Financial Literacy for Raising Money The Questions You Need to Ask Yourself
As we continue to discuss increasing our financial literacy, we must also consider the ways in which a company increases its chances for securing money for growth. The list of possible ways to obtain money to finance the growth of a company is extensive, including multiple forms of debt and equity instruments. The question of which is right for you is dependent upon your particular situation and your level of understanding of each. In order to navigate through this scenario, we have come up with a list of questions you need to be able to answer to make the best decision for you and your company overall.
Do you really need money for growth?
While there are many professional organizations that make endless promises to help you raise capital for your business, and while they all sound tempting, you must first understand whether or not you actually need money for growth. Contrary to popular belief, you will not always answer this in the affirmative. If you decide your organization requires capital for growth, then begin the process by speaking to your trusted advisors about their opinion on your plans. This discovery process should happen with professionals you already have a relationship with and who know about your company. Think about your attorney, CPA, outsourced CFO, or someone in a similar situation who has previously advised you in these matters. Only after this discovery and pertinent conversations can you then move forward with first designing a strategy, and then executing that strategy in a way that does not allow the fund raising process to consume the C-suite and deteriorate the business itself. These results can occur whether you are a small start-up or a large organization.
How do you know in which direction to go?
If you’re the decision maker and have governance over an organization, the first step is to evaluate your ethics and check your ego at the door before you begin to have the necessary conversations. Raising capital has become so sensationalized that those with decision-making authority tend to think of fund raising as a necessity. However, that is not necessarily the case. While raising funds is a common impetus to growth, it isn’t for every company.
Start by looking at the historical and projected financial information. Ensure the use of funds you expect to raise is clear, and that the financial strategy for growth is viable. This initial step will require that you have quality up-to-date financial information. Click here to see my blog about the need for financial infrastructure.
How do you know who to trust?
Many entrepreneurs tell me about situations where a third party offers to help them raise capital, but charge them a percentage of what they raised. Keep in mind, if the person who made that statement is not a broker or investment banker, that arrangement could be illegal and cause issues as the company grows. My biggest piece of advice is to ask if the person if he or she has a license to effectuate this type of arrangement.
The other issue is that some of the investment bankers have had a difficult time getting clients in the pandemic environment. As a result, they have started consulting to assist with cash flow and to provide themselves with additional companies to move into the investment banking sales funnel. The issue with this is that these companies are signing up to be with the investment banker before they even know if that is the right fit for them or not.
As a true professional, both of these instances are painful to witness. Before executing a contract or providing a deposit to anyone to assist with fund raising, proceed with caution. Make sure their culture and track record are consistent with your goals and strategy. If you have partners that have different goals and ethics, it could be catastrophic to the organization. Do your homework to make sure it is the right partner from the outset!
Do you need debt, equity, or a combination of the two?
Banks are conservative, and it is difficult for any size corporation to secure debt these days. This form of capital is, of course, cheaper than equity overall as you do not have to give up ownership and the interest rates are currently so low.
Equity partners can potentially have in-depth experience with the industry you are in and can actually help you build a larger and more robust entity. The saying is, “You can have a smaller piece of a big pie and actually have more value than a larger piece of a small pie.” If you do your homework and make sure your equity partner is aligned with your values and the right fit overall for your company, you can accomplish this goal.
In a scenario with a combination of convertible preferred stock, it provides the investor with a liquidation preference. In the event a few unlucky events happen, this could mean the common stock investors could wind up with nothing in the end, which is exactly what happened when BlackBerry liquidated. In that case, the company emphasized to employees that they should buy in while they could. When they were granted stock, they had to pay the taxes at the value at the time, and then when they sold the stock, it was, at time, at 1% of the value on which they paid the taxes. So, that could mean they were granted stock worth $45 per share, paid the taxes on it at their rate, let’s say 20% or $9, then they sold it for $.40, which was all the cash they received for that share, despite the taxes they paid. If they had a number of shares, that is a lot of money wasted.
In the situation with a SAFE combination, there is a debt instrument that converts to equity at the next round of investment. This is a great instrument when companies are at an early stage and the discussion over valuation is difficult. When valuations increase quickly for successful companies, this can actually turn into an uncomfortable conversation that can hold up an exit transaction under certain circumstances.
