New home sales go in the positive column as good economic news this Thanksgiving. In October, sales of single family homes increased by 6.2%. Home values are still falling, though by a smaller percentage. The median price of a new home in the U.S. was $212,200 in October, down by 0.5%. The inventory of new homes for sale also fell to 6.7 months from a 7.4 month inventory in September.
Don't celebrate just yet! New home sales actually fell in most regions in the U.S. but were up substantially in the South. However, expectations were that new home sales certainly would not jump by this amount due to the fact that the $8,000 new home buyer tax credit was due to expire in November. But, since it was expanded and extended to April 2010, it apparently impacted October home sales.
There are some other positive signs. The latest numbers for consumer confidence are up slightly. Consumer spending is up. First-time unemployment claims are under 500,000 for the first time since January 2009.
The stock market is climbing even though there was a major revision in third quarter economic data. Corporate earnings are holding up which is a positive sign for the stock market.
As I blog about the economy, I keep saying the same thing. Economic news is mixed and we will enter 2010 with a fragile, slow recovery in progress, with the hope that nothing happens to derail it.
Friday, November 27, 2009
Sunday, November 22, 2009
Too Big to Fail
Too Big to Fail - The Inside Story of how Wall Street and Washington Fought to Save the Financial System - and Themselves, by Andrew Ross Sorkin, a New York Times financial journalist, is a long, but fascinating story about the collapse of the U.S. and global financial markets in 2008. The book was written based on interviews the author conducted with the major players in the financial crisis. These interviews are documented through tapes, notes, presentations, calendars, call logs, and more. The level of detail is nothing short of amazing, and makes the story long. The author keeps it interesting.
Too Big to Fail
Andrew Ross Sorkin, a financial journalist for the New York Times, has attempted, in Too Big to Fail, to provide a moment-by-moment account of the worst calamity to ever affect the U.S. financial markets since the Great Depression. It became a tsunami that triggered financial collapse in the world markets as well.
Sorkin builds a story of how the financial collapse of Wall Street in the fall of 2008 actually started much earlier - in the spring of 2008. Wall Street and Washington were intricately tied together in the collapse and Sorkin details the level and depth of these ties. At the first of the book, he lists his cast of characters. They include the management of all the major investment banks like Goldman Sachs and Morgan Stanley, along with AIG, Bank of America, Fannie Mae and Freddie Mac, as well as overseas organizations from countries like China and Korea.
The cast of characters also includes a whole raft of attorneys, individuals from Great Britian, as well as from the U.S. Congress, the Department of the Treasury, the Federal Reserve, the White House, and the FDIC. This is not an exhaustive list.
Because of the author's position at the New York Times, he had unprecedented access to this cast of characters and was able to write a book with all the detail supporting the drama of what led up to the collapse of Wall Street and our financial system in 2008. The major players on Wall Street knew that the dominoes were going to fall as early as the spring of 2008 as Lehman Brothers started to fail. Sorkin discusses the events leading from that time to the collapse.
Summary
Too Big to Fail is actually a thriller about a time in America's financial history when our entire economy could have crumbled and almost did. Greed, the hunger for power, the hunger for money, and the lack of financial regulation all led to the financial collapse. You will see inside the egos of the cast of characters including the politicians involved.
Some say that Sorkin writes with a "liberal bias" but I, as a reviewer, don't see that. He seems to write the facts based on an incredible level of documentation. I give the book 4 stars. The only reason I don't give it 5 stars is because I thought the editing was poorly done.
If you want to truly understand what happened when our financial system failed and the economy went into a deep recession because of it, read this book. At the end, you will be astonished and amazingly well-informed.
Too Big to Fail
Andrew Ross Sorkin, a financial journalist for the New York Times, has attempted, in Too Big to Fail, to provide a moment-by-moment account of the worst calamity to ever affect the U.S. financial markets since the Great Depression. It became a tsunami that triggered financial collapse in the world markets as well.
Sorkin builds a story of how the financial collapse of Wall Street in the fall of 2008 actually started much earlier - in the spring of 2008. Wall Street and Washington were intricately tied together in the collapse and Sorkin details the level and depth of these ties. At the first of the book, he lists his cast of characters. They include the management of all the major investment banks like Goldman Sachs and Morgan Stanley, along with AIG, Bank of America, Fannie Mae and Freddie Mac, as well as overseas organizations from countries like China and Korea.
The cast of characters also includes a whole raft of attorneys, individuals from Great Britian, as well as from the U.S. Congress, the Department of the Treasury, the Federal Reserve, the White House, and the FDIC. This is not an exhaustive list.
