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Larry’s Funding Strategies, Inc.

Posted on June 20th, 2016

Jack Kern
Outsourced Accounting Department, Inc.  

As I indicated in my previous article, “Larry’s Exit Strategies, Inc.,” it will usually take a period of years (versus the one-year profit that was indicated in that scenario) for a business to reach the level of income where they command an attractive sales price. Most businesses I have worked with do not show a 30% net profit margin, maybe a pre-tax  margin 5 to 12% would be more typical, with some much higher, of course.  And at a lower net margin, many businesses must also finance their grow from external funds such as loans, or an infusion of capital by the owner or from other outside investors.  In this article, I will demonstrate a model I use to determine the amount of funding that will be required, and to identify the most appropriate source of funding.

First, using as a starting point the previous financials I created for my previous article (mentioned above), I made a few assumptions to increase the company’s funding requirement. These were (rounded):

  • Material Costs – Increased from 25% to 50%, thus reducing Gross Profit from $750,000 to $500,000.
  • Credit Cards – Paid off previous balance of $28,300.
  • Loans from Shareholder – Paid remaining balance of $44,000 back to owner.
  • Long Term Debt – Amortized previous loan balance over 24 months, resulting in principal reductions of $14,900, and increasing interest expense to $6,300.
  • Shareholder Distributions – Distributed $13,000 to owner to pay taxes (S-Corporation).
  • Accounts ReceivableSlowed turnover from 30 to 50 days, increasing accounts receivable by $19,000 (from where it would have been under the “exit” scenario).
  • Inventory – Increased $41,600 (from the previous “exit” scenario) due to the above increase in material costs.

Using the (simplified) profit and loss and cash flow formats that I’ve used for previous articles, below is what just those two statements now look like after making the above changes:

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Now, to introduce a slightly different way of looking at “cash flow,” below is a monthly Profit & Loss statement reflecting the accelerated sales growth, as well as changes in the various balance sheet items over the 12-month period.  Note first the net losses that occur from Month 1 through Month 6, adding to the above cash requirements (per several previous articles). This is due to the above increase in material costs at the lower sales volume during the first half of the year. Then also notice the ending cash balance, which is the same as the ending cash balance per the above simplified cash flow statement. (So don’t be confused by the different looking format, they both end up at the same place.)

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Also shown in the above is a section called “Borrowing Availability – Note Payable LOC.”  Basically, this analysis looks at the cash required from the cash flow statement above, and calculates the amount of funding against accounts receivable (only, which I will explain further in a future article) that would be available to fund this requirement.  If there is not enough borrowing availability, the resulting “Cash Over Advance” indicates the amount of money that must come from other external sources of funds, whether that be a different loan structure against the company’s fixed assets, money put back in by the owner, or an infusion of capital by outside investors.

Due to all of the above factors, for this company, a cumulative loan balance of $144,000 is indicated by year-end. But note in particular, the cash shortfall (“Cash Over Advance”) that occurs in the second half of the year, as profit and cash flow lag behind the company’s growth. Herein lies the financial risk relating to “growth,” and therefore the importance of “strategic financial planning.” otherwise, the business owner may very well find him or herself bouncing checks, or worse, being cut off by his bank and critical suppliers.  This will become the focal point of several of my future articles, and using this new model I have now introduced.


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