Dated: 3 May 2003
Financial management in the small company is characterized, in many different
cases, by the need to confront a somewhat different set of problems and opportunities
than those confronted by a large corporation. One immediate and obvious difference
is that a majority of smaller companies do not normally have the opportunity
to publicly sell issues of stocks or bonds in order to raise funds. The owner/manager
of a smaller company must rely primarily on trade credit, bank financing, lease
financing and personal equity to finance the business. One therefore faces a
much more severely restricted set of financing alternatives than those faced
by the financial vice president or treasurer of a large corporation.
On the other hand, many financial problems facing the small company are very similar to those of larger corporations. For example, the analysis required for a long-term investment decision such as the purchase of heavy machinery or the evaluation of lease-buy alternatives, is essentially the same regardless of the size of the company. Once the decision is made, the financing alternatives available to the company may be radically different, but the decision process will be generally similar.
One area of particular concern for the smaller business owner lies in the effective management of working capital. Net working capital is defined as the difference between current assets and current liabilities and is often thought of as the "circulating capital" of the business. Lack of control in this crucial area is a primary cause of business failure in both small and large companies.
The business manager must continually be alert to changes in working capital accounts, the cause of these changes and the implications of these changes for the financial health of the company. One convenient and effective method to highlight the key managerial requirements in this area is to view working capital in terms of its major components:
This most liquid form of current assets, cash and cash equivalents (usually marketable securities or short-term certificate of deposit) requires constant supervision. A well planned and maintained cash budgeting system is essential to answer key questions such as: Is the cash level adequate to meet current expenses as they come due? What are the timing relationships between cash inflows and outflows? When will peak cash needs occur? What will be the magnitude of bank borrowing required to meet any cash shortfalls? When will this borrowing be necessary and when may repayment be expected?
Almost all businesses are required to extend credit to their customers. Key issues in this area include: Is the amount of accounts receivable reasonable in relation to sales? On the average, how rapidly are accounts receivable being collected? Which customers are "slow payers?" What action should be taken to speed collections where needed?
Inventories often make up 50 percent or more of a company's current assets and therefore, are deserving of close scrutiny. Key questions that must be considered in this area include: Is the level of inventory reasonable in relation to sales and the operating characteristics of the business? How rapidly is inventory turned over in relation to other companies in the same industry? Is any capital invested in dead or slow moving stock? Are sales being lost due to inadequate inventory levels? If appropriate, what action should be taken to increase or decrease inventory?
In a business, trade credit often provides a major source of financing for the company. Key issues to investigate in this category include: Is the amount of money owed to suppliers reasonable in relation to purchases? Is the company's payment policy such that it will enhance or detract from the company's credit rating? If available, are discounts being taken? What are the timing relationships between payments on accounts payable and collection on accounts receivable?
Notes payable to banks or other lenders are a second major source of financing for the business. Important questions in this class include: What is the amount of bank borrowing employed? Is this debt amount reasonable in relation to the equity financing of the company? When will principal and interest payments due? Will funds be available to meet these payments on time?
Accrued expenses and taxes payable represent obligations of the company as of the date of balance sheet preparation. Accrued expenses represent such items as salaries payable, interest payable on bank notes, insurance premiums payable, and similar items. Of primary concern in this area, particularly with regard to taxes payable, is the magnitude, timing, and availability of funds for payment. Careful planning is required to insure that these obligations are met on time.
As a final note, it is important to recognize that although the working capital accounts above are listed separately, they must also be viewed in total and from the point of view of their relationship to one another: What is the overall trend in net working capital? Is this a healthy trend? Which individual accounts are responsible for the trend? How does the company's working capital position relate to similar sized companies in the industry? What can be done to correct the trend, if necessary?
Of course, the questions posed are much easier to ask than to answer and there are few "general" answers to the issues raised. Your accountant or financial adviser will provide further suggestions, techniques, and guidelines which we hope will result in successful management which, when tempered with the experience of the individual owner-manager and the unique requirements of the particular industry, may be expected to enhance one's ability to manage effectively the financial resources of a business enterprise.
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