Because of the author's position at the New York Times, he had unprecedented access to this cast of characters and was able to write a book with all the detail supporting the drama of what led up to the collapse of Wall Street and our financial system in 2008. The major players on Wall Street knew that the dominoes were going to fall as early as the spring of 2008 as Lehman Brothers started to fail. Sorkin discusses the events leading from that time to the collapse.
Summary
Too Big to Fail is actually a thriller about a time in America's financial history when our entire economy could have crumbled and almost did. Greed, the hunger for power, the hunger for money, and the lack of financial regulation all led to the financial collapse. You will see inside the egos of the cast of characters including the politicians involved.
Some say that Sorkin writes with a "liberal bias" but I, as a reviewer, don't see that. He seems to write the facts based on an incredible level of documentation. I give the book 4 stars. The only reason I don't give it 5 stars is because I thought the editing was poorly done.
If you want to truly understand what happened when our financial system failed and the economy went into a deep recession because of it, read this book. At the end, you will be astonished and amazingly well-informed.
Thursday, November 19, 2009
What is the times interest earned ratio and what does it measure?
Question: What is the times interest earned ratio and what does it measure?
Answer:
The times interest earned ratio is another debt ratio that measures the long-term solvency of a business. It measures how well a company can meet its interest expense obligations.
For example, if a company owes interest on its long-term loans or mortgages, the times interest earned ratio can measure how easily the company can come up with the money to pay the interest on that debt.
The calculation of the times interest earned ratio is use the earnings before interest and taxes (EBIT) figure off the income statement and divide it by the interest expense (I) figure off the income statement.
Times interest earned = EBIT/I = Number of Times
The number of times indicates how well the firm meets its interest obligations. The higher the number, the better the firm can pay its interest expense on debt. If the TIE is less than 1.0, then the firm cannot meet its total interest expense on its debt.
Usually, if the debt to assets ratio is high, you will find that the times interest owned ratio is low since the business has a lot of debt.
Answer:
The times interest earned ratio is another debt ratio that measures the long-term solvency of a business. It measures how well a company can meet its interest expense obligations.
For example, if a company owes interest on its long-term loans or mortgages, the times interest earned ratio can measure how easily the company can come up with the money to pay the interest on that debt.
The calculation of the times interest earned ratio is use the earnings before interest and taxes (EBIT) figure off the income statement and divide it by the interest expense (I) figure off the income statement.
Times interest earned = EBIT/I = Number of Times
The number of times indicates how well the firm meets its interest obligations. The higher the number, the better the firm can pay its interest expense on debt. If the TIE is less than 1.0, then the firm cannot meet its total interest expense on its debt.
Usually, if the debt to assets ratio is high, you will find that the times interest owned ratio is low since the business has a lot of debt.
Wednesday, November 18, 2009
What is the fixed charge coverage ratio and how is it calculated?
Question: What is the fixed charge coverage ratio and how is it calculated?
Answer:
The fixed charge coverage ratio is a broader measure of how well a firm covers their fixed costs than the times interest earned ratio.
The fixed charge coverage ratio includes lease payments as well as interest payments. Lease payments, like interest payments, must be met on an annual basis. The fixed charge coverage ratio is especially important for firms that extensively lease equipment, for example.
Here is the calculation for the fixed charge coverage ratio:
Earnings Before Interest and Taxes (EBIT) + Lease Payments/Interest Expense + Lease Payments = # Times
Interpretation: EBIT, Taxes, and Interest Expense are taken from the company's income statement. Lease Payments are taken from the balance sheet and are usually shown as a footnote on the balance sheet. The result of the fixed charge coverage ratio is the number of times the company can cover its fixed charges per year. The higher the number, the better the debt position of the firm, similar to the times interest earned ratio.
Like all ratios, you can only make a determination if the result of this ratio is good or bad if you use either historical data from the company or if you use comparable data from the industry.
Answer:
The fixed charge coverage ratio is a broader measure of how well a firm covers their fixed costs than the times interest earned ratio.
The fixed charge coverage ratio includes lease payments as well as interest payments. Lease payments, like interest payments, must be met on an annual basis. The fixed charge coverage ratio is especially important for firms that extensively lease equipment, for example.
