Understanding Break-Even PointA company's break-even point or break-even analysis is the point at which their sales equal the cost of doing business. The organization has not made a profit yet but is not operating at a loss. Every product a company sells or service offers carries an associated cost. Whether it is the cost of the raw materials or wages to implement new software, there are always costs incurred when running a business. These costs show up as the cost of goods sold (COGS) in a production environment. The more physical products you produce, the higher your COGS. By understanding how much output is required for the company to break even, adjustments can be made accordingly. A business can adjust output as well as the sale price of their products or services. Beyond the break-even point, all incremental revenue beyond this point contributes to the organization's gross profit.
Break-Even Point FormulaA break-even analysis is a formula that shows how many units of phones, chairs, legal services, etc. you need to sell to cover your costs. Calculating the break-even point involves taking the fixed cost and dividing the amount by the contribution margin per unit. To find the contribution margin per unit, take the price per unit and subtract the variable costs per unit. Before calculating this formula, we need to pinpoint the following three variables.
- Fixed Costs - these are costs independent of sales volumes such as rent, insurance, and loan payments. These are commonly known as SG&A.
- Variable Costs - are expenses that fluctuate up or down per sales volume. Examples are raw materials, manufacturing labor costs, and sales commissions and are generally part of COGS.
- The sale price of the product or service.
ExampleTo illustrate the break-even point, let's assume a sock manufacturer has fixed expenses that total $10,000 per month. Their variable cost (COGS) per unit is $5 per pair of socks, and the socks retail for $25 (sale price). We first find the contribution margin, which is $20 per pair of socks. Then by dividing the fixed costs by the contribution margin, you will know how many units of socks you need to sell to break even.
AnalysisA break-even analysis is helpful whether you are just starting a business or have been operating already for several years. It is never too late to start using this new tool, and there are also a few instances where this metric becomes increasingly valuable.
- Before starting a business - it is essential to conduct this financial analysis when developing a business plan. Then you will have a good idea of the risks involved.
- New product or service - existing businesses should conduct this analysis before launching a new product to learn how it will affect profitability. You might discover you will need to sell too many units to cover your overhead.
- Performing a break-even point for a new product may help determine the right price for the item.
- Changes in manufacturing - a business is considering outsourcing a portion of their manufacturing. Suppose the organization can produce the same quality with lower variable cost but isn’t sure if working with a partner would increase fixed cost. In that case, this analysis will play a critical role in determining if the change would be cost-effective.
1099 FormTo understand the W9 Form, it is beneficial to have first-hand experience with 1099 forms. Businesses file 1099 forms when they have paid more than $600 to an independent contractor or non-employee during the year. You do not need to withhold any money when you provide payment; however, you must use the 1099 form to declare the exact dollar amount your company disbursed to the IRS. Therefore, the 1099 form serves as a record for the total amount of compensation a non-employee received. Before a contractor begins a work assignment, your business must deliver the W9 Form; then, the contractor must complete it before starting their project. This Form gives your business the necessary information to provide the 1099 form at the end of the tax period.
Purpose of W9 FormThe W-9 Form, officially titled "Request for Taxpayer Identification Number and Certification," is used to verify your independent contractor's tax withholding status. They will supply you with their TIN or Tax Identification Number, which you use later in conjunction with the 1099 form. Besides non-employee compensation, here are a few other examples of W9 income.
- Cancelation of debt
- Acquisition or abandonment of secured property
- Real estate transactions
- Mortgage interest
- Miscellaneous income
Checklist for CompletingForm W9 is one of the most straightforward IRS forms to complete. Here are the required fields that all non-employed staff must complete.
Box 1: Contractor name goes here as it appears on their tax return.
Box 2 - Business name. Enter LLC, S-Corp, or sole proprietor name here.
Box 3: Box check required to distinguish between LLC, S-Corp, or sole proprietor.
