1 00:00:05,230 --> 00:00:09,940 In the first section of this course I'll explain the times when you want to consider getting a business 2 00:00:09,940 --> 00:00:10,890 loan. 3 00:00:10,930 --> 00:00:15,670 I'll show you some quick tests that you can estimate whether your company has a large enough cash cushion 4 00:00:15,970 --> 00:00:18,230 or might run low over the next year. 5 00:00:18,250 --> 00:00:22,590 The most accurate way to assess whether you need a loan is to do a cash flow projection. 6 00:00:22,630 --> 00:00:25,320 I'll provide a template for this and talk you through how to use it. 7 00:00:26,290 --> 00:00:31,180 Now that you can find out your cash position I'll explain how lending fits into business cash flows 8 00:00:31,270 --> 00:00:35,220 and the categories of the sources and uses those cash flows. 9 00:00:35,230 --> 00:00:40,510 This information is useful both for you and show lenders your ability to pay back any loan. 10 00:00:40,510 --> 00:00:45,260 Lenders will analyze your balance sheet may do some of the metric calculations I'll be showing you. 11 00:00:45,400 --> 00:00:47,660 They'll want to see your cash flow projections. 12 00:00:47,740 --> 00:00:53,020 Knowing your fluctuations in cash helps you and your lender determine the appropriate size for a line 13 00:00:53,020 --> 00:00:58,440 of credit one of the most obvious times is when you are buying buildings or equipment. 14 00:00:58,460 --> 00:01:03,710 These require huge amounts of cash that few businesses have sitting in their bank accounts getting loans 15 00:01:03,710 --> 00:01:07,880 for these is easier than getting some other types of business loans because the building or equipment 16 00:01:07,880 --> 00:01:14,210 can be pledged as collateral to the lender closely related to buying property is constructing or improving 17 00:01:14,210 --> 00:01:16,900 a building during the construction phase. 18 00:01:16,910 --> 00:01:21,590 The structure of the short term construction loan you will receive is very different than the long term 19 00:01:21,590 --> 00:01:23,910 loan once the construction is completed. 20 00:01:23,930 --> 00:01:30,240 I'll talk about the types of loans later in this course a very common use is for short term lending 21 00:01:30,240 --> 00:01:33,120 needs for companies with healthy cash flows. 22 00:01:33,120 --> 00:01:38,370 It's more profitable to borrow money during times of net cash outflows and pay the short term loan off 23 00:01:38,370 --> 00:01:40,320 during times of cash inflows. 24 00:01:40,320 --> 00:01:46,710 For example many companies have regular patterns of large cash inflows from sales followed by big cash 25 00:01:46,710 --> 00:01:51,020 net outflows for payroll or to pay vendors. 26 00:01:51,040 --> 00:01:56,350 This is similar to the previous bullet but the cash inflow and outflow cycles are much longer. 27 00:01:56,350 --> 00:02:01,350 Examples include seasonal businesses like landscapers ski resorts and hotels. 28 00:02:01,450 --> 00:02:04,920 I used to work at a bank that provided seasonal loans to farmers. 29 00:02:04,930 --> 00:02:11,220 Finally some loans are used more for operating efficiency and ease than for cash flow reasons. 30 00:02:11,290 --> 00:02:16,160 Corporate credit cards are a very expensive way to borrow money if you don't pay them off each month. 31 00:02:16,150 --> 00:02:20,800 They're very useful though to allow employees to buy items especially when they're buying things online 32 00:02:22,610 --> 00:02:24,090 in the next few slides. 33 00:02:24,110 --> 00:02:27,430 I'll talk through four ways to estimate whether you need loans. 34 00:02:27,470 --> 00:02:32,720 The current ratio and quick ratio or two ratios to quickly compare your cash to future needs for that 35 00:02:32,720 --> 00:02:33,620 cash. 36 00:02:33,680 --> 00:02:38,630 If you're low on these ratios getting longer term funding like real estate loans or funds from the owners 37 00:02:38,630 --> 00:02:45,650 may be good sources of cash reviewing past bank statements can show you how much your cash goes up and 38 00:02:45,650 --> 00:02:48,120 down within a month or across multiple months. 39 00:02:48,320 --> 00:02:54,290 Business lines of credit which I'll explain later in this course are good solutions for these cash fluctuations. 40 00:02:54,290 --> 00:03:00,960 Knowing the sizes of these fluctuations allows you to determine how big of a line you'll need the current 41 00:03:00,960 --> 00:03:04,070 ratio is also known as the working capital ratio. 42 00:03:04,350 --> 00:03:08,810 It's calculated as current assets divided by current liabilities. 