Small Business Finance – How To Understand Expenses On The Income Statement

Expenses like income are treated differently depending on your method of accounting (cash or accrual). Cash accounting says a cost is “expensed” when you write the check to pay for it. Accrual accounting expenses the cost when the transaction occurs whether or not money is exchanged, e.g. a supplier may give you 30 days to pay your bill or you may pay your payroll/sales taxes monthly. Accrual accounting attempts to keep expenses matched up with the sale that generated it. Bills that are paid in a lump sum for the year can be accrued (spread out) each month; e.g. unemployment insurance is paid in lump sums which throws off your P&L because of the large payment.

A solution is to record the payment to the Pre-paid Expenses account within Current Assets on the Balance Sheet. You can then divide the amount by the number of months paid and then each month reduce the Pre-Paid Expenses by the smaller monthly payment and record it in the Unemployment Insurance account on your P&L.

Most of your expenses come from your checkbook register but there is a couple you will want to watch out for.

The principle portion of your loans and credit cards that you pay on your bill are not expenses. The principle portion paid should go to the liability account on the balance sheet for the loan. The interest portion of the bill is an expense. You need to look at the bill and split out the two portions.

Items that are purchased in the $500+ range (start ups and businesses with sales less than $300,000) are considered investments in the business and should be depreciated over an IRS predetermined time span. This is where tax law and Generally Accepted Accounting Principles are applied. Larger businesses are able to expense bigger ticket items. A small business puts these $500+ purchases on their balance sheet under long term assets.

Don’t worry about recording depreciation monthly unless your accountant has given you a schedule. Depreciation becomes a non-cash expense and accounts for the items you put on the balance sheet above $500 earlier.

Something to watch out for with depreciation is that the new tax laws have accelerated the ability to depreciated your assets, a good thing for lowering taxes but it often leaves a small business looking like it is not re-investing in itself. Ask your accountant to run the depreciation schedule two ways, one for taxes using the acceptable accelerated depreciation and the second way using the straight line depreciation based upon the lifespan of the asset for your business books. Why is this important? Banks run ratios that use assets to determine bank ability. As for you, it will give you a better idea of when to re-invest in furniture, fixtures, and equipment.

The most difficult thing about using P&Ls is consistent coding of expenses into their appropriate accounts. If you are unsure about which accounts to use, start with the ones on the tax return you will be using; e.g. schedule C for sole proprietors.

Buying a Business – Understanding Small Business Financing

As a business broker I am frequently discussing with clients and prospective buyers methods of small business financing. Once a buyer and seller agree on price and terms, it all boils down to due diligence and financing.

A lot of factors can determine how lenders will view your deal. It will depend on the type of lender, type of business, and what kind of assets does the business own that can be used as collateral. Is there real estate involved in the transaction?

A commercial banker or loan broker will show you what factors matter most and get your deal funded with their products.

Cash and Equity

Of course, if you’re paying all cash, none of this is your concern, however 100% cash deals are not the norm.

Every business is unique and different, but one thing is certain before you seriously consider pursuing a business for sale: You or one of your partners will need sufficient liquid capital or equity for anyone to finance your deal.

Bank Financing

The stories of a “no money down” deals and 90% seller financing are rare and I have personally never seen one that was legitimate.

Again, depending on various factors, when acquiring small business financing through a commercial lender, there is a good chance you’ll need 20-40% cash/equity down on the business, financing the balance with debt capital.

You will probably pay “prime + 2″ in interest, meaning if the prime rate is 8%, your interest will probably pay 10%.

The term of the loan will probably be 5-10 years. Many of the commercial loans I’ve seen are 7 year terms.

Business with Real Estate

If you are acquiring real estate in addition to the business, many products are available as “Blended Loans”. These loans are “blended” with the standard “real estate loan” (10% down, 30 years).

You end up with roughly a 15% down payment, and a term of 18 – 22 years, which is great for keeping your debt service down and increasing your Cash Flow.

On the other hand, 15% of business and real estate can still be a sizable down payment.

The cost on the “blended loan” will likely be more favorable as well with the real estate as collateral.

Seller Financing

Most small and mid size companies will involve a portion of seller financing.

It is appropriate to amortize the financing over a period of time and have a balloon after 2 or 3 years.

This way the financing serves two purposes: Funds the deal and shows that the seller has confidence in the business – and the buyer.

Obtaining Small Business Loans

Obtaining small business loans is tricky unless you are well prepared. Whether you are applying for a loan from your local bank, credit union, or some other source, you need to do your homework first to ensure that your loan application is successful. Most banks and other creditors consider small business loans risky especially in the initial years of the business. So, you have to work doubly hard to convince them that your business idea will succeed, you have a good business plan, that you are willing to invest your time and money in the venture, and that the venture will have sufficient cash flow to service the loan.

When looking at small business financing, most bankers check if the entrepreneur has also invested in the venture. They expect you to bring in between 25 and 50 per cent of the money needed for the start-up. The banker sees no reason to risk their money unless you are willing to risk some of your cash by way of capital.

Another reason why many start ups are denied small business credit is the lack of a convincing business plan. Before you go to meet potential lenders, you need to firm up your business plan. You need to show the lender exactly what their money will be used for and how you plan to repay the loan.

If you are a merchant, you can apply for a merchant cash advance, where the money borrowed can be used at your discretion. However, you do need to show regular sales and the potential to increase sales after the borrowings.

When in need of small business loans try approaching the Small Business Administration for help first. If they are willing to underwrite your loan amount, banks and other small business lending institutions will be more willing to lend to you. This is because their risk is lower. You can even try negotiating for a lower rate of interest.

When you need business credit line for operating expenses or to expand your business by purchasing more stock, it helps if you can offer the lender some collateral. If your business has tangible assets such as real estate or machinery, now is the time to use them to get credit at a lower rate of interest.

When applying for small business loans it is important to keep in mind that the primary concern of the lender is your ability to repay the loan. If you are able to convince potential lenders on this point by presenting a sound business plan and a repayment schedule you are more likely to obtain the loan. Yet another thing that bankers and lenders check is the personal credit rating of the borrowing entrepreneur. If you have not done so yet, get your credit rating reports and ensure that they reflect positively on your willingness to repay loans. By taking these very essential steps, it will be easy for any entrepreneur to obtain loans for their business needs.