Here is the calculation for the fixed charge coverage ratio:
Earnings Before Interest and Taxes (EBIT) + Lease Payments/Interest Expense + Lease Payments = # Times
Interpretation: EBIT, Taxes, and Interest Expense are taken from the company's income statement. Lease Payments are taken from the balance sheet and are usually shown as a footnote on the balance sheet. The result of the fixed charge coverage ratio is the number of times the company can cover its fixed charges per year. The higher the number, the better the debt position of the firm, similar to the times interest earned ratio.
Like all ratios, you can only make a determination if the result of this ratio is good or bad if you use either historical data from the company or if you use comparable data from the industry.
Tuesday, November 17, 2009
Before You Take out a Bank Loan, Learn to Calculate Your Interest Rate
Before you take out a bank loan, you need to know how your interest rate is calculated. There are many methods banks use to calculate interest rates and each method will change the amount of interest you pay. If you know how to calculate interest rates, you will better understand your loan contract with your bank. You are also in a better position to negotiate your interest rate with your bank. Banks will quote you the effective rate of interest. The effective rate of interest is also known as the annual percentage rate (APR). The APR or effective rate of interest is different than the stated rate of interest.
Effective Interest Rate on a one Year Loan
If you borrow $1000 from a bank for one year and have to pay $60 in interest for that year, your stated interest rate is 6%. Here is the calculation:
Effective Rate on a Simple Interest Loan = Interest/Principal = $60/$1000 = 6%
Your annual percentage rate or APR is the same as the stated rate in this example because there is no compound interest to consider. This is a simple interest loan.
Effective Interest Rate on a Loan With a Term of Less Than one Year
If you borrow $1000 from a bank for 120 days and the interest rate is 6%, what is the effective interest rate?
Effective rate = Interest/Principal X Days in the Year (360)/Days Loan is Outstanding
Effective rate on a Loan with a Term of Less Than one Year=$60/$1000 X 360/120 = 18%
The effective rate of interest is 18% since you only have use of the funds for 120 days instead of 360 days.
Effective Interest Rate on a Discounted Loan
Some banks offer discounted loans. Discounted loans are loans that have the interest payment subtracted from the principal before the loan is disbursed.
Effective rate on a discounted loan = Interest/Principal - Interest X Days in the Year (360)/Days Loan is Outstanding
Effective rate on a discounted loan=$60/$1,000 - $60 X 360/360 = 6.38%
As you can see, the effective rate of interest is higher on a discounted loan than on a simple interest loan.
Effective Interest Rate with Compensating Balances
Some banks require that the small business firm applying for a business bank loan hold a balance, called a compensating balance, with their bank before they will approve a loan. This requirement makes the effective rate of interest higher.
Effective rate with compensating balances (c) = Interest/(1-c)
Effective rate compensating balance= 6%/(1 - 0.2) = 7.5% (if c is a 20% compensating balance)
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Effective Interest Rate on Installment Loans
One of the most confusing interest rates that you will hear quoted on a bank loan is that on an installment loan. Installment loan interest rates are generally the highest interest rates you will encounter. Using the example from above:
Effective rate on installment loan = 2 X Annual # of payments X Interest/(Total no. of payments + 1) X Principal
Effective rate/installment loan=2 X 12 X $60/13 X $1,000 = 11.08%
The interest rate on this installment loan is 11.08% as compared to 7.5% on the loan with compensating balances.
Effective Interest Rate on a one Year Loan
If you borrow $1000 from a bank for one year and have to pay $60 in interest for that year, your stated interest rate is 6%. Here is the calculation:
Effective Rate on a Simple Interest Loan = Interest/Principal = $60/$1000 = 6%
Your annual percentage rate or APR is the same as the stated rate in this example because there is no compound interest to consider. This is a simple interest loan.
Effective Interest Rate on a Loan With a Term of Less Than one Year
If you borrow $1000 from a bank for 120 days and the interest rate is 6%, what is the effective interest rate?
Effective rate = Interest/Principal X Days in the Year (360)/Days Loan is Outstanding
Effective rate on a Loan with a Term of Less Than one Year=$60/$1000 X 360/120 = 18%
The effective rate of interest is 18% since you only have use of the funds for 120 days instead of 360 days.
Effective Interest Rate on a Discounted Loan
Some banks offer discounted loans. Discounted loans are loans that have the interest payment subtracted from the principal before the loan is disbursed.
Effective rate on a discounted loan = Interest/Principal - Interest X Days in the Year (360)/Days Loan is Outstanding
Effective rate on a discounted loan=$60/$1,000 - $60 X 360/360 = 6.38%
As you can see, the effective rate of interest is higher on a discounted loan than on a simple interest loan.
