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Cash Flow Expressed as Asset-Based Borrowing Availability

Posted on June 25th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In this article from Entrepreneur Magazine, “How Much Cash Do You Need for Your Business’s Safety Net?,” the author discusses the importance of maintaining sufficient liquidity in your business, or in other words, a cash reserve.

Then in another article from Entrepreneur Magazine, “The Ins and Outs of Cash Flow Statements,” the author explains the basics of what goes into creating a cash flow statement, including a link to this sample the author created in a spreadsheet: Sample – Traditional Cash Flow Statement.  Notice the bottom line of her sample is the ending “cash balance.”

But, what if your company is growing fast, and maintaining a sufficient cash reserve simply isn’t feasible. What then? Another way of looking at cash flow when you’re in a growth mode is in terms of borrowing availability against the company’s accounts receivable and inventory.  The difference here is that rather than forecasting a cash balance, you are now forecasting a cash requirement, and the ability to fund it externally through an outside lender, using the company’s accounts receivable and inventory as collateral.

Here’s what it looks like:

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Monthly Cash Flow Statement: The top section of this page is merely another cash flow format often used by banks to estimate a company’s ability to repay debt from cash flow.  It first converts accrual financial statements to a cash basis by calculating the changes in accounts receivable, inventory, accounts payable, and other miscellaneous balance sheet accounts to arrive at “Cash Available for Debt Service.”

Then, the general theory is, if “Cash Flow After Debt Service” is positive, the company is bankable.  If not, the company is growing too fast, or accounts receivable and/or inventory turnover is too slow, or maybe the company is losing money. In this sample, on average, a negative $113,488 (see report) is forecast for the year.  So, either an improvement in profitability or cash management is needed, or, some other type of non-bank lender or an equity infusion is more appropriate.

The next lines then reflect the “Financing and Investing Activities” (described in the “The Ins and Outs of Cash Flow Statements” article above).

Asset-Based Credit Facility – Borrowing Availability: Note in the Cash Flow Statement above the forecast ending cash balance of $10,000 through the end of the year.  This is just an assumed minimum balance the company desires to maintain in its bank account.

The next section then creates a whole different method of defining “Cash Reserves.” Instead of a cash balance, the above negative cash flow, or the “Change in Cash” after all operating, and long-term financing and investing activity, drives a funding requirement that is assumed to be funded under the company’s line of credit. The amount the company can actually borrow is then restricted to the percentage advance rate against receivables and inventory imposed by its lender, and whatever the lender considers to be “eligible” collateral, such as accounts receivable less than 60 or 90 days old, with a maximum advance on certain customers, inventory, and ultimately on the line of credit itself (i.e., the note amount).

In the above sample, the amount of borrowing availability is projected to be more than adequate to support the company’s cash requirements through the end of the projected period.  However, if circumstances change in the wrong direction, and certain major assumptions are altered, an “over-advance” may occur in the forecast.  If so, it’s an indication that either corrective action is needed internally, or alternative financing options must be explored to augment the company’s line of credit.  These “what-if”scenarios will be further demonstrated in future articles.                               

Related Articles:

Analyzing the Components of Cash Flow

The Effect of Sales Growth on Cash Flow

The Relationship Between Turnover Ratios and Cash Flow

Larry’s Funding Strategies, Inc.

Larry’s Debt Repayment Strategies, Inc.


Deducting Travel and Entertainment Expenses

Posted on June 17th, 2017

Tax law allows you to deduct two types of travel expenses related to your business, local and what the IRS calls “away from home.”

  1. First, local travel expenses. You can deduct local transportation expenses incurred for business purposes such as the cost of getting from one location to another via public transportation, rental car, or your own automobile. Meals and incidentals are not deductible as travel expenses, but you can deduct meals as an entertainment expense as long as certain conditions are met (see below).
  2. Second, you can deduct away from home travel expenses, including meals and incidentals, but if your employer reimburses your travel expenses your deductions are limited.

Local Transportation Costs

The cost of local business transportation includes rail fare and bus fare, as well as costs associated with use and maintenance of an automobile used for business purposes. If your main place of business is your personal residence, then business trips from your home office and back are considered deductible transportation and not non-deductible commuting.