Box 4 - Exemptions. Certain businesses are exempt from backup withholding, and this is when the employer is required to withhold a percentage of any future payments to ensure the IRS receives the tax due on this income.
Most likely, backup withholding will not apply unless a vendor refuses to provide a Social Security number (SSN) or tax identification number (TIN)
Box 5 - Business street address, city, state, and zip code.
Box 6 - Option box to include requestor's name or payer's name.
Box 7 - Social security number or tax identification number. If a business is a partnership, LLC, or corporation, there should already be a TIN, also referred to as an Employer Identification Number (EIN).
Box 8 - Signature required to attest to the truthfulness of all information.
Things to Look Out forIf you have a contractor who will not provide their completed W9 or TIN, the IRS requires your company to start withholding 24% of their compensation for tax money. There are penalties for failing to submit this backup withholding, and it is better to avoid this altogether and require W9 completion before work begins. Since the W9 Form contains sensitive information, always make sure to use secure channels to send. If your organization uses email for the hiring process, ensure the contractor sends the form back encrypted. If a single person owns the LLC, list the name of the owner on the "name" line in box 1 and the name of the LLC on the "business name" line in box 2. If the business owner provides both SSN and TIN, the IRS would prefer the owner's Social Security number. At the end of the tax year, the information contained on the completed Form W9 gets used to prepare 1099 forms like 1099-NEC, 1099-MISC, 1099-INT, and 1099-DIV. Therefore, ensuring the W9 Form gets completed accurately will save you time during tax season. Managing your money effectively is about having the right team. Take advantage of FINSYNC’s large network of bookkeepers and accountants.
Included in COGSWhen determining COGS, a good rule of thumb is to ask the question–Would the cost exist if no products were produced? If the answer is no, then there is a good chance that cost is part of the cost of goods sold. Cost of goods sold examples:
Operating Expenses vs COGSBoth operating expenses and cost of goods sold are expenditures a business incurs to create goods and services. However, unlike COGS, operating expenses are not directly related to the production of goods. Operating expenses are SG&A: selling general, and administrative expenses. These are costs to keep the business open that would occur regardless of how many products are produced. Here are some examples below. Operating expenses examples:
- Office supplies
- Sales and marketing
- Legal costs
Calculating Cost of Goods SoldHere is the general formula for calculating COGS We will take a deeper dive into this formula as there are four steps involved to perform this calculation.
- Identify beginning inventory of raw materials and completed goods, which are the previous period's ending inventory.
- Determine the total cost of purchases for any raw materials and parts used in production.
- Find ending inventory - determine the total value of all items in inventory at the end of the period.
- Total up all other direct costs of production, including labor and shipping costs.
FIFO and LIFOInventory is the biggest business asset within production-based organizations which directly affects gross profit. Inventory valuation allows you to evaluate your Cost of Goods Sold (COGS) and your profitability. The most widely used method of inventory valuation is to us FIFO & LIFO. Since COGS subtracts ending inventory from the beginning, any change in the value of products over time could drastically alter our final calculations. Here is where FIFO or "first in, first out" comes into play. FIFO assumes that the oldest items in the inventory were the first to be sold for accounting purposes. This does not mean that the oldest items are always sold first, but this assumption simplifies the accounting process. LIFO, or "last in, first out," is the opposite of FIFO. Last in, first out assumes the newest items are the first to be sold. This inventory method can offer companies significant tax advantages if a company's inventory costs are rising. An example of older inventory affecting valuation is seen with new car sales. A newly arrived car is worth more than the similar model that has been sitting on the lot for the past 8 months. Therefore, the longer a car is in inventory the lower the value is over time. Using LIFO, an increase in the product's value over the period would result in the cost of goods sold being skewed toward a higher value and vice versa if the product's value dropped.