Effective Interest Rate with Compensating Balances
Some banks require that the small business firm applying for a business bank loan hold a balance, called a compensating balance, with their bank before they will approve a loan. This requirement makes the effective rate of interest higher.
Effective rate with compensating balances (c) = Interest/(1-c)
Effective rate compensating balance= 6%/(1 - 0.2) = 7.5% (if c is a 20% compensating balance)
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Effective Interest Rate on Installment Loans
One of the most confusing interest rates that you will hear quoted on a bank loan is that on an installment loan. Installment loan interest rates are generally the highest interest rates you will encounter. Using the example from above:
Effective rate on installment loan = 2 X Annual # of payments X Interest/(Total no. of payments + 1) X Principal
Effective rate/installment loan=2 X 12 X $60/13 X $1,000 = 11.08%
The interest rate on this installment loan is 11.08% as compared to 7.5% on the loan with compensating balances.
Monday, November 16, 2009
Calculate Your Company's Breakeven Point
Knowing Your Company's Breakeven Point is key in Cost Volume Profit Analysis
Once you know the fixed and variable costs for the product your business produces, or a good approximation of them, you can use that information to calculate your company’s breakeven point. The breakeven point is a popular tool used by small business owners to determine how much volume of their product they must sell in order to make a profit. It’s an important part of cost-volume-profit analysis.
What is Breakeven Point?
A company’s breakeven point is the point at which its sales exactly cover its expenses. The company sells enough units of its product to cover its expenses without making a profit or taking a loss. If it sells more, then it makes a profit. On the other hand, if it sells less, it takes a loss.
To compute a company’s breakeven point in sales volume, you need to know the values of three variables. Those three variables are fixed costs, variable costs, and the price of the product. Fixed costs are those which do not change with the level of sales, such as overhead. Variable costs are those which do change with the level of sales, such as cost of goods sold. The price of the product has been set by the company through looking at the wholesale cost of the product, or the cost of manufacturing the product, and marking it up.
How do you Calculate Breakeven Point?
In order to calculate your company’s breakeven point, use the following formula:
Fixed Costs/Price – Variable Costs
In this formula, fixed costs are stated as a total -- the total fixed costs for the firm. Basically, this means the total overhead for the firm. Price and variable costs, however, are stated as per unit costs – the price for each product sold and the variable cost for that unit of the product. The denominator of the equation, price minus variable costs, is called the contribution margin. In other words, this is the amount, per unit of product sold, that the firm can contribute to paying its fixed costs.
An Example of Breakeven Point
XYZ Corporation has calculated that it has fixed costs that consist of its lease, depreciation of its assets, executive salaries, and property taxes. Those fixed costs add up to $60,000. Their product is the widget. Their variable costs associated with producing the widget are raw material, factory labor, and sales commissions. Variable costs have been calculated to be $0.80 per unit. The widget is priced at $2.00 each.
Given this information, we can calculate the breakeven point for XYZ Corporation’s product, the widget.
Fixed Costs/Price – Variable Costs
$60,000/$2.00 - $0.80 = 50,000 units
XYZ Corporation has to produce and sell 50,000 widgets in order to cover their total expenses, fixed and variable. At this level of sales, they will make no profit but will just breakeven.
What Happens to the Breakeven Point if Sales Change?
What if your sales change? For example, if the economy is in a recession, your sales might drop. If sales drop, then you won’t sell enough to make your breakeven point. In the example of XYZ Corporation, you might not sell the 50,000 units necessary to breakeven. In that case, you would not be able to pay all your expenses. What can you do in this situation?
If you look at the breakeven formula, you can see that there are two solutions. You can either raise the price of your product or you can find ways to cut your costs, your fixed and/or your variable costs.
Let’s say you find a way to cut the cost of your overhead or fixed costs by reducing your own salary by $10,000. That makes your fixed costs drop from $60,000 to $50,000. The breakeven point is, holding other variables the same,:
$50,000/$2.00-$0.80 = 41,666 units
Predictably, cutting your fixed costs drops your breakeven point.
If you reduce your variable costs by cutting your costs of goods sold to $0.60 per unit, then your breakeven point, holding other variables the same, becomes:
$60,000/$2.00-$0.60=42,857 units
From this analysis, you can see that if you can reduce the cost variables, you can lower your breakeven point without having to raise your price.
Relationships Between Fixed Costs, Variable Costs, Price, and Volume
As the owner of a small business, you can see that any decision you make about pricing your product, the costs you incur in your business, and the resulting volume that you sell are interrelated. Calculating the breakeven point is just one component of cost-volume-profit analysis.
