘Working capital’ is a notion that many business owners are not familiar with. It seems difficult, complicated, so many prefer to just ignore it.

But it is important and it does not have to be complicated: It can be put in simple words.

I agree that the definition in Wikipedia is not easy to follow: “Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.” Even some finance experts need to read this definition three times to comprehend the wording…

To put it simply, working capital measures the short-term financial health of a business, ‘short-term’ being less than 12 months. Read more

Stocktake

Doing A Stocktake Is In Your Interest!

The end of Financial Year approaches and most businesses would typically be planning and organising their annual stocktake. Other companies may do one or several interim stocktakes during the year in order to better monitor their inventory and/or minimise the disruption of a full stocktake.

A stocktake is the verification of the items physically held in inventory (also called stock). Both the quantity and the condition of each item are checked. The purpose of a stocktake is to confirm that the real physical inventory of a company reconciles with the theoretical inventory held in the accounts.

The objectives of a stocktake are multiple:

  • To remove the items that are broken, damaged or that have become obsolete;
  • To learn of items that are no longer there;
  • To provide valuable information on slow moving items;
  • Last but not least, to reduce your taxable profit via inventory write-offs.

You would not want to pay taxes on a profit you did not make, would you?

Inevitably, a stocktake will end up with a list of discrepancies: Items unaccounted for, missing or that reduced in volume, density, quality, etc. Even the best companies with well implemented inventory procedures will have discrepancies: It is human nature or should I say it is “business nature”. Read more

The Real Impact of Giving Discounts

As a consumer, we all love to receive discounts when we purchase. The same goes when buying goods or services for our company.

But discounts have a strong impact on the business and its Gross Profit (also called ‘Gross Margin’):

  • Discounts received trigger:
    • Increase in Gross Profit
    • Increase in Profit before Tax
  • Discounts given can trigger:
    • Loss or Revenue
    • Loss of Gross Profit
    • Decrease of Profit before Tax

So if you intend to give a discount to your customers, the question becomes: How much increase in Revenue do I need, in order to maintain the Gross Profit in $ value?

The answer is in the following formula:

= [(Gross Profit ratio / (Gross Profit ratio – % Discount given)) – 1] x 100

If it sounds complicated, here is a table with all calculations already done: Read more

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You Need a Cash Flow Forecast!

Cash is the lifeblood of any business, large or small.

When cash runs out, the business goes bust: Ansett, Babcock & Brown, Centro, HIH and OneTel are some of the famous names that went belly up. Thousands of businesses do the same every year, for the same reason.

All bankruptcies are not avoidable: Sometimes the business model is flawed, the market conditions change, or a fierce competitor comes in and ravages everything.

I recall an article in the Australian Financial Review stating that 28% of the business failures were caused by poor financial management!

Those bankruptcies could have been avoided if the business had better planned the cash movements: The periods of famine would have been foreseen and the business would have taken measures to sail through the storm.

The key to this problem is called: Cash flow forecast. Cash flow forecast is not a miracle recipe. It is a tool that all business owners should work on and work with. Read more

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Better Budgets

Budgeting is part of good management. No business can expect to succeed unless it has a plan for expenditures that is related to its revenue estimates. Companies that spend more than they earn won’t be in business long.

But businesses generally have a number of budgets operating concurrently. There are budgets for categories like stationery and marketing that are not apparently interrelated, although collectively they become part of the organization’s annual budget.

Each of these ‘subsidiary’ budgets needs to be set according to the same set of principles, and each should take projected revenues into account. Budgeting is an essential requirement for effective financial planning and those planning budgets at all levels have a lot to keep in mind.

Every budget needs objectives

Expense budgets must be framed within specific parameters and targeted to achieve objectives that are compatible with overall corporate goals. There’s no point in massively overspending on entertainment when revenues are in free-fall. Objectives at times of decreasing income must be scaled back to reflect revenue expectations. Read more

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Common Financial Ratios For Business

Ratio analysis is a process that incorporates a series of simple mathematical functions and applies them to financial statements or projections to determine fiscal performance and conditions of a business enterprise.

They become even more valuable when you compare those ratios over time, from one period to the next. The primary use, however, should be to compare your ratio results with those of other businesses in your industry.

Some of the most basic ratio formulas, such as liquidity and debt ratios, are also the ones to which most small businesses pay the closest attention.

An example of liquidity ratios is current ratio, which indicates how well the company can cover all short-term debt with all current assets. The formula is total current assets divided by total current liabilities.

For example, a company has total current assets of $100,000 and total current liabilities of $75,000. Apply the formula as follows:
Total Current Assets $100,000/Total Current Liabilities $75,000 = 1.33.
The result indicates the company has $1.33 of current assets for every dollar of current liability. Many companies seek a ratio of 2.0 or better, though less can be acceptable.