43 00:03:08,820 --> 00:03:14,040 It's a simple definition but immediately leads to the question What's a current asset and a current 44 00:03:14,040 --> 00:03:18,430 liability assets are things you own or have right to. 45 00:03:18,670 --> 00:03:22,900 Examples include cash or inventory and accounts receivable. 46 00:03:22,900 --> 00:03:26,950 Liabilities are things you owe like payments to your vendors or lenders. 47 00:03:26,950 --> 00:03:28,770 These items are listed on your balance sheet. 48 00:03:29,820 --> 00:03:34,860 The word current means the asset will be converted into cash within a year or the liability will be 49 00:03:34,860 --> 00:03:40,890 paid within a year non-current assets and liabilities are all other assets and liabilities. 50 00:03:40,890 --> 00:03:46,530 Many accounts and accounting software create balance sheets grouped into current and non-current sections 51 00:03:48,760 --> 00:03:52,460 Here's a sample balance sheet that shows how to calculate the current ratio. 52 00:03:52,480 --> 00:03:57,520 This is a classified balance sheet meaning current assets and non-current assets are subtotal within 53 00:03:57,520 --> 00:03:59,200 the asset section. 54 00:03:59,200 --> 00:04:04,000 Current assets are six hundred thousand dollars current liabilities are three hundred and fifty thousand 55 00:04:04,000 --> 00:04:09,340 dollars so the formula is six hundred thousand dollars divided by three hundred and fifty thousand dollars 56 00:04:09,400 --> 00:04:14,230 for a current ratio of one point seven one is one point seventy one good or bad. 57 00:04:14,620 --> 00:04:16,480 I'll explain that in the next slide. 58 00:04:18,670 --> 00:04:20,690 A higher current ratio is better. 59 00:04:20,700 --> 00:04:27,550 Here's a quick way to assess your financial health with the current ratio a working capital of one needs 60 00:04:27,560 --> 00:04:32,390 your current assets are as big as your current liabilities a working capital of less than 1 means your 61 00:04:32,390 --> 00:04:37,490 current assets are less than your liabilities whereas a current working capital of more than 1 means 62 00:04:37,490 --> 00:04:40,880 your current assets are more than your current liabilities. 63 00:04:40,970 --> 00:04:45,140 If your current ratio is 1 meaning your cash inflows will cover your cash outflows. 64 00:04:45,170 --> 00:04:46,160 That's good right. 65 00:04:46,160 --> 00:04:49,250 Well it's good but it may not be good enough. 66 00:04:49,250 --> 00:04:53,650 This formula is an estimate of future cash flows and has weaknesses that I'll soon explain. 67 00:04:54,800 --> 00:05:00,230 That's why many people recommend having a ratio between one point two and 2.0 to give yourself a cash 68 00:05:00,230 --> 00:05:02,610 cushion for unexpected cash needs. 69 00:05:02,690 --> 00:05:07,700 If you have consistently strong profits with good access to debt and equity then you can have a lower 70 00:05:07,700 --> 00:05:09,400 working capital ratio. 71 00:05:09,410 --> 00:05:14,750 Some companies like Amazon have negative working capital ratios because of their financial strength 72 00:05:14,750 --> 00:05:16,880 and sophisticated cash management. 73 00:05:16,880 --> 00:05:22,850 Small businesses are an amazon so it's better for you to keep working capital above one a ratio above 74 00:05:22,850 --> 00:05:29,210 2 may mean you can invest cash in your business pay down debt or distribute it to owners run on cash 75 00:05:29,210 --> 00:05:34,100 flow projection to confirm this and decide whether you want to keep the cash for safety or invest it 76 00:05:34,100 --> 00:05:40,580 for higher profits the current ratio is one of the easiest ways to estimate if you have enough cash 77 00:05:40,580 --> 00:05:41,330 for the next year. 78 00:05:41,360 --> 00:05:47,600 But it has some weaknesses it doesn't include cash received from profits or cash will pay for losses 79 00:05:47,630 --> 00:05:49,250 that are reflected on your income statement. 80 00:05:50,320 --> 00:05:55,120 You won't receive and keep the cash from some assets that are traditionally classified as current. 81 00:05:55,150 --> 00:06:00,460 For example your accounts receivable are constantly replaced with new ones so they don't provide as 82 00:06:00,460 --> 00:06:06,400 much cash as you may think your inventory sold will be replaced with new purchases of inventory items 83 00:06:06,400 --> 00:06:13,060 like these are called permanent working capital and must be financed with long term debt the quick ratio 84 00:06:13,120 --> 00:06:15,240 is known as the acid test ratio. 85 00:06:15,250 --> 00:06:19,800 Frankly that's a pretty extreme title for an accounting metric but it sounds cool. 86 00:06:20,110 --> 00:06:27,140 It's calculated as current assets less Inventory Prepaid Expenses and supplies divided by current liabilities. 