Once you know the fixed and variable costs for the product your business produces, or a good approximation of them, you can use that information to calculate your company’s breakeven point. The breakeven point is a popular tool used by small business owners to determine how much volume of their product they must sell in order to make a profit. It’s an important part of cost-volume-profit analysis.
What is Breakeven Point?
A company’s breakeven point is the point at which its sales exactly cover its expenses. The company sells enough units of its product to cover its expenses without making a profit or taking a loss. If it sells more, then it makes a profit. On the other hand, if it sells less, it takes a loss.
To compute a company’s breakeven point in sales volume, you need to know the values of three variables. Those three variables are fixed costs, variable costs, and the price of the product. Fixed costs are those which do not change with the level of sales, such as overhead. Variable costs are those which do change with the level of sales, such as cost of goods sold. The price of the product has been set by the company through looking at the wholesale cost of the product, or the cost of manufacturing the product, and marking it up.
How do you Calculate Breakeven Point?
In order to calculate your company’s breakeven point, use the following formula:
Fixed Costs/Price – Variable Costs
In this formula, fixed costs are stated as a total -- the total fixed costs for the firm. Basically, this means the total overhead for the firm. Price and variable costs, however, are stated as per unit costs – the price for each product sold and the variable cost for that unit of the product. The denominator of the equation, price minus variable costs, is called the contribution margin. In other words, this is the amount, per unit of product sold, that the firm can contribute to paying its fixed costs.
An Example of Breakeven Point
XYZ Corporation has calculated that it has fixed costs that consist of its lease, depreciation of its assets, executive salaries, and property taxes. Those fixed costs add up to $60,000. Their product is the widget. Their variable costs associated with producing the widget are raw material, factory labor, and sales commissions. Variable costs have been calculated to be $0.80 per unit. The widget is priced at $2.00 each.
Given this information, we can calculate the breakeven point for XYZ Corporation’s product, the widget.
Fixed Costs/Price – Variable Costs
$60,000/$2.00 - $0.80 = 50,000 units
XYZ Corporation has to produce and sell 50,000 widgets in order to cover their total expenses, fixed and variable. At this level of sales, they will make no profit but will just breakeven.
What Happens to the Breakeven Point if Sales Change?
What if your sales change? For example, if the economy is in a recession, your sales might drop. If sales drop, then you won’t sell enough to make your breakeven point. In the example of XYZ Corporation, you might not sell the 50,000 units necessary to breakeven. In that case, you would not be able to pay all your expenses. What can you do in this situation?
If you look at the breakeven formula, you can see that there are two solutions. You can either raise the price of your product or you can find ways to cut your costs, your fixed and/or your variable costs.
Let’s say you find a way to cut the cost of your overhead or fixed costs by reducing your own salary by $10,000. That makes your fixed costs drop from $60,000 to $50,000. The breakeven point is, holding other variables the same,:
$50,000/$2.00-$0.80 = 41,666 units
Predictably, cutting your fixed costs drops your breakeven point.
If you reduce your variable costs by cutting your costs of goods sold to $0.60 per unit, then your breakeven point, holding other variables the same, becomes:
$60,000/$2.00-$0.60=42,857 units
From this analysis, you can see that if you can reduce the cost variables, you can lower your breakeven point without having to raise your price.
Relationships Between Fixed Costs, Variable Costs, Price, and Volume
As the owner of a small business, you can see that any decision you make about pricing your product, the costs you incur in your business, and the resulting volume that you sell are interrelated. Calculating the breakeven point is just one component of cost-volume-profit analysis.
How to do a Cash Flow Analysis
Cash is the gasoline that makes your business run. Cash flow can be defined as the way money moves into and out of your business; it is the difference between just being able to open a business and being able to stay in business. A cash flow analysis is a method of checking up on your firm’s financial health. It is the study of the movement of cash through your business, called a cash budget, to determine patterns of how you take in and pay out money. The goal is to maintain sufficient cash for firm operations from month to month. This type of cash flow analysis is called developing the cash budget.
Difficulty: Average
Time Required: 3 hours
Here's How:
1. This type of cash flow analysis is called cash budgeting analysis. It is part of your firm's financial forecasting plan. Determine the amount of cash that will flow into your firm during the month. If you are just starting your business, you should include the beginning balance in cash that you want to have available every month. There would also be the amount of sales you have during the first month. Sales would include both cash sales and sales that you make to your customers who pay on credit. Here's an example you can follow to develop your Schedule of Cash Receipts (Sales Receipts).