OverviewTracking your cost of goods sold regularly will give you a lot of information about the productivity of your business. You will be able to tell if you are paying too much for raw materials or labor. You can also determine if you need to change the price of your finished product. Moreover, COGS determines the profitability of your organization and is subtracted from a company's revenue to determine the gross profit. Cost of goods sold is a direct indicator of how efficient a company is in managing its labor and supplies in the production process. Lastly, you can take advantage of the COGS deduction on your tax return. You will need to keep meticulous records throughout all manufacturing and inventory expenses incurred during the production or acquisition of sold goods. The FINSYNC profit and loss setting automatically compares periods such as monthly, quarterly, or yearly, so you can see trending reports.
Cash Basis AccountingCash basis accounting represents the most commonly used method for small businesses because it is straightforward. In cash accounting, revenue and expenses are recorded during the period in which the money changed hands. Therefore, income is recorded as soon as the business acquires the cash. In the same respect, expenses are paid as soon as the money goes out, not when the bill is received. For example, a landscaping company bills one of their customers $4,000 for services on December 1st. But doesn't receive the money until the following year, on January 15th. On a cash basis, this income would be recorded in January so no taxes on it would be owed for the year ending December 31st. Let's take a look at the differences in accrual accounting.
Accrual AccountingThe accrual accounting method is when transactions are recorded as they occur, even if payment has yet to be exchanged. Typically, revenue and expenses are recorded before any money changes hands such as when an invoice or bill is received. The use of accrual accounting is particularly helpful for businesses that offer credit on a majority of their sales, which means there’s a gap between invoice creation and receipt of payment. When using either the cash or accrual method, you must employ double-entry accounting. Double-entry is a system of accounting that requires a two-sided book entry that “balances” for every transaction: the credit and debit sides must match in amount. The double-entry system safeguards your organization as it protects your business against costly accounting errors. In addition, it provides a larger perspective of the money going in and out of the company. Most modern accounting software uses double-entry accounting when entering an invoice or deposit into the system.
DisadvantagesDespite being more challenging to implement, the main disadvantage of accrual accounting involves tax payments. It is possible to pay taxes on the income you haven't received yet. If a customer’s payment is delinquent and you have already paid taxes on it, this creates more paperwork to implement a tax refund. Per the IRS, cash accounting is only available if the business earns less than $5 million in average sales. Beyond $5 million in earnings, a company will need to implement the accrual method. Organizations that earn less than this can choose to do either cash or accrual accounting. Additionally, if your company needs to perform an internal or external audit, the only method accepted is the accrual method. Cash basis accounting has a few disadvantages. First, the cash method doesn't factor in accounts receivable or accounts payable. Since these businesses are recording transactions when they receive them, it doesn't forecast money coming in or future bills that are almost due. Another setback with cash accounting is that it may not provide an accurate picture of the organization's financial health. Let's say a business just completed a large project for which they are still awaiting payment. Presently, this business would look less profitable in the period after which bills related to the project were paid but before the customer payment was received. Therefore, cash accounting can both overstate or understate the condition of a business depending on collections or payments being high within a certain period.
Making a ChoiceAccrual accounting better indicates business performance because it shows when revenue and expenses occurred. If you want to see if a particular month was profitable, this is easy to assess with the accrual method. In real-time, accrual accounting provides a clear picture of your company's profitability along with the ability to identify areas for improvement. To have a firm grasp of your business's finances, you need to understand what your numbers mean and how to use them to answer specific financial questions. Start your financial management process off right with FINSYNC's automated cash flow manager.
What Is SG&A?Direct costs, which are associated with a companies' core business, are always under observation. They are highly controlled and constantly analyzed since they directly impact the product or service. Indirect costs, when not managed, can be like transferring feathers in an open truck bed. Your money is constantly blowing away little by little without ever noticing. The worst-case scenario could mean a lack of return for your company. Selling, General & Administrative (SG&A) expenses are the costs a company incurs to promote, sell, and deliver its products and services and expenses involved in managing the entire company. These expenses are different from COGS but you won’t see necessarily see them in a service-based organization. Also known as operating expenses, SG&A is the overhead required to support operations. These expenses include rent, advertising and marketing, administrative costs, sales commissions, and utilities.