The acid test takes the current ratio one step further for companies with inventory and is intended to indicate how well you can cover short-term liability with current assets less inventory. The formula is total current assets (minus inventory) divided by total current liability.

The concept of eliminating inventory is that it represents that portion of current assets, which are most difficult to liquidate immediately into cash. Take the example of the company that has $100,000 in total current assets, $25,000 in inventory and $75,000 in current liability. Apply the formula as follows:
Total Current Assets – Inventory ($100,000 – $25,000)/Total Current Liability ($75,000) = 1.0.

The result indicates the company has $1.00 of current assets (minus inventory) to pay for each dollar of current liability. This ratio should always equal 1.0 or more.
Debt ratio relates to a company’s ability to engage in borrowing. Two such examples are the debt ratio and the debt-to-equity ratio. The debt ratio (debt to assets) indicates how much a company relies on borrowing to finance its operations.

The formula is total debt divided by total assets. Consider the example of the company that has a total debt of $25,000 and total assets of $200,000. Apply the formula as follows:
Total Debt $25,000/Total Assets $200,000 = .121
This translates to 12.1 cents in debt for every dollar of total asset, an excellent ratio in any industry. The acceptable ratio level varies by industry.

The debt-to-equity ratio compares a company’s indebtedness to its net worth. The formula is total debt divided by total equity (net worth). Consider the example of the company that has a total debt of $25,000 and a total equity of $25,000. Apply the formula as follows:
Total Debt ($25,000)/ Total Equity ($25,000) = 1.0

This company has $1.00 of debt for every dollar of total equity. A debt-to-equity ratio of 1.0 is excellent in many industries. Again, the average varies from one industry to the next.

Business Roadmap can help you identify the rations best needed for your business and how to use these in your planning and management. Once you determine your ratios, you can compare them against other companies in the same industry.

SOURCE Note – RAN One

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Tips for Effective Cost Control

Two words that individually do not usually enthuse the masses… Very few people get inspiration from the two words put together.

‘Cost Control’ can be described as the activity of controlling costs within a process, within a project, department, division or company.

Cost Control needs to be carefully managed: Yes reducing costs is the quickest and easiest way to improve profits (every $ saved is a $ more in profits), but indiscriminate cost cutting can lead to reduced efficiencies, falling quality and poor morale.

Cost Control typically includes:
• Accurate classification and measurement;
• Analysis of variances of actual costs versus budget (sometimes also versus the previous year) and their relevance;
• Determination of the causes for variances;
• Corrective actions to adjust the budget, bringing the actual in line with budget, or a combination of both.

While a small business will look at the total company costs, a larger business will be organised by departments, cost centres and will trace the costs as such: Cost of Sales, Sales & Marketing, Research & Development and Finance & Administration.

Each of these different Departments or Activities of the company will have purchasing costs, personnel costs, equipment costs, utilities costs, etc.

Ways to reduce the purchasing and productions costs:
• Guarantee minimum quantities commitment, against lower prices;
• Try to negotiate long-term purchasing contracts, against lower prices;
• Look for a cheaper supplier with the same level of quality;
• Match the quality level of your purchases with the quality of your own outputs (You may not need a 10 year guaranteed component to go into your 3 year guaranteed products);
• Improve processes to reduce wastage of materials and energy;
• Improve inward quality control to reduce rejects and reworking costs;
• If importing, consider putting two banks in competition for the purchase of overseas currencies.

Ways to reduce personnel expenses:
• Consider part-time employees, instead of full-time employees;
• Consider outsourcing some activities such as payroll, accounting;
• Consider possible automation of tasks and processes;
• Consider increasing the variable part of employee remuneration, based on performance, instead of a base salary increase.

Ways to improve cash flow and reduce finance costs:
• Optimise inventory/stock control to reduce unnecessary purchases;
• Get rid of obsolete stock to reduce unnecessary storage space;
• Implement proper collection follow up and procedures;
• Negotiate longer payment terms with suppliers;
• Consolidate several financing facilities into one;
• Make sure you do not finance your business on credit card interest rate;
• Look at possible grants and subsidies.

Ways to improve on utility costs:
• Make sure all equipment, computers and electricity consuming devices are switched off at night and during week ends;
• The same goes with switching off heating systems at night and weekends;
• Every two years, put your utility supplier in competition with other suppliers.

Ways to improve on other costs such as communication, telecommunication and travel & entertainment:
• Use teleconference and email communication instead of travelling;
• Use a company intranet to reduce duplication of information and manuals;
• Every two years, put your telecommunication provider in competition with other suppliers and new technology.

So, who is responsible for cost control?
Effective cost cutting involves everybody in the business, starting from the top and going down the organisation chart. The head (Managing Director/Business Owner) is the one setting the objectives to be achieved.

