| Financial management in the
small firm is characterized, in many different cases, by the need to
confront a somewhat different set of problems and opportunities than those
confronted by a large corporation. One immediate and obvious difference is
that a majority of smaller firms do not normally have the opportunity to
publicly sell issues of stocks or bonds in order to raise funds. The
owner-manager of a smaller firm must rely primarily on trade credit, bank
financing, lease financing, and personal equity to finance the business.
One, therefore faces a much more severely restricted set of financing
alternatives than those faced by the financial vice president or treasurer
of a large corporation.
On the other hand, many financial problems facing the small firm are
very similar to those of larger corporations. For example, the analysis
required for a long-term investment decision such as the purchase of heavy
machinery or the evaluation of lease-buy alternatives, is essentially the
same regardless of the size of the firm. Once the decision is made, the
financing alternatives available to the firm may be radically different,
but the decision process will be generally similar.
One area of particular concern for the smaller business owner lies in
the effective management of working capital. Net working capital is
defined as the difference between current assets and current liabilities
and is often thought of as the "circulating capital" of the
business. Lack of control in this crucial area is a primary cause of
business failure in both small and large firms.
The business manager must continually be alert to changes in working
capital accounts, the cause of these changes and the implications of these
changes for the financial health of the company. One convenient and
effective method to highlight the key managerial requirements in this area
is to view working capital in terms of its major components:
(1) Cash and Equivalents
This most liquid form of current assets, cash and cash equivalents
(usually marketable securities or short-term certificate of deposit)
requires constant supervision. A well planned and maintained cash
budgeting system is essential to answer key questions such as: Is the cash
level adequate to meet current expenses as they come due? What are the
timing relationships between cash inflows and outflows? When will peak
cash needs occur? What will be the magnitude of bank borrowing required to
meet any cash shortfalls? When will this borrowing be necessary and when
may repayment be expected?
(2) Accounts Receivable
Almost all businesses are required to extend credit to their customers.
Key issues in this area include: Is the amount of accounts receivable
reasonable in relation to sales? On the average, how rapidly are accounts
receivable being collected? Which customers are "slow payers?"
What action should be taken to speed collections where needed?
(3) Inventories
Inventories often make up 50 percent or more of a firm's current assets
and therefore, are deserving of close scrutiny. Key questions which must
be considered in this area include: Is the level of inventory reasonable
in relation to sales and the operating characteristics of the business?
How rapidly is inventory turned over in relation to other companies in the
same industry? Is any capital invested in dead or slow moving stock? Are
sales being lost due to inadequate inventory levels? If appropriate, what
action should be taken to increase or decrease inventory?
(4) Accounts Payable and
Trade Notes Payable
In a business, trade credit often provides a major source of financing
for the firm. Key issues to investigate in this category include: Is the
amount of money owed to suppliers reasonable in relation to purchases? Is
the firm's payment policy such that it will enhance or detract from the
firm's credit rating? If available, are discounts being taken? What are
the timing relationships between payments on accounts payable and
collection on accounts receivable?
(5) Notes Payable
Notes payable to banks or other lenders are a second major source of
financing for the business. Important questions in this class include:
What is the amount of bank borrowing employed? Is this debt amount
reasonable in relation to the equity financing of the firm? When will
principal and interest payments fall due? Will funds be available to meet
these payments on time?
(6) Accrued Expenses and Taxes Payable
Accrued expenses and taxes payable represent obligations of the firm as
of the date of balance sheet preparation. Accrued expenses represent such
items as salaries payable, interest payable on bank notes, insurance
premiums payable, and similar items. Of primary concern in this area,
particularly with regard to taxes payable, is the magnitude, timing, and
availability of funds for payment. Careful planning is required to insure
that these obligations are met on time.
As a final note, it is important to recognize that although the working
capital accounts above are listed separately, they must also be viewed in
total and from the point of view of their relationship to one another:
What is the overall trend in net working capital? Is this a healthy trend?
Which individual accounts are responsible for the trend? How does the
firm's working capital position relate to similar sized firms in the
industry? What can be done to correct the trend, if necessary?
Of course, the questions posed are much easier to ask than to answer
and there are few "general" answers to the issues raised. The
guides which follow provide suggestions, techniques, and guidelines for
successful management which, when tempered with the experience of the
individual owner-manager and the unique requirements of the particular
industry, may be expected to enhance one's ability to manage effectively
the financial resources of a business enterprise.
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