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Finance For Bootstrappers – Part 2

May 12, 2011 by · 1 Comment

$20,000

This is the second post in a series about Finance for Bootstrapped Companies.

One of my favorite posts until now was the original Finance for Bootstrappers post. I decided to make the topic into a series of posts because it’s such a broad and expansive topic that it couldn’t be adequately touched on in a single post. In fact, it should probably be it’s own blog. So there’s an idea of any aspiring bloggers. On with the tips…

Businesses Have Budgets Too

I whole-heartedly believe in the value of a budget for your business. Having a budget gives you an initial idea of just how much money you can spend before the month starts. Without a budget it’s entirely too probable that you’ll end up spending more than you make at some point, and once you do that it’s hard to get back into the black.

Your budget should include absolutely all income and expenses that you realize in a month. If there is an entry in your checking account then it should be in your budget as well.

You also have to understand that a budget is a monthly task and the results will differ each month. No two months are the same. Incomes will vary each month, even if slightly, due to accounts payable terms, holidays, etc. The same goes for expenses.

When it comes to budgeting (and business finance in general) I really rely on the advice of Dave Ramsey. His thoughts on personal finance translate very well to business situations as well.

Have Some Savings Available For Emergencies

Emergencies and unexpected expenses do come up, so you have to be prepared for them as best you can. You should have a money market account, separate from your main checking account(s), that you accrue emergency savings in. Even if you can only accumulate a couple hundred bucks a week then it’s worth it.

I advise putting it in a money market account simply because you will earn some small amount of interest. You shouldn’t put it in a non-liquid account or invest it in stocks because it may not be readily available should an emergency arise. If you want to do business investing then you should have another account just for that purpose.

Stay tuned for the next entry in this series. What business finance and financial management tips do you have? Do you have an emergency account for your company?

 

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Profit Versus Revenue

March 23, 2011 by · Leave a Comment

Profit and Loss

Profit and revenue are pretty basic terms when taken at face value. The picture becomes a little bit less clear when you apply them together and try to understand their relationship to your business and growth. A simple equation to understand the relationship is PROFIT = REVENUE – EXPENSES. The proportion of profit to revenue is your profit margin. Seems pretty simple and straightforward, right?

I’ll give a couple of examples to get started. Let’s say that company A has $50,000 of revenue each month with $30,000 of expenses. And company B has $30,000 of revenue and $10,000 of expenses monthly. Both companies have the same monthly profit, but company A has much more expense to achieve that profit. Company B clearly has a better profit margin (67% vs 40%).

So which company is in the better position for the future? Both companies have the same profit, but company A has more revenue. Having more revenue will theoretically allow company A to borrow more. (Have you ever noticed that business credit card applications only ask for the company’s revenue, not profit?) Company B has less expense and needs to make less revenue each month to be profitable. Both positions have benefits, but which is right for you and your company? I believe that company B, in general, is in a better position for future growth because their cash-flow needs are less, allowing them more flexibility and time to grow.

It’s important to think about the profit vs revenue picture when considering new business opportunities or significant new features to your existing business. If the new ideas will get you an extra $10k/month in revenue but will also result in $10k/month of new expense, are you really any better off? What good does increasing revenue do if profit does not also increase? At that point you are just moving from being company B to being more like company A. You have just decreased your margins and taken on new expense. The new expense opens you up to more cash-flow risk.

I would argue that a company that can qualify for more credit, like company A, will at some point need to take on more debt than a company that can’t qualify for as much. If your company produces widgets and has pretty significant cash-flow needs then you may benefit significantly from the added security that available credit would provide. If your margins are high then most likely your cash-flow needs aren’t as great, so available credit wouldn’t help you tremendously. I should make it clear here that I believe in a business having as little debt as possible, but the reality is that many small businesses with lower profit margins will need to rely on available credit at some point; more so than their higher margin brethren.

I suggest the following for all businesses: try to increase your profit without having to significantly increase your revenue. Each incremental improvement in your profit margin improves your cash-flow situation, which is the lifeblood of any business. For companies like company A, you first try to reduce expenses. If that doesn’t yield significant results then it’s time to look at your product offering and see if you can realign to improve margins. For companies like company B, you don’t have as much expense to eliminate, so try to grow your revenues without increasing cost.

This article was originally posted on our company blog. I’ve updated it slightly for this audience.

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Finance for Bootstrappers

March 15, 2011 by · 3 Comments

Money Money Money

Financing is usually the largest obstacle for a bootstrapped company. You have to be able to pay yourself and your team, as well as any vendors that you use on a monthly basis. Cash flow truly is king; it reigns over your business decisions. I’m certainly no expert, but being a CEO for 10 years has required lots of learning. This is the first post in a series designed to give you a few ideas to help you think through your financing and cash flow issues.

Aggressively Manage Salaries

As a founder you should strive to keep your salary as low as possible. You need to make enough to pay your bills, but the priority is to make sure that your team is compensated well to keep up motivation and productivity. A founder’s yearly salary does need to be high enough to avoid unwanted attention from the IRS. It’s better to take distributions from your company as money comes in as opposed to paying a higher salary.

I also recommend reviewing salaries on a yearly basis. If business isn’t as good as the year before then you should feel completely justified in lowering salaries a bit. There’s no rule that says you can’t cut salaries. The viability of the business has to come first, even at the expense of employees, though that should always be a last resort. If you’re giving a raise, make sure the raise is something that you know you’ll be able to afford for an entire year. If you want to give a $10k raise, but only feel comfortable giving a $5k raise, then you should give a $5k raise.

Work With Vendors

If you have large vendors that you need to pay each month you should work with them to find a payment schedule that works best for your cash flow situation. For example, if you have a regular monthly payment of $10k to a vendor then it would probably be easier, in terms of cash flow, to make 2 $5k payments a couple of weeks apart. If you’d rather stick with just one payment then try to schedule that payment for an optimal time of the month for you. Vendors, especially ones that take large payments, are used to working with their clients, so you should take advantage.

Avoid Debt

If the recent financial meltdown has taught us anything it’s that we should avoid debt if at all possible. I whole-heartedly believe that a business should avoid debt, but I realize that’s not always possible. I recommend against using credit cards to make small purchases. That $5 Starbucks trip should just be put on your debit card. Save the credit cards for larger purchases (if you can’t pay with debit).

What are you thoughts on small business finance? Feel free to leave any tips in the comments, as well as any suggestions for what you’d like me to talk about in the next entry in this series.

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