Investing, small business, lending, small business owners, Kapitus

Should You Invest Your Business’ Surplus Cash? Absolutely

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If sales are booming and your small business is flush with cash, congratulations! While having a large surplus of cash is great for your small business, SMB owners also need to understand that the more surplus cash you have, the greater your chances are of losing money. 

How? Well, the rate of inflation reached a four-decade high of 7.9% in February, and the interest you’re collecting on your business savings account is almost certainly far less than that. Also, if you have any outstanding loans, the interest you’re paying on them is far greater than the interest from your savings account. You should also remember that we’re still going through “The Great Resignation,” so if you plan to increase your staff, current wage growth most likely is exceeding the interest that you’re getting from your business savings account.

How to Determine Timelines For Reinvesting Excess Cash

If you’re in the fortunate position of having a large cash surplus for your business, you have plenty of options to invest that cash in a way that you won’t lose money. Before you consider your options, however, you should first take the time to determine what you want to use that excess cash for. The first thing you want to do is assess what you want to spend it on, and what your time horizons may be for spending that cash. 

Kapitus, small business, investment, advisor, lending

A registered investment advisor can assist and educate you on your investment decisions.

You may want to seek advice from a financial advisor or a broker-dealer on how to invest your extra money. Take note that some financial advisors will only deal with you if you have a certain amount to invest and are generally more expensive than brokers, so choose carefully. If you feel you’re a sophisticated investor, you can always use online trading services such as Ameritrade, E*Trade or Robinhood. 

Short-Term Spending and Investing

If you have short-term plans to spend your surplus cash over the next year or less, such as expanding your business with additional staff; leasing a larger workspace; purchasing additional non-perishable inventory before inflation rises even further; or replacing old equipment crucial to your business in the next 12 months, there are investment instruments that can give you a much higher yield than your business savings account. 

You can also forgo investing by using your surplus cash to pay off any outstanding loans you may have, as many lenders do offer a pre-pay discount if you choose to pay off several types of loans before their terms expire.

If you are willing to go the investment route, there are plenty of asset management firms that offer a wide array of short-term investment options. As a business owner, you want these options to give you returns that are greater than your business savings account and are highly liquid. Some of these options include:

  • A money market account. This is an account that you can open at most large banks or by going through a broker and purchasing shares in a money market mutual funds. It will provide a higher yield than a savings account because it invests your money in short-term treasury bonds or commercial paper – a form of short-term financing typically used by large corporations. These types of accounts are considered very low risk and can be liquidated at a moment’s notice. 
  • A short-term treasury market mutual fund. Most investment managers do offer mutual funds designed for short-term investors. These funds tend to be low risk and typically invest in a mix of investment-grade and short-duration treasury bonds. Keep in mind, however, that mutual fund fees can be expensive, so shop around.
  • A certificate of deposit (CD). With the federal funds overnight rate set to rise, you may consider a CD. This is considered a low-risk account in which you can park your money and get a monthly fixed, compounding interest rate over a predetermined period that can be six months, a year or longer.  Most banks offer these types of vehicles, but you should shop around for ones that offer the best rate.
  • An exchange-traded fund (ETF).  ETFs are often cheaper than mutual funds because they don’t invest directly in securities like stocks and bonds, but rather, index futures. Put simply, they are funds that will typically generate the passive returns of whatever financial index you choose. Common indices include the S&P 500 Index (stocks) and the Bloomberg US Aggregate Bond Index (bonds). If your risk/return tolerance is high, you can invest in the stock market. Keep in mind that the average annual compounded return for the S&P 500 since its inception in the early 20th century is 10.5%, but the short-term volatility is high. 

How To Determine Your Business Short Term Spending vs. Long Term Investments

Are there long-term spending goals in your business plan, such as developing and offering a new product, or moving your headquarters to a larger space a few years down the road? The COVID-19 pandemic, which is now entering its third year, taught us that the economy can turn on a dime, so maybe you want to create an emergency cash reserve fund to keep your business afloat when the next recession hits. These are just a few examples of what you may have long-term spending plans for. 

If you have plans for your surplus cash that extend beyond a year, you can tolerate more risk, which means you have the potential to generate higher returns on your investments over the long haul. There are plenty of asset classes you can choose from that, despite having short-term volatility, have average annual returns that are much higher than anything you would see from a savings account or short-term bond investment. To put it simply, the longer your investment time horizon is, the greater your returns on capital can be. 