87 00:06:27,160 --> 00:06:32,170 This ratio removes some assets and is a tougher test for your cash flow than the current ratio. 88 00:06:32,410 --> 00:06:36,250 Like the current ratio higher is better from a cash flow perspective. 89 00:06:36,250 --> 00:06:42,960 A common recommendation is for this to be equal to one or higher here's the same balance sheet we looked 90 00:06:42,960 --> 00:06:48,000 at earlier but now we'll calculate the quick ratio current assets are six hundred thousand dollars but 91 00:06:48,000 --> 00:06:51,690 we reduced that by the inventory balance of three hundred thousand dollars. 92 00:06:51,690 --> 00:06:56,700 Current Liabilities are three hundred and fifty thousand dollars so the formula is three hundred thousand 93 00:06:56,700 --> 00:07:02,210 dollars divided by three hundred and fifty thousand dollars for a quick ratio of point eighty six. 94 00:07:02,220 --> 00:07:07,870 That's a little under 1 and may mean the company will be tight on cash in the future reviewing your 95 00:07:07,870 --> 00:07:13,340 daily cash balances from recent months can tell you if you have large cash fluctuations within a month. 96 00:07:13,360 --> 00:07:17,830 I know the head of a small company that received monthly financial statements that always showed decent 97 00:07:17,830 --> 00:07:19,270 cash balances. 98 00:07:19,330 --> 00:07:22,540 He went to write a check in the middle of a month and there was no cash. 99 00:07:22,570 --> 00:07:27,600 The bulk of his revenues were received near the end of the month his month and cash balances were fine. 100 00:07:27,640 --> 00:07:30,620 But he didn't realize how tight cash was mid-month. 101 00:07:30,670 --> 00:07:32,950 He got a line of credit to fix that. 102 00:07:33,120 --> 00:07:37,380 There are few ways to get this info and I go from low tech to high tech. 103 00:07:37,380 --> 00:07:39,930 One way is to review your paper bank statements. 104 00:07:39,930 --> 00:07:44,880 Another is to review the banking transactions either in your accounting system or your bank's online 105 00:07:44,880 --> 00:07:46,290 banking site. 106 00:07:46,320 --> 00:07:52,610 A third way is to download transaction histories from your accounting software or bank your first looking 107 00:07:52,610 --> 00:07:56,750 for patterns of when you have high points in cash and low points in cash. 108 00:07:56,750 --> 00:08:00,950 See if you can find any consistent times of the month when cash is high or low. 109 00:08:00,950 --> 00:08:04,790 These patterns will be useful for you when you make cash projections. 110 00:08:04,790 --> 00:08:08,200 Also calculate the differences between the high and low balances. 111 00:08:08,210 --> 00:08:12,640 This can give you an estimate for future months of how much cash will drop or rise. 112 00:08:12,650 --> 00:08:17,000 For example if you know the difference is one hundred thousand dollars and you have eighty thousand 113 00:08:17,000 --> 00:08:19,170 dollars in cash at a high cash point. 114 00:08:19,350 --> 00:08:23,780 There's a chance that you may need to borrow twenty thousand dollars by the time cash drops back to 115 00:08:23,780 --> 00:08:30,320 its low one hundred thousand dollars lower I worked at a financial institution where a cash balances 116 00:08:30,320 --> 00:08:34,470 would pop up ten to twenty five million dollars on the last day of every month. 117 00:08:34,610 --> 00:08:39,620 The day of the week the month ended on also greatly influence whether the pop was closer to 10 million 118 00:08:39,680 --> 00:08:41,370 or twenty five million. 119 00:08:41,390 --> 00:08:48,670 This knowledge helped me manage cash a month in reviewing monthly cash balances helps you identify seasonal 120 00:08:48,670 --> 00:08:51,270 trends and the size of those trends. 121 00:08:51,310 --> 00:08:56,470 You can look at bank statements your accounting system or an online banking site you can use end of 122 00:08:56,470 --> 00:08:59,530 month balances or monthly average balances. 123 00:08:59,560 --> 00:09:03,700 Many business bank statements show an average balance for the month which is a little better to use 124 00:09:03,700 --> 00:09:05,680 for this exercise. 125 00:09:05,680 --> 00:09:08,140 One year of data can show a potential trend. 126 00:09:08,140 --> 00:09:14,680 But looking at 24 to 36 months will tell you if the pattern is consistent year after year when I worked 127 00:09:14,680 --> 00:09:19,870 at banks I would submit a worksheet to the Federal Reserve monthly average balances over the past 36 128 00:09:19,930 --> 00:09:20,950 months. 129 00:09:20,950 --> 00:09:23,890 They use this information to set the line of credit we had with them.