2. Determine the amount of cash that will flow out of your firm during the month. You will have expenses. You will probably have to buy office supplies. Other monthly expenses may include advertising, vehicle expenses, payroll expenses, just to name a few. You will have some quarterly expenses, such as taxes. You may have expenses that just occur occasionally, like purchases of computer equipment, vehicles, or other larger expenses. Here is an example of a Schedule of Cash Payments that is the second step of the cash budget.
3. You want the cash that will flow into your firm (Step 1) to be greater than the cash that will flow out of your firm (Step 2). This means that your monthly cash inflow needs to be greater than your monthly cash outflow so you will have sufficient cash to operate your firm. Here's a blank worksheet you can use to calculate your cash inflow or cash receipts and another blank worksheetyou can use to calculate your cash payments.
4. Your ending balance for the first month becomes the beginning balance for the second month. You do the same type of analysis. Each month, you may have to add more items to your cash flow analysis as your business grows. You need to decide what the minimum ending cash balance is that you find acceptable for your firm and aim toward that figure each month.
5. If your cash flow turns negative for any one month, you will have to borrow money for that month from family or friends, investors, or from a bank or other financial institutions. Then, if your cash flow is positive the next month, you can repay that loan.
6. Keep on doing this each month for your forecasting period. Try to keep your borrowing to a minimum and your cash inflow greater than your outflows. Remember that this cash budget is a financial forecasting document but try to follow it as closely as possible. Here is an example of a completed Cash Budget, based on the schedules already completed, that you can look at. Here is a blank worksheet you can use for your own company.
Tips:
1. Take a look at this article. It shows you how to use the cash budget as a part of a comprehensive financial forecasting plan.
2. This worksheet helps you develop the first part of your cash budget, the Schedule of Cash Receipts. This blank worksheet gives you space to develop your own Schedule of Cash Receipts.
3. This example of the Schedule of Cash Payments shows you how to develop the schedule for your company. Here is the blank worksheet you can use to develop a Statement of Cash Payments for your company.
4. Here is an example of a cash budget based on the schedules developed previously. Here is a blank worksheet you can use for your own company.
What You Need:
* Your business computer
* The computerized accounting program you use
* All your sales receipts and expenses
* How much cash you want to have on hand at all times
* Your initial beginning cash balance
Difficulty: Average
Time Required: 3 hours
Here's How:
1. This type of cash flow analysis is called cash budgeting analysis. It is part of your firm's financial forecasting plan. Determine the amount of cash that will flow into your firm during the month. If you are just starting your business, you should include the beginning balance in cash that you want to have available every month. There would also be the amount of sales you have during the first month. Sales would include both cash sales and sales that you make to your customers who pay on credit. Here's an example you can follow to develop your Schedule of Cash Receipts (Sales Receipts).
2. Determine the amount of cash that will flow out of your firm during the month. You will have expenses. You will probably have to buy office supplies. Other monthly expenses may include advertising, vehicle expenses, payroll expenses, just to name a few. You will have some quarterly expenses, such as taxes. You may have expenses that just occur occasionally, like purchases of computer equipment, vehicles, or other larger expenses. Here is an example of a Schedule of Cash Payments that is the second step of the cash budget.
3. You want the cash that will flow into your firm (Step 1) to be greater than the cash that will flow out of your firm (Step 2). This means that your monthly cash inflow needs to be greater than your monthly cash outflow so you will have sufficient cash to operate your firm. Here's a blank worksheet you can use to calculate your cash inflow or cash receipts and another blank worksheetyou can use to calculate your cash payments.
4. Your ending balance for the first month becomes the beginning balance for the second month. You do the same type of analysis. Each month, you may have to add more items to your cash flow analysis as your business grows. You need to decide what the minimum ending cash balance is that you find acceptable for your firm and aim toward that figure each month.
5. If your cash flow turns negative for any one month, you will have to borrow money for that month from family or friends, investors, or from a bank or other financial institutions. Then, if your cash flow is positive the next month, you can repay that loan.
6. Keep on doing this each month for your forecasting period. Try to keep your borrowing to a minimum and your cash inflow greater than your outflows. Remember that this cash budget is a financial forecasting document but try to follow it as closely as possible. Here is an example of a completed Cash Budget, based on the schedules already completed, that you can look at. Here is a blank worksheet you can use for your own company.
Tips:
1. Take a look at this article. It shows you how to use the cash budget as a part of a comprehensive financial forecasting plan.