Your registered investment advisor (RIA) should educate you on the different asset classes and types of mutual funds that are best for long-term investing, as well as the basics such as risk management, modern portfolio theory, and portfolio optimization strategies. Depending on how much cash you have to invest, you may wish to invest in a basket of mutual funds for a diversified portfolio. Your RIA should also keep you informed on world events and how they may affect your portfolio.

Long-term Asset Classes

Some options you may consider for long-term investing include:

  1. An asset allocation mutual fund. If you want to invest in the long-term but don’t have the stomach for taking on excess investment risk, this may be the option for you. This type of mutual fund automatically allocates your assets among stocks, bonds and cash to optimize investment risk.
  2. Mutual funds that invest in equities (stocks). There are plenty of funds that invest in stocks. While these funds tend to be more expensive than low-risk bond funds – especially if they are actively managed – they tend to produce the highest returns over the long term. There are equity mutual funds that invest in everything from the S&P 500 Index to foreign stocks in emerging economies.
  3. Real Estate mutual funds. There are mutual funds that invest exclusively in various forms of real estate. Before you decide to invest, you should speak to your financial advisor and know that these types of mutual funds carry high management fees and high short-term volatility.
  4. Alternative investments. There are mutual funds that engage in exotic investment strategies, such as long/short, absolute return, and portable alpha strategies, and carry high management fees. These funds often seek to curb risk while delivering consistent returns. However, you need to make sure you get a solid understanding of these funds from your RIA before investing.

Don’t Lose Money!

Having surplus cash is a great thing for your small business, as it gives you many options for growing your business and surviving during a downturn. You must understand, however, that simply squirreling it away in your business savings account can cost you dearly. If you’re in such a fortunate position, speak with your accountant or an RIA to find out what your options are. 

 

Managing your financial turn around strategy

How to Manage Your Company’s Financial Turnaround

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If you’re a small business owner, you probably took a major financial hit during the dark times of the COVID-19 pandemic. Right now however, you should probably be congratulating yourself – you survived over a year of turmoil! 

With a light at the end of the tunnel shining brightly as more Americans get vaccinated, now is the perfect time to plan your company’s financial turnaround, provided you’re willing to rethink your operations, cash flow, employment situation and potential financing.

How To Rethink Your Business Cash Flow

Maintaining a healthy cash flow is one of the most important aspects of running a business, as it impacts every area of day-to-day operations – both current and future. If the last year and a half taught us anything, it’s that you never know what can come around the corner and negatively impact your cash flow, so it’s important to address this head-on, and there are a number of areas where you can do that, but a great place to start is your collections and billing processes.

Tackle those outstanding invoices

Lazy bookkeeping, the pandemic, and other factors could have resulted in a negative cash flow for your business over the past year. While outstanding invoices are positive assets on your company’s balance sheet, they are useless until your customers actually pay them. If you’re behind on collecting invoices, or if your customers are slow to pay, one strategy that could be useful to you is invoice factoring – financing that quickly provides you with cash tied up in outstanding invoices.  

Review and Adjust Your Process

As you ramp back up post-pandemic, take advantage of the opportunity to do a complete review of your billing and collections policies.  Many times, a review will reveal some holes and/or inefficiencies that, if corrected, can have a substantial impact on cash-flow stability. Once you’ve defined any gaps, consider implementing invoice management software, such as Quickbooks or Invoice2Go – useful tools that can automate the invoice, payment processing and collections systems for your business. 

Negotiate with Vendors

Healthy vendor relationships are almost as important as a healthy cash flow, and one way to maintain a great relationship with your vendors and suppliers is to negotiate contracts that are mutually beneficial. Suppliers generally want to keep you as a customer, so it never hurts to ask them if you can renegotiate prices and payment options, at least until the economy gets back on its feet. Be honest about your financial situation and propose a solution that seems mutually beneficial, such as longer-term payment options. 

Restructuring Your Business Should Be a Consideration in Your Company’s Turnaround

Operational restructuring should be a major consideration in any organization’s financial turnaround.  Look for costly and redundant processes in your business and have a plan to streamline or outsource them. Consider that it could be cheaper to outsource certain services to freelancers or outside firms. For example, if you’re a small publishing company, it may be cheaper to streamline production services for all of your publications and hire freelance writers. If you’re a doctor’s office, for example, it may be cheaper to outsource x-ray analysis work to radiologists in a different country.

