The biggest lesson I have learned from this experience is that we have a different mindset when it comes to our personal finances. When managing cash for a business we tend to make fairly educated decisions. For example, we analyze why we need the new equipment and how it will create efficiencies. Or we have a list of reasons why the new item is necessary for the business or how it will be beneficial in the long-term. This does not appear to be the case with our personal monies.

As individuals we tend to participate in emotional purchasing. We buy what we want vs. what we need. We make impulse purchases (and stores know this, which is why they have so much “stuff” near the cash registers). Or we can be guilty of buying something when it is on sale so we can brag about what a great deal we got.

One of the guest lecturers had a tool that showed the difference in the amount of money someone would have if they invested 5 percent of their income over a 20 year period. He then compared this to how much money they would have if they increased the investment to 10 percent. This difference was staggering. If we could all cut out 5 percent of our spending and put that money into a savings account we would all be much more prepared for retirement.

Personal financial planning does take time. I have learned a lot about my own personal goals and limitations during this process. It was interesting to see what my net worth is as I haven’t completed a balance sheet using my personal information before. Where you really see your spending habits is in the creation of an income statement. Once you see where you are spending money, it is easier to make changes.

So set aside some time to write your short-term, intermediate and long-term financial goals. Then create a balance sheet to determine what you own and what you owe. From there complete a summary of your income and expenses. Find an area or two where you can reduce your spending and allocate that money into a savings account. You are on your way to financial freedom.

One of my students, Mark, stated that, “relying on a checking account balance is very dangerous.” He mentioned that by looking only at the bank account a business owner isn’t preparing himself for liabilities that may come due, such as sales taxes. In many states the business is a collection agent for sales taxes on behalf of the state. The business will collect sales taxes upon recording a sale. The cash will sit in their bank account for about 30 days (give or take depending on their submission due dates). This is false cash in the bank. Even if you know a portion of the cash in the bank it isn’t yours, you might not be considering all of your debt and accounts payable items along with account receivables to determine your true cash position.

Another students, Craig, summarized that the statement of cash flows allows you to view the cash on hand in tandem with the items due to you and payable by you. This is because the statement of cash flows presents the flow of cash in three different categories: operating, investing and financing. In the operating section you can see how much cash is being generated from the daily sale of products and services as well as the payment for operational items.

Most accounting software providers offer the option to generate a statement of cash flows at a point in time. If you are currently reviewing your income statement and balance sheet each month or each quarter consider adding the statement of cash flows to analyze. Knowing how much cash you have in the bank is important, but planning for both the receipt and use of cash can be accomplished easier with the statement of cash flows at your fingertips.

I think this logic can apply to accounting as well. Business owners with an understand, not necessarily expertise, in accounting are more likely to be successful than those that do not have a basic understand. This is a generalization as many business owners can hire an accountant or bookkeeper to help them use their accounting information effectively.

A tip that is easy to implement and use in your business is a regular review of the Statement of Cash Flows in addition to your bank balance or check register. Most accounting software, such as Quickbooks, will calculate a Statement of Cash Flows for you so you don’t even need to really know how to do the math. The Statement of Cash Flows will show you how you are using your cash, including any increase in your Accounts Payable or other debt related accounts. It will also show changes in your Accounts Receivable account.

Managing your cash by solely using your bank account will not tell you everything that is going on in your business. Knowing how much cash is on hand is important, but it is just as valuable to know what items are due to you and are due from you.

A really good summary of what the Statement of Cash Flows is, what it includes and what it looks like is found on Wikipedia-Cash flow statement. While I do not use Wikipedia as a primary source, it often makes difficult topics easy to understand.

Hopefully you’ll use the Statement of Cash Flows in your business for the new year. You’ll be glad you did.

Did you plan for year-end bonuses? Or was it a last minute decision? What about purchases for automobiles, machinery, equipment, furniture, etc.? If you want to expand your business you will need to buy new equipment. If you want to maintain your business you will need to replace old or outdated equipment. The best way to prepare for the purchase of these large items is to prepare a capital budget.

