It’s Time to STOP

It’s Time to STOP

Be Sociable, Share! Tweet This post is going to be short and simple. One of the most overused quotes on the Internet – maybe in general – is by Albert Einstein. “The definition of insanity is doing the same thing over and over again and expecting different results.” There’s a reason it’s overused. It’s because people still constantly do the same thing and expect different results. Here’s my response. “Duh.” There’s another quote. “Fail fast.” I’m not sure who said it first, so I’ll leave it unattributed. My response? “Bravo” And herein lies the problem. People are resistant to change and are usually afraid to pull the plug on something that’s failing. They’ll keep doing it and they’ll expect it to start working at some point. They’ll pump time and money into it without thinking about how that time and money could be better spent. That leads me to my next quote. “If you can’t measure it, you can’t manage it.” Now, I don’t fully believe in this one. For example, how do you quantify creativity? But it’s right – so right – on many levels. If you can’t quantify something, it’s near impossible to know whether it’s working. So let me create a new quote that, perhaps, brings all of this together. “If you don’t define success, you’ll never know if you have it. The same goes for failure.” When was the last time you took an “outside looking in” view of everything your company does? How about the ways that you do things? Sales, marketing, websites and social media. Customer service, product and service delivery and support. Human resources, management and...
Are Your Assets Working for You? The Return on Assets Ratio

Are Your Assets Working for You? The Return on Assets Ratio

Be Sociable, Share! Tweet This Return On assets post is the fifth post in a series of articles about financial ratios. Which Company is Worth More? Let us assume you are interested in purchasing a company that makes bicycles here in the USA. You have narrowed your search to two companies. Remarkably, net profits from both companies are almost identical, varying by only $2,500. Company One has net profits of $235,000 and Company Two has profits of $237,500. Each company is asking $1,000,000 in an asset only sale. You are confused, which should you buy? The Return On Assets Ratio One way of sorting the wheat from the chaff in this example is to look at Return On Assets. Return on Assets determines how efficiently a company is using its assets to produce profits. Often, asset heavy companies such as an airline, produce low profits on large amounts of assets. Their capital intensive nature demands large investment in assets before any profits are seen. Less capital intensive companies, such as a bagel shop, may produce large profits on a small amount of assets. So Let’s Examine the Targets In the case above, let’s assume average assets for 2013 (beginning year total assets + ending year total assets from the balance sheet divided by 2) for Company One is $560,000 and Company Two is $730,000. Return On Assets for Company One is 0.42. Return On Assets for Company Two is 0.33. Company One had a slightly lower net profit but more efficiently used its assets to manufacture those profits. All other factors being equal, and they never are, Company One should be able to expand its...
Can You Afford That Loan? The Debt Service Coverage Financial Ratio

Can You Afford That Loan? The Debt Service Coverage Financial Ratio

Be Sociable, Share! Tweet This is the fourth post in a series of articles about financial ratios. In evaluating any borrower for a loan or lease request, one of the financial ratios that lenders run is a Debt Service Coverage Ratio (DSCR or sometimes DSC) to determine if the loan can be repaid. Ideally, the company will have sufficient profits to service the debt completely – with extra left over. How Do You Calculate the DSCR Financial Ratio To calculate the DSC on a proposed loan the formula is as follows: Note that the top of the formula states “Annual Net Profit”.  Once you add back the amortization/depreciation and interest, this is the income or cash flows that are left over after all of the operating expenses have been paid. This is often called earnings before interest, taxes depreciation and amortization – or EBITDA. For “Existing Interest Expense”, make sure to include the interest of any debt that is being refinanced by this loan.  Otherwise, just include the interest expense for any other loans you may have.  Non-cash or discretionary items should include things like management bonuses. On the bottom half of the financial ratio, the principal payments and interest payments are those of the new debt you are looking to take on. The DSCR is also sometimes calculates without adding back in amortization/depreciation, interest expense or non-cash items.  This means you are taking your net profit and dividing it by the loan payment and leases.   Neither method is right or wrong but you get two different numbers, leading to disagreements with or at the bank.  You’ll often find that the person...
Strong Sales Does Not Mean Strong Cash Flow