Profit & LossOperating expenses do not include the direct costs of producing goods or acquiring goods for sale, which are calculated separately as cost of goods sold or COGS aka P&L (profit and loss). P&L statement shows how much revenue a business generated, the cost incurred to create this revenue, and the other expenses necessary for the business's operations. COGS represents how much it costs to produce a product or service. Examples include direct expenses such as raw materials, direct labor, and shipping costs. These expenses are recorded in the profit and loss statement that summarizes the revenues, fees, and overhead incurred during a specific period. Operating expenses are very important, but the individuals within these departments are not directly involved in making the final product or service. Therefore, these operating expenses are not directly what the customers are purchasing.
CalculationsTo calculate SG&A, use the formula below to add together selling expenses and general & administrative expenses. SG&A costs are typically the second expense category recorded on an income statement after COGS. Also found in the financial statements is the ratio of SG&A expenses to sales revenue. This calculation is another way of understanding the financial health of a business. The SG&A sales ratio gives an organization a big picture of your business expenses compared to the money coming in. If this ratio increases over time, it may be more challenging to earn a growing profit.
ChallengesOverall, operating expenses should be stable year to year, or in a growing business, they should be declining. If this number increases, it sends up a big red flag to lenders, creditors, and potential investors. This number evaluates how companies effectively utilize their cash. When operating expenses grow too large without a corresponding rise in sales, businesses need to start cutting costs. Cutting out non-sales salaries can usually be done without impeding manufacturing, which is often why company layoffs can increase overall profitability. After defining the need to reduce SG&A expenses, there should be an assessment of the company's main accounts. It is important to scrutinize each account and prioritize the areas with the greatest reduction potential. Additionally, monitoring the administrative areas, replacing suppliers, and even renegotiating contracts can impact your organization's profit over time.
Final ThoughtsIt isn't always apparent whether your business is losing or earning money. Sometimes you may receive large bundles of capital at once, and it can feel like your business is prospering. Only to find out later that your business is in a cash-flow deficit. Monitoring and understanding your SG&A within a product-based setting in addition to COGS is vital because it affects your bottom line. In conjunction with adopting more efficient budget management, reducing these expenses can boost an organization's financial results. Take control of your small business finances today with FINSYNC’s all-in-one accounting solution.
Understanding Net IncomeNet Income (NI), also called net earnings or net profit, is the total amount earned in a period minus expenses. Examples of the type of expenses include:
- Advertising and Marketing
Gross vs NetThe key to simplifying NI is by comparing and contrasting gross versus net. Whether you are looking at revenue or income, the gross number is always larger than the net. Gross profit signifies the total amount of money a company makes minus the cost of goods sold. COGS are expenses incurred to produce the goods that a company sells. These expenses include raw materials, labor, packaging, and utilities in a manufacturing facility. Gross profit does not include other costs associated with marketing or selling activities, administration, taxes, etc. Gross revenue is the aggregate sale price of goods and services over a period of time. Gross revenue is also known as total revenue or the top line, as this is the starting point from which other financial metrics are calculated in a P&L. Lastly, net revenue is how much gross revenue remains after deducting commissions, sales, losses, or returns. Knowing your net revenue can help you understand what discounts work in your business, for example.
Operating IncomeThe last of the three standard income calculations is operating income. Operating income is a more conservative approach than gross income as it also subtracts operating expenses. Like GI and NI, operating income is another way to view profitability and success. All three forms of income are crucial when applying for financing. Banks and lenders typically look at your business's income with and without expenses to predict a company's future performance before approving a loan.
CalculationsSometimes it is easier to differentiate between these terms by looking at the equations.
Operating IncomeYou may need to do additional calculations to find your business's total revenue. These equations give a different perspective of the business's finances and differ depending on which analysis you are running.