Just as with our previous financial literacy articles, it’s not just about improving your financial knowledge of the present, but about strengthening that knowledge to predict a brighter future, especially as it pertains to the growth of your company. If you would like to discuss various growth strategies and what makes the most sense for your business, or if you have other specific areas of concern, please click here to schedule a 30-minute free consultation. NOTE: beginning May 1, 2021 consultations will no longer be free.
The Balancing Act of Account Reconciliation and Online Banking Convenience Doesn’t Make Up for Inaccuracy
We are continuing our financial literacy discussion with something we all know about … or do we? We’re talking about online banking and its effect on our reconciliation habits (or lack thereof). In our daily routines, with our phones and computers easily assisting us with deposits, automated payments, and Zelle transfers, do we ever think about good old bank account statements and the ever-important task of regular bank account reconciliations? My guess for many is no.
Most of us happily “live” online. Our online lives provide convenience and speed like we’ve never known before. Simply, they provide what we all crave – instant gratification. As a society, we have become accustomed to having all of the information we need with the click of our mouse or a swipe on our smartphone. Dare I say, we tend to get a little lazy, not to mention, annoyed, when we don’t have instantaneous satisfaction. Everything from groceries to dinner delivery to setting appointments to virtual doctor’s appointments to online banking just helps make our lives easier. And we’re all for it.
With regard to online banking, being able to find out your balance, arrange for a payment, and make a deposit all from the palm of our hand is wonderful … in certain situations. However, in many instances, people are becoming far too reliant on this online information and forgetting about some of the basics, such as bank account reconciliation.
In the Days Before Online Banking
Once upon a time, long before online banking became a regular part of our lives, the standard practice for both personal and business checking accounts was to reconcile a check register to a monthly bank statement. You remember those days (or you should) – when you received your bank statement in the mail (yes, the actual mailbox, not email) and then you’d open your checkbook and go through line-by-line check-marking away to make sure each transaction was accounted for? Well, there was a reason for that. You need to know which transactions have cleared and which haven’t, so you can accurately determine how much is in your account (which, in reality, is not always what the number on the statement says).
Yet, when accounting professionals adopted online banking into their processes, organizations tended to forgo the discipline of maintaining a check register as part of their reconciliation processes. In the interest of increasing efficiencies, and feeling as if the ends no longer justified the means, reconciliation became an “obsolete” practice. But should it have? Absolutely not.
A Common Conversation
The following is a typical conversation I’ve had when consulting with clients on accounting process improvements:
Accounting professional (with a bundle of unsigned checks): “This is our process for obtaining check signatures.”
Me:“How do you know you have enough money in the account to cover these checks? What is your procedure?”
Accounting professional:“I checked the balance online this morning.”
Me:“Where is the reconciliation to the check register? How do you know that all of the uncashed checks will not deplete the entire balance?”
Accounting professional:“I know there are not that many outstanding checks.”
Me:“When is the last time you reconciled the account?”
Accounting professional: Answers range from “a year ago” to “I do not remember” (not good) to “yesterday” or “a month ago” (which is good).
Finding the Right Balance
I am not saying there aren’t times when viewing online balances without going through the reconciliation process is appropriate, but it’s not the final reconciliation resource. It’s okay to use online banking as an effective tool to manage your daily cash flow, but it requires the extra effort of being connected to a cash reconciliation process that is properly maintained and reviewed periodically. Without accurate and consistent reconciliations, your organization is at risk of fraud, unauthorized withdrawals, or bank errors. If left unchecked, these issues can quickly lead to cash flow issues that will hurt business operations and stifle growth.
Let’s avoid those situations with an experiment: If you are a CEO, President of a company, or a Finance Chair of a non-profit, ask the accounting department for the latest bank/cash reconciliation of the operating account. Ask specifically for these documents:
The bank reconciliation
A copy of the bank document to which it was reconciled
The Balance Sheet balance to which it was reconciled
(Note: Publicly traded companies, financial institutions, insurance companies and other regulated industries have to maintain reconciliation procedures, so if you are in charge of one of those, regulation will take care of this.)
If you are bold enough to move forward with this call to action, my experience tells me about 50% of you will get a reconciliation completed in the last 45 days. If you get one and do not know how to review it, schedule time with me for a free, no-obligation checklist that will guide you through a high-level review.
