Monday, June 16, 2014

Improving your cash flow: Part IV

We have talked about how to improve your business' cash flow by being aware of the components (accounts receivable, inventory, accounts payable) and how they impact the amount of money available to a company.  This week we will discuss debt service and how that can effect cash flow.

Debt service means the payments you make on loans, both the interest portion and the principal, if applicable.  The interest portion appears on the profit and loss statement, but the portion reducing the debt (principal) shows up on the balance sheet as a small loan balance.  As such, if your budget is solely a P&L based budget, you may not have the full loan payments reflected.  This can have a major impact on the business if you have significant debt.  Another aspect of debt service is the need to pay down or rest a line of credit.  A lender will want a borrower to occasionally pay the loan down to zero or close to it.  A line of credit is designed to help cash flow in cases where large purchases are needed (raw materials or other types of inventory) and the length of time before the items are sold and the proceeds collected is significant enough to cause the bank balance to dip too low.  The idea is to draw on the line (transfer the money into checking) to pay for the purchases and then to pay it back when the sales proceeds are collected.  Too often, businesses do not keep in mind the need to pay the line back down.  This not only causes concern by the lender, it can also cause problems down the road for the business as there may not be sufficient money left to borrow on the line for the next large purchases.

Debt is necessary for many business owners, but properly managing it is an important part of managing cash flow.  Next week we will talk about owner's draws and how they effect cash flow.

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