ConclusionRevenue alone will not give you a comprehensive representation of your finances. It would be best to incorporate NI to fully understand your organization's profitability. NI and GI reveal a different perspective and thus can affect actions you might take as a business owner. Gross income can indicate the revenue generated year over year and give a perspective on how your business is doing. However, net income will tell you a slightly different picture of how much you are making after expenses are factored into the equation. Even though net income is a critical metric within all three financial statements, it is not an indicator of cash flow. NI includes non-cash items like depreciation and amortization. Therefore, creating a separate process for your cash flow management is highly recommended. FINSYNC - Allow our accounting software to calculate all forms of income and more for your organization.
Operating Cash FlowOperating cash flow or OCF is the cash a company generates from normal business activities within a certain period. This measurement shows how much money is generated from business operations without considering factors such as interest or investments. Normal business operating costs include the Cost of Goods Sold or COGS, expenses that directly correlate with the income from selling those same goods. In addition, less directly-correlated expenses such as marketing, advertising, rent, insurance, and administrative overhead are also part of operating costs and fall into a grouping typically referred to as Sales, General and Administrative or SG&A. OCF keeps track of all money coming in and going out and is recorded in the company's cash flow statement. Sometimes OCF is listed as "cash flow from operating activities" and represents the cash impact on a company's net income. If your company requires a small business loan, many lenders will look at your OCF to ensure you bring in enough money to pay your bills and ascertain your ability to repay the loan.
Operating Cash Flow CalculationThe operating cash flow formula can be calculated two different ways under GAAP or Generally Accepted Accounting Principles.
Indirect MethodNet Income: Net income is how much your business earns from its operations. Find net income by taking the company's total revenue minus all expenses. The indirect method is a lot more complicated, but it gives more information.
Free Cash FlowOperating cash flow has its limitations because it doesn't take into account the cost of acquiring and managing fixed assets such as machinery, software, furniture, and vehicles. Free cash flow or FCF measures how much cash a company generates from normal operations minus any cash spent for long-term fixed assets. Understanding how much money you have left over after paying for everything is valuable because you can assess how much money you may reinvest back into the company. It also has the potential to identify red flags in your accounts receivable process. For example, if revenue increases but free FCF is not, it could mean customers are not paying invoices on time.
Free Cash Flow CalculationFCF can show you how much you have after paying interest expenses during a period. However, it will not reflect newly acquired, or old debt recently paid off. Free cash flow is a measure of financial performance, similar to earnings, and although it can be useful, it’s not a part of any of the core financial statements included in GAAP reporting.
SummaryOperating and free cash flow are essential metrics for financial health and sustainability. While they each tell you different information, together, they illustrate a more significant picture representing your financial health. As sales increase, so do your operating costs, which makes understanding cash flow more powerful. Without proper cost controls and tight cash flow management, increasing sales may not improve net income. Regardless of which method you choose for your organization, it is vital for management to assess these metrics in order to have a clear awareness of money generated. This data will help determine if a company can hire more staff, purchase better equipment or software, and invest in growth overall. FINSYNC can help simplify your cash flow management with our all-in-one innovative software. Gain control of your financial management today.
Principle of RegularityThe principle of regularity states that GAAP compliance happens throughout the entire accounting period. Individuals cannot pick and choose which accounting methods they use period by period for their financial statements. Accountants must adhere to these generally accepted accounting principles provided by the Financial Accounting Standards Board or FASB. Then they must ensure these procedures remain consistent thereafter.
Principle of ConsistencyThe accounting team should adhere to the same practices across all internal income statements during all accounting periods. This process ensures consistency when comparing multiple periods. Accountants must explain any variability in this process within the footnotes of the income statement.
Principle of SincerityAccountants should remain unbiased with the utmost goal of providing an accurate and objective depiction of the company's financial health. An objective perspective provides great significance to an organization. Many businesses choose to employ independently audited financial statements.