Strong Sales Does Not Mean Strong Cash Flow

Be Sociable, Share! Tweet When I was a young MBA student, one of my professors had a saying that has stuck with me ever since. “You can live without sales, you cannot live without cash flow” he used to say. This saying has been proven again and again to me in the course of my career as executive and as a commercial banker. Most of my commercial customers who sought lines of credit were doing so to cover cash flow issues they were having. Some were experiencing rapid growth and needed the short term borrowing to purchase inventory or finance work ahead of payment. From time to time however, I found myself in front of a customer that had severe cash flow issues that were not associated with rapid growth. Finding the Cash Flow Problem One particular case was intriguing for a number of reasons that highlight both the need for short term borrowing for cash flow issues, and how that very borrowing can delay the company in confronting the underlying cause of the cash flow issue at hand. In this particular case, the company was experiencing very slow payment on its accounts receivable. Normally in such a case, the bank calculates an average collection ratio. This is calculated on an annual basis by taking the accounts receivable divided by (total sales/365). The shorter the number of days, the more quickly the company is collecting payment on its A/R. And of course the quicker the collection the better the cash flow. For this particular company, the average collection was over 90 days. Some accounts were in excess of 365 days....
Turn Baby Turn – Why Inventory Turns Matter

Turn Baby Turn – Why Inventory Turns Matter

Be Sociable, Share! Tweet This is the third part of our series on ratios and what they mean to your business. Inventory turns are the amount of times in a fiscal year that you sell your complete inventory. The ratio is normally calculated by dividing sales by inventory on the year end balance sheet. As an example, if sales are $1,500,000 and inventory is 300,000 on the year end balance sheet, then: In this case the inventory turns five times per year. It can also be calculated by dividing cost of goods sold by average inventory. However, the sales/inventory is the more popular method. If you then divide the number of days in a year by the number of inventory turns, you get the inventory turnover period.  For example, using the 5 inventory turns from above, the inventory turnover period would be 73 days.   The reason this ratio is so important is that the more often the inventory turns the higher the profits. Profit is made each time inventory sells (or at least it better be!), so the quicker it sells the more profits you are bringing in.  A high turnover ratio implies that purchasing is managed well. Alternatively, it may mean that there is not enough cash to maintain normal inventory levels, and so the company is turning away possible sales. The second scenario is most likely when the amount of debt is unusually high and there are few cash reserves.   On the other hand, a low turnover ratio implies  implies that a business may have bought too many goods and their approach to purchasing is unsound. In this case, inventory aging may occur...
Debt to Net Worth – The Pros and Cons of Leverage

Debt to Net Worth – The Pros and Cons of Leverage

Be Sociable, Share! TweetAn old bank customer of mine called me the other day. He was wondering whether he should borrow to finance an impending, but temporary, shortfall in cash flow later in the year. He had sufficient personal cash to inject to get over the hump. I advised him that he was better off in this case using leverage rather than an equity injection. Why? Simply put, leveraging the bank’s balance sheet to fund the temporary shortfall left him with cash for opportunistic inventory purchases, which could increase profits dramatically. Using all available cash removed that option. This is our second article on financial statement ratios and what they mean. The Debt to Net Worth Ratio Debt to Net Worth (also known as Debt to Equity) is the ratio of total liabilities on the balance sheet to owner equity. A company that had $500,000 of liabilities to $100,000 of owner equity would have a Debt to Net Worth ratio of 5/1. For every dollar the owner has in equity, the company owes five dollars to creditors. That would be considered highly leveraged. In some start ups, where the owner is injecting only 10% equity and the bank is financing the rest of the start up capital requirements (nearly always with an SBA guaranty) Debt to Net Worth can be 10/1. Most banks subtract intangible items like goodwill from the owner equity to get a ratio called Debt to Tangible Net Worth. What The Debt to Net Worth Ratio Means It is generally assumed that as companies mature, their Debt to Net Worth will improve over time. A company that...
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