If you do not get a reconciliation, and, in fact, get a blank stare from your accounting person, contact me to complete a review of your cash procedures and processes. You may have plenty of cash flow today, but how do you really know without a current reconciliation? Don’t risk finding yourself in a position where you cannot meet your basic financial obligations. “Cash is king” is a cliché’ for a reason – it’s true!
This week, we continue our month-long discussion on financial literacy, including best practices to increase your financial knowledge. While there are numerous reasons business owners do not have an adequate level of financial knowledge (some people are just not good with numbers, guidance from GAAP has gotten so complicated it makes it even more difficult to understand, and business owners are just “too busy” to get into it), this knowledge is crucial to having effective conversations about your business.
Can You Stand Your Financial Ground?
If the right investor came along tomorrow, how confident are you that you are prepared with accurate historical and projected financials? Can you demonstrate thorough knowledge of your company’s financials, cash flow, burn rate, and return on investment? Are you prepared to get drilled on each number you provide and have the ability to accurately explain where it came from? If you are not prepared, it will feel like the longest half hour of your life.
So, how confident are you?
If your answer is, “Not confident,” or “Somewhat confident,” it is time to make an investment in yourself. Here are a few tips to increase your financial knowledge:
Prioritize your financial education. We know how busy you are, but think of it as the investment it truly is.
Develop a financial advisory team. Ask these trusted individuals questions and encourage them to do the same.
Make the cash flow statement your new best friend. This is the lifeblood of business and you should understand everything on it at all times.
Take some basic accounting courses. It’s never been easier to take a class online.
Connect with a CFO firm. Not everyone has all of the required resources at their fingertips. Allow the right CFO firm to become that resource as a trusted partner.
Get a better understanding of key financial terms. We’re including some right here to help get you started.
Terms to Help You Stand Stronger
When an investor begins to ask about gross profit, net profit, or EBITDA, often the business owner’s face says it all – like when you’ve caught a teenager in a lie. Knowing these financial terms helps you not only have a more constructive conversation with potential bankers and investors, but also to truly have a better understanding of your business. Some of the basics (there are many more) include:
Aged Accounts Receivable. This is a report that categorizes a company’s accounts receivable according to how long invoices have been outstanding. This report is used as a benchmark in measuring the financial health (or lack thereof) of a company’s customers.
Burn Rate. Burn Rate refers to how much money it takes to operate your business for a period of time (generally, a month). Knowing your burn rate helps to ensure that you have enough available cash to adequately run your business. Experts advise being able to cover your burn rate for at least six months.
Cost of Goods Sold (COGS). This refers to the total cost of all labor and materials required to provide the products or services that your customers ultimately purchase.
Debt-Service Coverage Ratio (DSCR). A ratio calculated by dividing your business’s net operating income by your debt payments. This compares cash flow to debt obligations. With the information, you can determine if you can cover debts due within one year.
EBITDA. Earnings before interest, taxes, depreciation, and amortization. To calculate EBITA, take the gross margin and subtract total operating expenses, plus depreciation and amortization. Keep in mind the difference between EBITDA and EBIT. EBITDA subtracts all expenses, whereas EBIT subtracts everything except depreciation and amortization.
Gross Profit Percentage or Gross Margin. This refers to the percentage of total revenue that remains after subtracting the direct costs of producing the product or service. For example, if your company’s revenue is $400,000 in one year and your gross margin is 25%, then your gross profit is $100,000.
Profit Margin.Profit margin is the percentage of your total revenue that you retain as profit. This metric is most often analyzed on a per unit basis. To calculate profit margin, subtract overhead expenses (along with direct costs) from your sales and then divide it by your total revenue. While it may take some time for a business to start generating profit, it is ultimately what makes it valuable … and a priority for investors. It is imperative that you are confident that your revenue you are charging for the product will cover the overall cost of the organization. When you are in growth mode, this may not be the case – which is why the Cash Burn rate (referred to earlier) is so important.
Working Capital. Working capital is cash plus other current assets, less current liabilities.
