One of the biggest dilemma / issues of the small business owner is the understanding and separation of business and personal assets. Most of us have heard of work & life balance, how about work and personal credit balance. Correct, similar to personal credit, we have business credit. It is very important for everyone business owner to understand the business credit – the pulse of every successful enterprise. The way personal credit is a reflection of a person’s character, business credit is the reflection of the business’ management.
Below are some financial jargon that we hear repeatedly:
Accounts Receivable (A/R): refers to money owed to a business by its clients for products or services provided while doing business.
Accounts Payable (A/P): refers to money owed by a business to its vendors for products or services acquired while doing business.
A/R or A/P Aging: refers to accounts receivables or payables organized in a tabular format based on the number of days outstanding from the date of invoicing. The general norm is: 0 – 29 days, 30 – 59 days, 60 – 89 days and 90+ days. The arrangement of the buckets is also specific to the industry.
Cash Flow: This is the cash that flows in and out of your business in a month. The cash coming into the business can come from customers & clients. Cash going out can be from expenses such as rent, payroll, taxes, etc.
Collateral: Any assets used to secure credit or a loan for the business is collateral and can be tangible or intangible. When you pledge an asset for collateral, it becomes subject to seizure by the lender if the business defaults on the terms.
Debt Service Coverage Ratio:
Gross Profit: After deducting the costs it takes to make and sell your company’s products or services, the gross profit is the money that remains. The gross profit shows up on the company’s income statement.
Line of Credit: A line of credit for a business is an account opened with a bank, credit union or lender that lets you borrow money when needed, up to a preset borrowing limit. Each issuer has its own unique underwriting criteria, guidelines and terms.
Net Terms: This is a specific type of trade credit offered to businesses which require payment in full in a short period of time after a product or service is purchased. The typical net terms are net 30 and net 60 days.
Personal Guarantee: A personal guarantee is a written promise from a business owner to accept responsibility in the event the business fails to pay.
Profit & Loss Statement: The profit and loss statement (P&L), also known as the net income statement, shows if your company is making money, breaking even or operating at a loss.
I cannot emphasize the need to understand one’s business credit. It is the single most important factor that determines the well-being of an organization and the people it supports. Business credit is the lifeline for a small business. Strong credit, enables a business to obtain cash needed to grow, advertise, hire employees, buy equipment and / or inventory and most importantly expand.