2. This worksheet helps you develop the first part of your cash budget, the Schedule of Cash Receipts. This blank worksheet gives you space to develop your own Schedule of Cash Receipts.
3. This example of the Schedule of Cash Payments shows you how to develop the schedule for your company. Here is the blank worksheet you can use to develop a Statement of Cash Payments for your company.
4. Here is an example of a cash budget based on the schedules developed previously. Here is a blank worksheet you can use for your own company.
What You Need:
* Your business computer
* The computerized accounting program you use
* All your sales receipts and expenses
* How much cash you want to have on hand at all times
* Your initial beginning cash balance
Debt and Equity Financing
The Advantages and Disadvantages of Debt and Equity Financing
When you decide to start a small business, one of your first questions is likely to be how to raise money to finance your business operations. No matter how you plan to obtain financing for your business, you need to spend some time developing a business plan. Only then should you go forward with financing plans for even a simple small business.
Equity Financing
You may have some cash you want to put into the business yourself, so that will be your initial base. Maybe you also have family or friends who are interested in your business idea and they would like to invest in your business. That may sound good on the surface to you, but even if this is the best arrangement for you, there are factors you must consider before you jump in. If you decide to accept investments from family and friends, you will be using a form of financing called equity financing.
One thing that you want to be clear about is whether your family and friends want to invest in your business or loan you some money for your business. That is a crucial distinction! If they want to invest, then they are offering you equity financing. If they want to loan you money for your business, then that is quite different and is actually considered debt financing.
Advantages of Equity Financing:
*
You can use your cash and that of your investors when you start up your business for all the start-up costs, instead of making large loan payments to banks or other organizations or individuals. You can get underway without the burden of debt on your back.
*
If you have prepared a prospectus for your investors and explained to them that their money is at risk in your brand new start-up business, they will understand that if your business fails, they will not get their money back.
*
Depending on who your investors are, they may offer valuable business assistance that you may not have. This can be important, especially in the early days of a new firm. You may want to consider angel investors or venture capital funding. Choose your investors wisely!
Disadvantages of Equity Financing:
*
Remember that your investors will actually own a piece of your business; how large that piece is depends on how much money they invest. You probably will not want to give up control of your business, so you have to be aware of that when you agree to take on investors. Investors do expect a share of the profits where, if you obtain debt financing, banks or individuals only expect their loans repaid. If you do not make a profit during the first years of your business, then investors don’t expect to be paid and you don’t have the monkey on your back of paying back loans.
*
Since your investors own a piece of your business, you are expected to act in their best interests as well as your own, or you could open yourself up to a lawsuit. In some cases, if you make your firm’s securities available to just a few investors, you may not have to get into a lot of paperwork, but if you open yourself up to wide public trading, the paperwork may overwhelm you. You will need to check with the Securities and Exchange Commission to see the requirements before you make decisions on how widely you want to open up your business for investment.
Debt Financing
If you decide that you do not want to take on investors and want total control of the business yourself, you may want to pursue debt financing in order to start up your business. You will probably try to tap your own sources of funds first by using personal loans, home equity loans, and even credit cards. Perhaps family or friends would be willing to loan you the necessary funds at lower interest rates and better repayment terms. Applying for a business loan is another option.
Advantages of Debt Financing
*
Debt financing allows you to have control of your own destiny regarding your business. You do not have investors or partners to answer to and you can make all the decisions. You own all the profit you make.
*
If you finance your business using debt, the interest you repay on your loan is tax-deductible. This means that it shields part of your business income from taxes and lowers your tax liability every year. Your interest is usually based on the prime interest rate.
*
The lender(s) from whom you borrow money do not share in your profits. All you have to do is make your loan payments in a timely manner.
*
You can apply for a Small Business Administration loan that has more favorable terms for small businesses than traditional commercial bank loans.
Disadvantages of Debt Financing
*
The disadvantages of borrowing money for a small business may be great. You may have large loan payments at precisely the time you need funds for start-up costs. If you don’t make loan payments on time to credit cards or commercial banks, you can ruin your credit rating and make borrowing in the future difficult or impossible. If you don’t make your loan payments on time to family and friends, you can strain those relationships.
#
For a new business, commercial banks may require you to pledge your personal assets before they will give you a loan. If your business goes under, you will lose your personal assets.
#
Any time you use debt financing, you are running the risk of bankruptcy. The more debt financing you use, the higher the risk of bankruptcy.
#
Some will tell you that if you incorporate your business, your personal assets are safe. Don’t be so sure of this. Even if you incorporate, most financial institutions will still require a new business to pledge business or personal assets as collateral for your business loans. You can still lose your personal assets.