Summarize the items you think you will need and in what month you plan on purchasing them. Compare the cost of these items to your cash budget. Will you have enough cash in the bank? If not, consider building a relationship with a banker if you do not already have one.

Next, determine the net cost or benefit of your purchase. There are a couple of ways to do this, but the easiest and most commonly used method is Net Present Value (NPV). You will need to know:

1) the cost of the item or project,
2) the life of the item or project,
3) annual cost savings or maintenance expenses,
4) the savage value, if any, and
5) the required rate of return.

Using the data listed above, you’ll drop the data into a table that includes some of the following pieces of information:

• Initial Investment (this is the amount you are paying for the new equipment or project. Show as a negative number)
• Annual cost savings (this is how much the new equipment is expected to save you over its useful life. Show as a positive number)
• Annual costs, if any (this is if the new equipment will have maintenance or other costs to operate in addition to what you pay now. Show as a negative number)
• Salvage Value (If the equipment will have value at the end of its useful life, show as a positive number)
• Net Present Value (this is the result of the figures above summed together)

For an example calculation of NPV visit NPV Example. The best way to decide when to buy, refurbish or scrap equipment/machinery is with a capital budget. Estimate the amount you will need to spend and when you plan on buying the item. Then conduct a NPV analysis to make sure the purchase is a good decision for our business.

• The timing of collections from customers. First determine what percent customers pay in the first month? In the second month? What portion is usually deemed uncollectible. For example, say 70 percent of your customers pay within 30 days, 20 percent pay within 30-60 days, 5 percent pay within 60-90 days, and the remaining customers never pay. Use this information to estimate your expected cash collections from customers by month.
• The timing of payments to suppliers and vendors. Do you pay your invoices in 30, 45 or 60 days?
• A summary of your monthly cash expenses for items such as: salaries, supplies, rent, utilities, telephone, bookkeeper fees, etc.
• The one-time or infrequent cash payments for insurance, licenses, tax preparation, etc.

With this information in hand you are ready to input the data into a cash budget template. Create a template that makes sense to you, and be sure to include sections to summarize all of the cash collections and cash payments (wages, inventory, rent, utilities, advertising expense, etc.) In order to prepare an accurate cash budget you will need the information from your master budgets, such as sales, production/inventory, and selling and administrative budgets.

A cash budget should be used to manage your daily cash flows, but more importantly, it can be a tool to help with planning for the future. Before you decide to buy a new piece of equipment, prepare a cash budget to determine if you have enough cash flow to purchase the item. Before you move into a bigger facility, review your cash budget to estimate the amount of cash flow left after the increase in rent payments have been taken into consideration.

As with any budget or accounting tool, the information provided by the cash budget is only as good as the data put into it. Use the information from the cash budget to time the payment of your expenses to maximize cash on-hand.

A friend of mine recently told me he has become a cash buyer. If he doesn’t have the cash, he doesn’t buy. In my personal life I follow this logic, to some extent. Our home is financed as is one of our cars, but everything else is paid for in full at the time of purchase. My husband and I are both simple people so this work for us. However, this might not work for you in your personal life, but can it work for your business?

What would happen in your business if you only made purchases when you had the cash to do so? Note, we are talking about big purchases, not your daily operational costs associated with inventory or supplies to provide your products or services. Would your manufacturing process suffer because you don’t have the most modern equipment? Can you get by with the computer equipment you current have?

We have all heard the saying that you have to spend money to make money. And while this saying does make sense, especially for advertising and outsourcing, we should strategically plan for how we use our cash. Incurring debt to buy a new laptop creates additional burdens on the business owner for how they manage the cash available for daily operations or emergencies.

I challenge you to only make purchases when you have the cash on hand for one month. Can you do it? If so, does the “cash only” negatively or positively impact your gross sales? If your sales are not negatively impacted, could you use this strategy for one more month? What changes do you notice in your bank account? To your stress levels?

Share your story here.

There are several advantages and disadvantages to debt financing and maintaining an appropriate debt-to-equity ratio is essential for securing future financing as well as for long term financial health. Financial experts cite numerous advantages to Debt Financing. One of the main advantages is that debt financing provides funding without diluting the ownership of the company. Additionally, with debt financing, lenders do not have a claim on any future profits of the company; the lender is limited to receiving an amount equal to the loan principal plus interest.  Most business owners find that raising capital from debt financing is much easier than equity financing as business owners do not have to comply with state and federal securities regulations. Debt financing also provides tax benefits in that the interest paid to service the debt is tax deductible.