Prepare Your Business for Rapid Growth

As the COVID-19 pandemic winds down, most small business owners and economists are expecting the economy to grow. The national unemployment rate dropped to 6.1% in April from 14.8% a year ago, according to the Bureau of Labor Statistics. Consumer spending has increased by over 40% in 2021, while it was down by nearly 30% in 2020, according to the Bureau of Economic Analysis. 

Whether you’re a construction company, a restaurant or retailer, you need to be ready to handle this growth. You should sit down with your accountant and produce a realistic, three-year business plan that accounts for an increase in sales, operational growth and an increase in your number of employees. Some factors to consider:

  • During the pandemic, employees have gotten a taste of working from the comfort of their own homes. If you’re a small business that operates out of an office and you want to permanently move to a remote working environment, you should consider relocating your company headquarters to a smaller, less expensive and more tax-friendly location. However, if you do this, talk to your accountant about the tax implications.
  • Consider financing to handle growth. More business should be coming your way over the next year. Whether you’re a construction company that needs a new excavator, or a restaurant owner that wants a new brick oven to make your famous pizzas, you may consider new financing that you can repay as your business grows. Kapitus offers a wide array of financing options such as equipment financing, a new line of credit or a business loan that could help you with that.
  • As business grows, you will probably need to hire additional employees. When you do, it is important to make sure that you are hiring within your means. The number of additional staffers you hire should be in lockstep with the rate at which your business is growing.

While the pandemic was a source of severe economic strain for many small businesses, there is a bit of a silver lining:  It has created a valuable opportunity to rework aspects of your business that you may have had to put on hold in the past, which puts you on the road to recovery while providing a stronger foundation for your business in the future. 

How to Strengthen Your Balance Sheet to Qualify for a Loan

How to Strengthen Your Balance Sheet to Qualify for a Loan

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Admittedly, some business owners neglect to review their financial statements monthly. Some, actually, only review financial statements yearly–and only for tax purposes! If you want a true ideal picture of your company’s financial health, you absolutely need to regularly monitor your financials, including your balance sheet. While lenders want to see that your firm is profitable, they are most concerned with whether or not you have sufficient working capital, a manageable debt to equity ratio and a strong operating history. Since your balance sheet provides all this information and more, you will definitely want to strengthen your balance sheet if you are seeking a loan.

Increase your working capital.

The more cash or assets you have readily on hand that can be converted into cash to pay your current obligations, the lower the risk you will default on a loan. In other words? Lots of cash and equivalents encourage a lender to lend. Working capital is short-term assets less short-term liabilities. Short-term assets include cash and cash equivalents as well as inventory and receivables. Short-term liabilities include all payables. Hence why lenders focus on working capital.

However, your working capital calculation can significantly differ from the lender’s. Lenders will drastically discount older current assets. If your inventory does not have quick turnover (this timing varies by industry), then lenders will discount its value from what shows on your balance sheet. Furthermore, if you are in an industry with shorter inventory lifespans such as retail and you have unsold inventory that is over two years old, when you sell it, you likely will only get a fraction of what you paid for it. Obviously, lenders cannot count on that cash for bill payment. They will thus exclude that inventory from your firm’s working capital calculation. The same applies to receivables. If your receivables are due in 30 days but 40 percent are over 90 days old, the lender will completely ignore that 40 percent. The exceptions are slow-paying industries such as industrial construction.

Since your old inventory and receivables will be totally excluded by lenders in their working capital calculation, convert those assets to cash. The cash will be included. Sell off your old inventory. Vigorously pursue all overdue receivables. To ensure your inventory turns over in a reasonable amount of time, only buy what sells or ramp up your marketing efforts. To square up your receivables within 30-day terms, create and implement strong accounts receivable and credit policies.

Decrease your debt.

Lenders look at your overall debt, your interest-bearing debt or both, compared to your equity. A high debt burden could mean trouble. Acceptable debt to equity ratios vary by industry. A capital-intensive industry like manufacturing will require much more capital investment than a services-oriented industry like marketing firms.

If you have unused or chronically underused equipment, strongly consider selling it. The purpose of an asset is to help produce or deliver the goods or services your firm provides. If a large asset is just sitting there, it is not fulfilling its mission. Not only will selling reduce your debt, it will convert the associated asset from PP&E to cash on the balance sheet. Although both are assets, the additional cash is much more powerful because it increases your working capital. Remember, working capital indicates your firm’s ability to repay debt in the near term.