Which is best; debt or equity financing? It depends on the situation. Your financial capital, potential investors, credit standing, business plan, tax situation, the tax situation of your investors, and the type of business you plan to start all have an impact on that decision.
Make this decision wisely!
When you decide to start a small business, one of your first questions is likely to be how to raise money to finance your business operations. No matter how you plan to obtain financing for your business, you need to spend some time developing a business plan. Only then should you go forward with financing plans for even a simple small business.
Equity Financing
You may have some cash you want to put into the business yourself, so that will be your initial base. Maybe you also have family or friends who are interested in your business idea and they would like to invest in your business. That may sound good on the surface to you, but even if this is the best arrangement for you, there are factors you must consider before you jump in. If you decide to accept investments from family and friends, you will be using a form of financing called equity financing.
One thing that you want to be clear about is whether your family and friends want to invest in your business or loan you some money for your business. That is a crucial distinction! If they want to invest, then they are offering you equity financing. If they want to loan you money for your business, then that is quite different and is actually considered debt financing.
Advantages of Equity Financing:
*
You can use your cash and that of your investors when you start up your business for all the start-up costs, instead of making large loan payments to banks or other organizations or individuals. You can get underway without the burden of debt on your back.
*
If you have prepared a prospectus for your investors and explained to them that their money is at risk in your brand new start-up business, they will understand that if your business fails, they will not get their money back.
*
Depending on who your investors are, they may offer valuable business assistance that you may not have. This can be important, especially in the early days of a new firm. You may want to consider angel investors or venture capital funding. Choose your investors wisely!
Disadvantages of Equity Financing:
*
Remember that your investors will actually own a piece of your business; how large that piece is depends on how much money they invest. You probably will not want to give up control of your business, so you have to be aware of that when you agree to take on investors. Investors do expect a share of the profits where, if you obtain debt financing, banks or individuals only expect their loans repaid. If you do not make a profit during the first years of your business, then investors don’t expect to be paid and you don’t have the monkey on your back of paying back loans.
*
Since your investors own a piece of your business, you are expected to act in their best interests as well as your own, or you could open yourself up to a lawsuit. In some cases, if you make your firm’s securities available to just a few investors, you may not have to get into a lot of paperwork, but if you open yourself up to wide public trading, the paperwork may overwhelm you. You will need to check with the Securities and Exchange Commission to see the requirements before you make decisions on how widely you want to open up your business for investment.
Debt Financing
If you decide that you do not want to take on investors and want total control of the business yourself, you may want to pursue debt financing in order to start up your business. You will probably try to tap your own sources of funds first by using personal loans, home equity loans, and even credit cards. Perhaps family or friends would be willing to loan you the necessary funds at lower interest rates and better repayment terms. Applying for a business loan is another option.
Advantages of Debt Financing
*
Debt financing allows you to have control of your own destiny regarding your business. You do not have investors or partners to answer to and you can make all the decisions. You own all the profit you make.
*
If you finance your business using debt, the interest you repay on your loan is tax-deductible. This means that it shields part of your business income from taxes and lowers your tax liability every year. Your interest is usually based on the prime interest rate.
*
The lender(s) from whom you borrow money do not share in your profits. All you have to do is make your loan payments in a timely manner.
*
You can apply for a Small Business Administration loan that has more favorable terms for small businesses than traditional commercial bank loans.
Disadvantages of Debt Financing
*
The disadvantages of borrowing money for a small business may be great. You may have large loan payments at precisely the time you need funds for start-up costs. If you don’t make loan payments on time to credit cards or commercial banks, you can ruin your credit rating and make borrowing in the future difficult or impossible. If you don’t make your loan payments on time to family and friends, you can strain those relationships.
#
For a new business, commercial banks may require you to pledge your personal assets before they will give you a loan. If your business goes under, you will lose your personal assets.
#
Any time you use debt financing, you are running the risk of bankruptcy. The more debt financing you use, the higher the risk of bankruptcy.
#
Some will tell you that if you incorporate your business, your personal assets are safe. Don’t be so sure of this. Even if you incorporate, most financial institutions will still require a new business to pledge business or personal assets as collateral for your business loans. You can still lose your personal assets.
Which is best; debt or equity financing? It depends on the situation. Your financial capital, potential investors, credit standing, business plan, tax situation, the tax situation of your investors, and the type of business you plan to start all have an impact on that decision.
Make this decision wisely!
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