Companies often find that there are disadvantages to debt financing. One of the obvious disadvantages is that funds financed through debt must eventually be paid back. In debt financing the principal and interest payments become fixed costs that must be accounted for when a company is determining its break-even point. Although debt payments occur on a fixed schedule, the payments require careful budgeting of cash flow which can be difficult for new businesses or business with highly varying business cycles. Debt financing also negatively affects the company’s debt-to-equity ratio causing lenders to view the company has a higher risk. With debt financing there is generally a requirement to offer company or personal assets as collateral to secure the loan. Small business owners often have to personally guarantee the loan, in full or in part. A personal guarantee means that if the company cannot pay back the debt the owner pledging the personal guarantee will repay the loan with his personal funds.

The decision to borrow funds from a bank or find an equity investor can be a tricky one. With debt you are only obligated to pay back the principle plus and interest component. With an equity investor you give up a portion of ownership in your company and your payment of dividends/distributions are variable over the life of their investment. An analysis to determine which option is best for your company should be completed before making a lending decision.

It makes sense to buy rather than lease an asset when:

1. You have the ability to use your cash reserves to pay for the asset. Or you have the ability to finance the asset through a bank or seller without hurting your debt covenants. You do not want to create too much debt for the business so take a look at the debt already outstanding before buying a new asset.

2. The asset will have a long estimated useful life and there is little risk of obsolescence.

3. You can take advantage of double-declining depreciation* in the early years of the assets useful life. This accelerates the benefit of tax deductions in the first few years of the asset life. *Double Declining Depreciation is a method commonly used for income tax purposes. Many businesses use Straight-Line for book purposes and Double-Declining for tax purposes.

4. You can afford the cash down payment or have the ability to obtain financing because the overall cash cost of the asset is less when you purchase vs. lease.

When you purchase an asset a few things happen from an accounting standpoint. The item is recorded on the Balance Sheet as an asset. The asset will be subject to depreciation so you’ll need to track the Depreciation Expense (which is reported on the Income Statement) as well as the Accumulated Depreciation (which is recorded on the Balance Sheet). In addition, as mentioned in point #1, you’ll have to record any related debt for the asset purchase as a liability.

The decision to lease vs. buy is not always an easy one. Compare the lists on the Lease blog post to this one and decide which option makes the most sense based on your current cash position.

When you lease an asset the transaction is fairly simple from an accounting standpoint. Since you don’t own the asset you are leasing there is no impact on the Balance Sheet, meaning you do not record the asset nor a corresponding liability for the debt (i.e., lease payments). You simply make monthly payments to the Lessor. Keep in mind, this is true for operating leases, not capital leases. With an operating lease you have no intent to own the asset at the end of the lease agreement along with a few other accounting tests to verify the lease is in fact an operating lease.

It makes sense to lease an asset when (i.e., operating lease):

1. Your cash flow is fairly low. Since you don’t have the ability (or willingness) to make a large payment to purchase the asset outright, a lease allows you to have access to the asset you need via monthly lease payments.

2. The asset is one where the risk of obsolescence is high, meaning that the technology will be outdated quickly. For example, many businesses lease rather than purchase computers/laptops for their employees because technology changes so quickly. Rather than being stuck with outdated technology they replace their computers every 2-3 years through lease agreements.

3. The debt on your balance sheet is a little too high or you have exceeded debt covenants by your lenders. If the asset you want to purchase is expensive, you might pay for it using some cash and financing the rest either through a bank or the seller. If you buy the asset, then you will need to record the corresponding debt on the balance sheet. If you lease the asset, you do not record any debt on the Balance Sheet.

Leasing an asset can be a good business decision, especially if you like the idea of no down payments and replacing the asset at the end of the lease term. Generally the overall cash cost of a leased asset is higher than that of a purchased one. There is no correct answer, it depends on what is the best option for your business.