Principle of Permanence of MethodsThe principle of permanence requires identical financial reporting methods applied throughout each accounting period. This principle aims to increase clarity around a business's financial statements and prevent switching methods to get more favorable-looking results.
Principle of Non-CompensationPer this principle, accountants must report all positive and negative values within the financial statements with complete transparency without attempting to hide debts behind assets or costs behind revenue.
Principle of PrudenceFinancial data should be gathered and reported "as is" without speculation or adjustments. A prudent or conservative approach ensures the company's financial performance is not inflated.
Principle of ContinuityAccountants who are producing financial statements that conform with GAAP work under the assumption that the business will continue its operations indefinitely. This assumption means that assets are priced at their historical value or original cost rather than their current value.
Principle of PeriodicityAll financial entries are distributed across the appropriate accounting periods. This principle prevents stretching periods or numbers to adjust the final numbers within a financial report. For example, if your business provides a service like auto repairs. You may complete the work on the car in November, but the insurance doesn't pay until December. If you are an accrual-based company, the revenue for the job must show up in November on your financial statements because that's when your business earned this money.
Principle of MaterialityA material event is anything that affects a company's financial standing. Therefore accountants must provide full financial disclosure and report all financial data to the best of their ability. The materiality principle also allows the accountant to use leeway to GAAP principles and use their best judgment when recording a transaction or addressing an error.
Principle of Utmost Good FaithThis principle comes from the Latin phrase "uberrimae fidei." It means accountants and business managers should act in good faith by honestly recording transactions and collecting financial data. Although optional for non-publicly traded companies, GAAP is viewed favorably by banks and creditors. Most financial institutions will require annual GAAP compliant financial statements as a part of their debt covenants when issuing business loans. These principles are important because they provide an accounting team with the framework for reporting and analyzing data. It keeps all organizations on a level playing field for benchmarking. On the other hand, if each business reported its financials differently, it would be challenging to compare metrics. On a final note, as a small business owner, it is essential to understand the basic concepts involved in these common accounting principles to understand e your accountant's viewpoint. This information will help interpret the bigger picture and detect potential hurdles when considering any changes further down the road. At FINSYNC we know the decision to hire good accountants is crucial. This is why we have personally vetted a network of thousands of accountants and bookkeepers.
1. TransactionsWe kick off the process by identifying and analyzing the financial transactions. These transactions include all monetary movement in and out of the organization. Activities would include but are not limited to receiving payment for an invoice, paying for utilities, selling products, purchasing equipment, and payroll.
2. Journal EntriesJournal entries are records of the initial transactions. Often, a bookkeeper manages and records these daily transactions and puts them in chronological order. Journal entries are a comprehensive way to keep track of money in and out of the company. In double-entry accounting, there must be two entries for each transaction. When a credit occurs, there must be a resulting debit.
3. PostingEach journal entry is organized and summarized in the general ledger. The general ledger is a record that categorizes all of the transactions into one of the accounts (categories) listed below: When posting to a general ledger, it is crucial to match the transaction with the correct account and subaccounts such as rent, marketing, loan payments, etc.
4. Trial BalanceAt the end of an accounting period, a trial balance assures that all debit and credit totals are equal. Thereby running this common report makes discrepancies easy to identify. The trial balance brings to light the unadjusted ratios for each account and subaccount posted in the general ledger. When the total for all credits do not equal the total debits, a mathematical or recording error was made somewhere earlier in the process and must be fixed in order for “the books to balance.”
5. WorksheetUnfortunately, many times the first calculation of the trial balance will produce a discrepancy. Meaning, the credit total does not equal the debit total. Therefore, adjustments need to be calculated until these equate. Adjusting these entries is also called the worksheet analysis. Here is where we can identify when payments aren't received or a transaction wasn’t recorded. These discrepancies must be identified and eventually corrected before the period ends.