Increase your equity.

The lender wants to see that your company has a profitable history. She also wants to know that you reinvest in the company. Why? That shows you both believe in your firm and expect it to grow. Therefore, the owner’s equity piece is very important. Do you retain a sizable portion of the earnings or do you pull every last dollar out you can? If it’s the latter, stop. Your owner’s equity needs to be high enough to be compelling.

One way to both decrease debt and increase owner’s equity at the same time is to convert any shareholder loans to equity. Owners often provide loans to the company instead of injecting equity capital for several reasons. The most notable reason is that you can receive a loan repayment of principal tax-free. But, you must pay taxes on any distributions received. However, if you are seeking funding, a strong balance sheet trumps your lower taxes. Make that conversion and immediately strengthen your balance sheet.

Reviewing your financial statements is important as they serve as the barometer of your firm’s financial condition. This is especially true of the balance sheet. If your firm is in expansion mode, use one or more of these suggestions to proactively strengthen your balance sheet to qualify for a loan.

Profit Plans for Business Success

Do You Know How to Make a Profit Plan?

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Is your business designed to make a profit? Do you have a target profit figure in mind? If not, you should consider creating a profit plan for your business. While a business plan shows the results you hope to achieve, a plan for profits details how you intend to make it happen. It puts you in charge.

To increase the chances of reaching your profit objective, follow this guide and learn how to create a profit plan for your business.

What is Planning for Profits?

In a nutshell, planning for profits requires management to make a set of decisions that describe how a company intends to reach a target profit level. As such, his plan details what actions will be taken, who will do them and when they will be done.

In this sense, a profit plan is a pro-active road map that an owner can use to take the company from Point A to Point B. It discourages wandering off on side roads and keeps the business focused on the goals.

The process of creating a profit plan forces you to make realistic evaluations of the strengths and weaknesses of your company, also known as a SWOT analysis. The results of this analysis will form the basis for determining a practical and achievable profit objective, not a pie-in-the-sky goal.

How to Create a Profit Plan

You will use the profit objective from the SWOT study to identify what steps must be taken to reach this goal. Is it a rise in sales, a reshuffling of your product mix, an increase in selling prices or a reduction in expenses?

Using your historical financial figures as a basis, identify the changes that will be necessary to reach your profit objective.

You must determine the actions needed and who will be responsible for the results. For example, you might:

  • Invest in research and development to modify product features to meet changing customer preferences
  • Expand by opening locations in other regions
  • Purchase more efficient production equipment
  • Negotiate better prices with suppliers to reduce costs of production
  • Hire additional sales staff
  • Spend more on marketing

Once you have made these decisions, the required actions can be incorporated into your profit plan. These actions can include making projections of revenues and setting costs for manufacturing products or providing services and establishing,  In addition, it should also include budgets for overhead expenses. Any additional capital investments should identify the sources of financing, either funded internally or with outside loans.

The resulting document becomes the road map that defines the company’s activities for the coming year. You can set up reporting systems with benchmarks to measure progress along the way.

How to Make Your Plan Effective

An effective profit plan should have the following traits:

  • Key managers and employees must be involved in the planning and development
  • The analysis must be thorough and address all of the company’s important short- and long-term issues
  • The plan should anticipate future trends and changes in the company’s market environment
  • You should make provisions for changes when key assumptions prove invalid

What are the Benefits of a Profit Plan?

In addition to providing a clear direction for your company, a profit plan has other benefits. A profit plan is useful for:

  • Giving managers explicit financial goals and objectives
  • Defining specific performance metrics for employees
  • Educating employees on the direction of the company to gain their participation
  • For motivating key employees
  • Establishing a foundation for making strategic decisions
  • Creating action plans as a basis for monitoring progress and measuring performance

Planning to make a profit is an important mindset for every small business owner. Profit plans create a different perspective of making something happen rather than working hard and hoping to get good results. You can increase your odds of success by taking charge of the business and directing it where you want it to go.

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Borrowing and Business: What You Don't Know Can Hurt Your Finances

Borrowing and Business: What You Don’t Know Can Hurt Your Finances

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So, you’re feeling confident enough about your business to go shopping for a loan. Congratulations! But before you start looking you should understand these five important areas impacting loans, beginning with the difference between interest rates and APR.

