8 Cash Management

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Cash Management

Essentials of Corporate Finance

Chapters 16 & 17

Materials Created by Glenn SnyderSan Francisco State University


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February 26, 2007 Materials Created by Glenn SnyderSan 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


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What is a Small Business?

Small Businesses are typically defined asbusinesses with under $25 million in annual revenue

Characteristics: Privately owned

Corporation, Partnership, or Sole Proprietorship

Typically under 100 employees

Management typically has significant personal investmentin the business


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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, yourbusiness will fail if it doesnt have:

A strong business plan

Financial discipline

Cash management


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Strong Business Plan

Understand the market

Customers Competitors

Personalities of the market players

Set challenging, but achievable goals Sales Growth

Profitability

Market share


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Financial Discipline

Risks and Decision Making

Every business has inherent risk, but the riskiness of abusiness 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 casescenario


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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 mostcritical and most overlooked aspect of managing a smallbusiness.


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Cash is King

The phrase Cash is King is more relevant toa small business owner, than perhaps toanyone else.

Without Cash you cant Pay your employees

Pay your rent

Pay your utility bills

Pay your suppliers

Pay yourself


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Cash Cycle

The first step to understanding your cashmanagement is to understand your cashcycle

Inventory Period

+ Accounts Receivable Period

Accounts Payable Period

= Cash Cycle


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Cash Cycle

Example:

Cash Cycle = 45 Days

Cash is spent on day 30 and collected on day 75

Day 1 Day 30 Day 45 Day 75

ReceivesSupplies / Begins

Production

Payable

Due

Product

Sold

Receives

Cash


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Cash Budget

A small business owner can use a cashbudget to:

Determine minimum balances

Understand short-term financing needs

Understand sources of cash

Understand significant sources of cash by products andcustomers

Understand uses of cash

Find cash savings and identify cash managementefficiencies


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Financing / Matching Principle

Between paying the supplier and collectingfrom the customer, the company has afinancing 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)


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Financing / Matching Principle

Business is an ongoing process, at virtuallyevery moment a business is at every point ofthe cash cycle.

During periods of growth

Cash financing can become permanent

Permanent working capital should be financedwith long-term debt


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Banking Relationships

A strong relationship with a bank can help asmall business owner

Cash management

Working capital line of credit

Equipment / vehicle financing

Credit card acceptance International services


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Loan Covenants

Banks use loan covenants to ensure thecompany maintains liquidity and financialstrength.

Loan Covenants are typically in the form offinancial 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


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Personal Guarantees

Bank financing of small businesses typicallyrequires a personal guarantee from theowner.

The owner would be personally liable to pay backthe loan if the company defaults

This provides a guarantee to the bank that theowner wont use the funds for personal use, thendeclare the business bankrupt


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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 competitiveadvantage

Develop strong business and financial plans

Finance the company with private fundsbefore applying for bank financing

Documents

8 Cash Management