6. Adjusting Journal EntriesOnce discrepancies related to cash transactions have been identified and entry adjustments recorded, it is time to recalculate a new trial balance. You’ll then want to add any journal entries for non-cash transactions such as a deferral or depreciation. Once the trial balance is complete and the credits and debits balanced, you can move forward with producing financial statements.
7. Financial StatementsNow that the accounts are adjusted and recorded correctly in the general ledger, we are ready to create the financial statements. Financial statements include the following:
- Income Statement
- Balance Sheet
- Statement of Cash Flow
- Statement of Retained Earnings (optional)
8. Closing the BooksThe last step in the accounting cycle is closing the books. Closing ties up all loose ends and occurs at the end of each accounting period. Accounting periods could be every month, quarter, year, or other consistent timeframes. After the books are closed out, the cycle starts all over again with the new period. New revenue and expense accounts start over with zero balances. In the most basic terms, the accounting cycle is the process for ensuring the accuracy of the books. This process demonstrates all money going in and out is accounted for and balanced. Errors made throughout this process typically occur. Therefore having a procedure for identifying and examining these errors is recommended for all organizations. Ready to alleviate the burden of bookkeeping? FINSYNC has an extensive network of bookkeepers and accountants. We will match the right person based on your budget, industry, experience, and more.
What Is Working Capital?Working capital or net working capital (NWC) is the difference between current assets and current liabilities. A liquid asset can be bought and sold quickly without affecting its price. Current assets, such as cash, securities, inventory, and accounts receivables, are resources a company owns that can be used up or converted into cash within one year. Current liabilities are the amount of money a company owes. Examples of liabilities include debt repayment, accounts payable (bills due), and operating expenses due within the year. In its most basic form, working capital is part of your cash flow management approach.
Business UsesNWC can be both positive and negative. The amount an organization needs to run smoothly varies depending on the size of the business and the industry. Of course, the more working capital a company has, the better its financial position. However, this number changes over time. Retailers, for example, will see higher working capital during the holiday season when sales are at their highest. During these same months, a pool manufacturer will likely have lower liquidity to run their business. Financial industries will frequently lend money to organizations during these off-peak periods. This movement of funds often requires tight monitoring between the company's management team and the bank itself. Businesses watch both their accounts receivable and accounts payable to help forecast future earnings. A shortfall occurs when the amount of money owed by the company is greater than the revenue coming in.
Mistakes to AvoidHaving positive NWC is the objective as the company will not need to borrow money. At the same time, an organization doesn't want too much cash or liquidity. Excessive working capital means funds remain idle, which aren't earning a profit for the business. Regular, high NWC could be used to increase social media marketing or other marketing strategies, provide additional training, or purchase software that could increase efficiency. Lastly, and perhaps the most severe working capital mistake is not having a proper cash flow management system in place. Although it may seem to be a good idea to pay bills as soon as they come, you may want to hold off until more invoices are paid. The consequence of paying a bill too soon might mean not having enough money for next month's inventory or payroll.
Tips to ImproveSince NWC is current assets minus current liabilities, there are mainly two ways to improve your working capital. A business can increase existing assets or reduce liabilities. A business can also tweak the dates that invoices are due. Companies can offer incentives to their customers to collect the receivables sooner. Conversely, an organization may negotiate a debt extension with creditors or suppliers. Once you have a solid cash management process in place, you will be able to determine the best course of action for new spendings. For example, in the long run, it might be cheaper to buy inventory in bulk; however, after plugging in the numbers, you may determine this would be sacrificing too much valuable working capital, which may result in inadequate NWC to package and ship.
OverviewWorking capital is one of the most critical metrics to running a business. Insufficient EWC amounts to a shortage of resources and even layoffs. At the same time, too much liquidity could mean the company is not reinvesting its money to improve the business. Most businesses fail, not because of a lack of profits, but because of poor EWC management. Cash flow management is critical, and the sooner you can initiate a consistent process, the more flexibility you will have to expand and grow. Start your financial management process off right with FINSYNC's automated cash flow manager.
|Cash Flow Management|