Whether it’s understanding these terms (and the many others), using the tips to increase your financial knowledge, or tightening up financial reporting, successful leaders ensure these characteristics are not contained within the walls of their accounting departments, but instead, are a part of their entire company culture. With financial clarity, you can maintain stability to carry out the company’s mission.
Simply, when you understand the financial terms and their effects on your business, it not only helps your bottom line, but also helps you have a more constructive (and potentially profitable) conversation with potential bankers and investors.
Let Mindy Barker & Associates show you how to raise your knowledge and be prepared for that next big conversation. We can help you improve your financial brilliance and empower you with the tools and financial information you need to improve your company value, cash flow, and profitability. Schedule a 30-minute free consultation here to learn how.
Can You Really Afford Not to Understand Your Budget? Get Off the Financial Treadmill with a Budget and Move Forward
Last week, we kicked off our series on increasing our financial knowledge and the tools needed to educate ourselves in observance of Financial Literacy Month. This week, we are starting with one of the basics – the process and tool without which a business could easily crumble. We’re talking about the importance not only of developing a budget, but developing your thorough understanding of the numbers behind it. At its most fundamental basis, understanding finance is, in fact, about mastering the business’s budget. Without it, there is no control over spending. And without control over spending, it is difficult (if not impossible) to plan for the future. And without a plan, how can a business reach its objectives or achieve its goals? Simply, it can’t.
There is only so far an incredible idea, enthusiasm, and optimism can take you in business. Without a carefully prepared budget, based on accurate information, you could be out of business before you begin, whether you are the owner of a small start-up or the finance manager of a large corporation. Absent clear direction, potholes surface all around you – revenue, expenditures, cash flow, strategic goals. A well-planned budget can pave the road for a smooth ride to financial longevity and success.
Numbers are Black and White; No Smoke and Mirrors Needed
Have you ever been in a financial meeting with someone who is at best unprepared and at worst clueless as to what the meeting is about? I have, and it is frustrating, to say the least. This is never more apparent than when someone is attempting a smoke and mirrors show, trying to distract you from their lack of knowledge. And, all you really want to ask is, “What do the numbers say? They’re black and white! There’s no need for all the gray.”
The issue often boils down to them either not having a budget at all, or having one with no understanding of how it came together or functions. It’s not a matter of a specific document. It’s a matter of understanding the implications of the numbers represented on that document. Absent that understanding, the person cannot communicate expectations and goals, set organizational objectives, assess or measure performance against those goals, gain insights, or allocate resources appropriately or strategically.
So, How Exactly Can a Budget Help?
Most people understand the essence of a budget – it is a financial plan that estimates revenue and expenses over a specified period of time, including cash flow, revenue, and expenses. But they do not understand where the numbers come from or the true benefits of understanding them. The ability of a business owner or manager to quickly identify available capital and expenditures, and anticipate future revenue is crucial to ensuring that resources are there when needed.
With a budget, a business can control its finances, ensure it can fund its current commitments, all well as future projects, and enable it to meet its objectives with decisions based on facts, not assumptions. Armed with this information, the owner or manager can concentrate on cash flow, reduce expenditures, and increase profits. It also allows him or her to speak to the organization’s accountant, key stakeholders, or potential investors confidently and accurately about the business’s overall financial health.
There are numerous benefits of budgeting. For example, budgets:
Provide revenue and expenditure estimates.
Highlight the strengths and weaknesses of the business.
Help set realistic expectations when planning out future years.
Minimize budget to actual variances.
Ensure money is allocated to appropriately support strategic objectives.
Ensure that the team involved in preparing them can effectively communicate with finance and accounting professionals, key stakeholders, and investors.
Help share the business’s vision with other team members.
Provide a tool to measure performance, comparing it to prior time periods and anticipating future ones.
Help ensure that a team has the resources needed to achieve its goals.
Running a business without a budget is like running on a treadmill – you are always working, but not going anywhere. If that feels like you, it’s time to hop off what keeps you moving, yet remaining in one place, and actually start moving forward. Remember, the budget process should be well planned out, informed, and include all of the responsible parties. It’s not just about improving your financial knowledge of the present, but about strengthening that knowledge to predict a brighter future. If you would like to discuss your budget and how to ensure it is working efficiently for you, or if you have other specific areas of concern, please click here to schedule a 30-minute free consultation.