What is APR?

APR is the annualized percentage rate, which measures the cost of borrowing money. It includes the total cost for the loan including covering all fees that the lender might charge.

By looking at the APR, you can objectively compare the costs of loans from different banks. That’s entirely different from looking at the headline interest rates that sometimes get advertised. Such headline rates frequently don’t include all the fees that you must pay to get the loan.

In short, if you looked only at the headline interest rates, then you might think you got a good deal when in reality you didn’t.

Always ask the loan officer for the APR in any loan. If they won’t provide it, then choose another bank.

LIBOR and interest rates.

The cost of a lot of business credit moves up and down in line with something called LIBOR, the London Interbank Offered Rate, which is an interest rate charged by banks to lend to other banks.

When the banks see little risk of lending to each other, then the LIBOR will be lower than it would be otherwise. When they see heightened risk of lending to each other, then the LIBOR typically rises as it did during the financial crisis.

Commercial businesses typically pay a fixed amount above the LIBOR for the duration of the loan, see the Small Business Administration website for examples. The prime rate, which is a common benchmark lending rate for both commercial and consumer loans, is usually between 2.5 and 3.5 percentage points higher than the LIBOR rate, according to the FinAid website.

The LIBOR is also partly determined by decisions made by the Federal Reserve, which is a target interest rate for short-term overnight loans between banks. When that rate changes you can usually expect the LIBOR rate to change as well. In the simplest terms, if the Fed Funds rate rises then you should expect LIBOR to increase.

Recently, the Fed has been transparent about likely future changes in Fed Funds rates. If you regularly read the business press, you’ll be aware of most likely future changes in the costs of borrowing.

Fixed versus floating interest rates.

Not all business loans have interest rates which vary. Some have a fixed rate for the term of the loan. Such loans reduce the uncertainty about what would happen to the company’s profitability due to changes in short-term interest rates.

The cost of these loans is typically far higher than for variable rate loans. That’s because the bank takes on the risk of the interest rates changing over the term of the loan.

When a company purchases a long-lived asset, such as a factory building, it can make sense to seek out a fixed rate loan. That’s similar to seeking out a fixed rate home loan mortgage. Often, purchasing a building is a major expense and the predictability of the same monthly payment can help managers plan better for the future.

On the other hand, working capital typically gets funded through credit lines with variable rates of interest. That makes a lot of sense. When times are lean in business, then interest rates are lower and so are working capital needs. Conversely, when the economy is expanding, then although the cost of borrowing is usually higher, so is the demand for goods and services.

Sensitivity and the cost of borrowing.

Before you take out a loan, you need to understand what would happen to your profitability if the cost of borrowing increased.

For instance, if the cost of borrowing is $5,000 a month in interest and your company still would likely be profitable, then that is a good start. But then you also need to know if the business would remain in profit if the cost of borrowing increased. For instance, what would happen it the interest expense was half as much again, or $7,500 a month. Making theoretical changes and then calculating the likely outcomes is known assensitivity analysis. It is something that your Chief Financial Officer or accountant should be capable of doing.

If a change in interest rates of relatively small magnitude would vastly reduce profitability, then you might want to consider a smaller loan.

Likewise, when you conduct the interest rate sensitivity analysis, you may want to consider what would happen to the earnings if revenue fluctuated when the company also had a new loan. If even a small dip in sales would cause the company to lose money then perhaps it would make sense to be cautious by reducing the possible size of the loan.

Wall Street Prep has some useful tips on running sensitivity analysis.

Derivatives and interest rates.

Interest-rate derivatives exist to help companies guard against changes in the cost of borrowing. Rather like knives, when appropriately used, they can be a useful tool. However, when wielded incorrectly they can be harmful.

So-called interest rate swaps can be used to convert a variable rate loan to a fixed rate loan, and vice versa. These products can be useful, but the customers should have a high level of sophistication.

Unfortunately, in the United Kingdom, some banks inappropriately sold small businesses some of these products. That eventually led to losses by some buyers of these derivatives. Given that many of the people selling these swaps hold higher-level finance degrees it is frequently the case that the buyers are far less sophisticated than those selling the products.

Two things to take away from this episode. First, if you have any doubts that you truly understand the product then don’t buy it. Second, just because these problems occurred in the U.K. don’t think they couldn’t happen in the U.S.

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