You generally cannot deduct lodging and meals unless you stay away from home overnight. Meals may be partially deductible as an entertainment expense.

Away From-Home Travel Expenses

You can deduct one-half of the cost of meals (50 percent) and all of the expenses of lodging incurred while traveling away from home. The IRS also allows you to deduct 100 percent of your transportation expenses–as long as business is the primary reason for your trip.

Here’s a list of some deductible away-from-home travel expenses:

  • Meals (limited to 50 percent) and lodging while traveling or once you get to your away-from-home business destination.
  • The cost of having your clothes cleaned and pressed away from home.
  • Costs for telephone, fax or modem usage.
  • Costs for secretarial services away-from-home.
  • The costs of transportation between job sites or to and from hotels and terminals.
  • Airfare, bus fare, rail fare, and charges related to shipping baggage or taking it with you.
  • The cost of bringing or sending samples or displays, and of renting sample display rooms.
  • The costs of keeping and operating a car, including garaging costs.
  • The cost of keeping and operating an airplane, including hangar costs.
  • Transportation costs between “temporary” job sites and hotels and restaurants.
  • Incidentals, including computer rentals, stenographers’ fees.
  • Tips related to the above.

Entertainment Expenses

There are limits and restrictions on deducting meal and entertainment expenses. Most are deductible at 50 percent, but there are a few exceptions. Meals and entertainment must be “ordinary and necessary” and not “lavish or extravagant” and directly related to or associated with your business. They must also be substantiated (see below).

Your home is considered a place conducive to business. As such, entertaining at home may be deductible providing there was business intent and business was discussed. The amount of time that business was discussed does not matter.

Reasonable costs for food and refreshments for year-end parties for employees, as well as sales seminars and presentations held at your home, are 100 percent deductible.

If you rent a skybox or other private luxury box for more than one event, say for the season, at the same sports arena, you generally cannot deduct more than the price of a non-luxury box seat ticket. Count each game or other performance as one event. Deduction for those seats is then subject to the 50 percent entertainment expense limit.

If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. The amounts separately stated for food and beverages must be reasonable.

Deductions are disallowed for depreciation and upkeep of “entertainment facilities” such as yachts, hunting lodges, fishing camps, swimming pools, and tennis courts. Costs of entertainment provided at such facilities are deductible, subject to entertainment expense limitations.

Dues paid to country clubs or to social or golf and athletic clubs, however; are not deductible. Dues that you pay to professional and civic organizations are deductible as long as your membership has a business purpose. Such organizations include business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards.

Tip: To avoid problems qualifying for a deduction for dues paid to professional or civic organizations, document the business reasons for the membership, the contacts you make and any income generated from the membership.

Entertainment costs, taxes, tips, cover charges, room rentals, maids, and waiters are all subject to the 50 percent limit on entertainment deductions.

How Do You Prove Expenses Are Directly Related?

Expenses are directly related if you can show:

  • There was more than a general expectation of gaining some business benefit other than goodwill.
  • You conducted business during the entertainment.
  • Active conduct of business was your main purpose.

Record-keeping and Substantiation Requirements

Tax law requires you to keep records that will prove the business purpose and amounts of your business travel, entertainment, and local transportation costs. For example, each expense for lodging away from home that is $75 or more must be supported by receipts. The receipt must show the amount, date, place, and type of the expense.

The most frequent reason that the IRS disallows travel and entertainment expenses is failure to show the place and business purpose of an item. Therefore, pay special attention to these aspects of your record-keeping.

Keeping a diary or log book–and recording your business-related activities at or close to the time the expense is incurred–is one of the best ways to document your business expenses.

Case Study: The Risk of Sales Concentrations

Posted on June 10th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In my previous article, “The Good News: Your Business is Growing – And That’s Also the Bad News,” I talked about how rapid sales growth can also create the need for large amounts of working capital to support it.  This need was subsequently met via an asset-based credit facility,  so the business was all set and off and running – that is, until the unexpected happened:  some major customer contracts for various reasons never materialized. And by this time, the company had already incurred large capital lease obligations on the equipment lines necessary to support its projected sales to these customers. In other words, its fixed costs had increased substantially, and therefore, its breakeven point of sales.