As a conclusion, cost control is about monitoring the costs and making sure they are what they should be in order to achieve your objectives.

wink

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How A Capital Expenditure Affects Your Business

Capital Expenditure (Also known as “Capex”) is an expense that will create future benefit to the business. Yes money is spent, but not on short term items such as wages, rent or insurances; it is spent on long term items such as property, plant or equipment. Property and plant are easy to understand. Typical examples of equipment are production equipment, tools, machinery, furniture, computers, motor vehicles, etc.

These items are not “expensed” (the amounts of money spent comes as expenses in the Profit & Loss Statement), they are “capitalised”: The items appear as assets in the Balance Sheet, for the same amounts of money spent, and the cost of the expenditure is spread over the useful life of the asset (This is called the “Depreciation”).

This is where the name comes from: A Capital Expenditure is an expenditure that is capitalised.

The conditions for an expense to be capitalised are:

– The money is spent on either acquiring the items or adding value to existing items.

– The item must have a life expectation superior to 12 months;

– As a “keep it simple” rule, the value must be superior to $1,000

This is why repairs and maintenance costs are fully expensed in the year they happen, as they do not add value to the existing item being repaired or maintained.

Put simply, a $10,000 expense to acquire a cutting machine would be capitalised (with a $500 yearly Depreciation if it has a 20 years life expectation), but the same $10,000 expense to repair a truck would be fully expensed.

What are the financial and tax impacts of a Capital Expenditure? They are multiple:

– The item appears for its cost as a Fixed Asset in the Balance Sheet;

– The business has effectively cashed out the cost of the item, which is money taken from the bank account or borrowed from lenders;

– The cash out has no effect on the Profit Before Tax as it is not an expense in the Profit & Loss Statement;

– Only the yearly Depreciation (Cost of the item spread over its useful life) appears as an expenditure in the Profit & Loss Statement, hence reducing the Profit Before Tax every year until the item is depreciated for 100% of its cost in the Balance Sheet;

This cash flow impact is one of the main reasons why a Capital Expenditure should be budgeted: The cash spent has to come from somewhere, even if the full amount does not show in the Profit & Loss Statement. So any business needs to budget and monitor its Capital Expenditure, to avoid a possible cash crisis.

The term capitalisation also applies to an amount of money used to start a new business, but that was not part of today’s article.

Good luck to you and your business!

 

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You Need A Budget!

Any business needs a Budget to foresee where it is going on a financial point of view. Running a business without a budget is like flying a plane without calculating how much fuel you need to get to your destination: You might be lucky, but you also have a large probability of crashing!

A budget is the dollar representation of your plan for the referred period. It is done for a full year, preferably showing each individual month for greater accuracy.

The process is simple:
· Set specific targets in terms of sales, production and distribution (In units or $);
· Quantify in dollar values the revenues, cost of sales and expenses;
· Consider the capital expenditures (Purchase of equipment or other assets), if any;
· Do not forget to account for other cash movements such as financing, taxes, etc.

The above will allow you to draft three statements:
· A Budgeted Profit & Loss (Revenues, cost of sales and all overheads such as rent, telephone, wages, etc.)
· A Cash Flow forecast (The timing effect of all income and expenses, plus the Capital Expenditures, plus the changes in financing)
· A Budgeted Balance Sheet (Assets and Liabilities)

The three above statements are connected with each other: Any change in one will have repercussion(s) in the other(s).

The easiest way to do a budget is to begin with the last known Profit & Loss and adjust for foreseeable changes: Figures should be adjusted for changes in Sales, Cost of Materials, Energy costs, Insurance, Rent, Telephone, Wages, etc.
Once you have your new Profit & Loss statement, preparing the Cash Flow forecast and the Balance Sheet is easy.

If you feel confident, you may chose between the different ways to prepare a P&L budget:
1. Using the last known one and adjusting for changes starting with Revenues (This is traditional budgeting);
2. Using information from the last known one and starting adjusting the Profit before Tax line all the way up to Revenues (This is traditional budgeting with the emphasis on Profits);
3. Starting with a clean blank sheet and beginning with Revenues, all the way down to Profit (This is known as “zero based budgeting”);
4. Starting with a clean blank sheet and beginning with Profit before Tax all the way up to Revenues (This is another variant of the “zero based budgeting”.

Okay: Your initial budget is ready.
You can now either keep it as it is or play with different scenarios and see the impacts.

Last but not least, the objective of a budget is not to be stored in the bottom drawer: It needs to be compared regularly against actual figures. If the actual figures come close to the budget, everything is fine and you know where your business is financially heading. But if actual figures differ widely from the budget, something is wrong and either corrective action needs to be taken immediately or the budget needs to be revised.

If you are on top of your budget, you are in control of what is happening in your business and where it is heading.