Thus, the company found itself in a major turnaround situation to fill its sales and production pipeline as quickly as possible to absorb its fixed costs (equipment leases).  Simultaneously, the company had exceeded its borrowing base on its asset-based credit facility, and was instructed by its lender to “stop writing checks immediately.” (And the almost humorous irony was, this company had recently been named by a local magazine as the “fasting growing company” in the region, precisely at a moment when it was on the verge of bankruptcy.)

Major steps were subsequently taken, including downsizing its employee staff while simultaneously negotiating extended credit terms from major suppliers, combined with revising its marketing strategy to target high volume contracts to absorb its fixed costs.  Then coincidentally, the company won a lucrative contract from an existing customer that both increased utilization of its new production line, and significantly boosted sales volume and cash flow. Another bullet dodged, right?  Yes – for a while. But the new problem now was that this customer had bet its future on a new product, one that quickly became obsolete with the advent of another product that quickly flooded the marketplace – the cell phone!  So suddenly what was the company’s saving grace was now becoming the final nail in its coffin.

The point is, as I discussed in my previous article, “Heading Off Business Failure,” one of the most common reasons I’ve observed as to how businesses get into financial trouble is a major sales concentration with one customer. If anything happens to that customer, even if their payments on accounts receivable just slow up a bit, it can have a major impact on your company’s cash flow, not to mention what happens to your company if they go out of business completely.

In the case of this company, what it really needed was to increase sales and diversify its customer base, and find an investor to either purchase or capitalize the business to buy time. However, its sales concentration with this one customer also created an insurmountable barrier for prospective investors who were valuing the company based on “earnings,” and its asset-based lender finally ran out of patience. Consequently, the company was ultimately forced into a distressed sales of its assets, leaving behind a major shortfall on its asset-based loan – to be repaid by the owner, personally.

Related articles:

7 Crucial Money Tips to Failure-Proof Your New Business

Larry’s Exit Strategies, Inc.

Larry’s Fairy Godmother Strategies, Inc.

The Role of Cost Accounting in Planning Your Business’ Success


The Good News: Your Business is Growing – And That’s Also the Bad News

Posted on June 3rd, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

This article from Entrepreneur Magazine, “Why Your Business Could Be Failing Even If You Hit Your Numbers,” brought to mind an experience I had with a former client / employer.  My initial task as a consultant was to prepare a business plan for this company, a contract electronics manufacturer, and assist the company with obtaining financing to support its growth.

In our first planning session, I asked the owner of the company to provide me with his sales projections for the last three quarters of the fiscal year. In a subsequent meeting a few days later, he came back with a spreadsheet indicating his sales would increase 6% in the second quarter, 9% in the third quarter, and12 % in the fourth quarter. And my response was, “OK, now, write in the margin ‘ha-ha’- what I really want to know is what your customers are going to buy from you, and if you don’t know, call them and ask them.” (In this type of business, future production requirements were known far in advance by the company’s customers).

So back to the drawing board he went, and to everyone’s surprise, the sales assumptions he came back with far exceeded his original forecast. That was the good news. But now here was the bad news:  This sales growth created another major challenge for the company – how much permanent working capital was needed to support the large amounts of inventory and increases in accounts receivable, and where was it to come from?

Well, we ultimately worked out that part. The company’s growth was so fast that it was not a “bankable” scenario, so initially we arranged an asset-based credit facility against accounts receivable only.  As the company grew more and its permanent working capital needs increased, this loan was later replaced by a larger asset-based credit facility from another lender that also included an advance component against certain classes of inventory.

Fortunately, this company became aware of the amount of funding it was going to require to support sales growth, and took the appropriate steps to plan for it well in advance of the need.  Had it not done so, the outcome could have been catastrophic. So all was well that ended well, right?  Stay tuned.

Related Articles:

The Effect of Sales Growth on Cash Flow

Financial Planning, or Business Turnaround – Your Choice

Heading Off Business Failure