U.S. Small Business Administration EB-7

**FINANCIAL MANAGEMENT**

**FOR THE GROWING BUSINESS**

Bryan Ziegler

Director

Indian Hills Community College

Small Business Development Center

Ottumwa, Iowa

# Emerging Business Series

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Copyright 1990, Bryan Ziegler. All rights reserved. \"How to Write a
Business Plan.\" Copyright 1990 Linda Pinson and Jerry Jinnet. No part
may be reproduced, transmitted or transcribed without the permission of
the author. SBA retains an irrevocable, worldwide, nonexclusive,
royalty-free, unlimited license to use this copyrighted material.

While we consider the contents of this publication to be of general
merit, its sponsorship by the U.S. Small Business Administration does
not necessarily constitute an endorsement of the views and opinions of
the authors or the products and services of the companies with which
they are affiliated.

*All of SBA\'s programs and services are extended to the public on a
nondiscriminatory basis.*

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**TABLE OF CONTENTS**

**INTRODUCTION**

Managing Financial Growth

There Is No One Right Way

**SECTION 1: OBTAINING CAPITAL FOR GROWTH**

Deciding to Actively Pursue Growth

Estimating Expansion Costs

Obtaining Financing

**SECTION 2: MANAGING CAPITAL**

Effective Cash Flow Management

Techniques for Reducing Costs

**SECTION 3: DOCUMENTING RESULTS**

Your Accounting System

Tax Consequences of Growth

**SUMMARY**

**APPENDIXES**

A. Sample Balance Sheet and Income Statement

B. Sample Pro Forma Statements

C. Blank Forms

D. Self-Assessment Questionnaire

E. How to Write a Business Plan

F. Information Resources

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**INTRODUCTION**

An expanding business offers the potential for numerous growth
opportunities. Employees benefit from business growth through increased
earnings and promotions. Customers benefit from expanded products and
services. Owners benefit through increased profit potential. Society
benefits through the new jobs created. Managing this growth, although
rewarding, can challenge your skills and financial resources.

Financial management involves all the activities that enable a company
to obtain capital for growth, allocate resources efficiently, maximize
the income potential of the business activity and monitor results
through accounting documents. Such management requires a well-written,
comprehensive financial management plan clearly outlining the assets,
debts and the current and future profit potential of your business.

This publication discusses the how to approach to financial management
(i.e., a method that makes the growth process easier to understand and
implement), in addition to providing general information on the
challenge of managing financial growth. It is divided into three
sections, with each focusing on important aspects of financial
management: Section 1: Obtaining Capital for Growth; Section 2: Managing
Capital and Section 3: Documenting Results.

Successfully managing financial resources is important in new and
expanding businesses, so take time to develop and implement a financial
plan that will ensure the success of your business.

**Managing Financial Growth**

Managing the finances of a growing business requires persistence and
balance. To obtain the funding needed to finance growth, you must
understand the roles of these concepts and how to apply them in managing
a growing business. A brief discussion of these concepts follows.

Persistence

In a growing business, financial resources are often viewed as the major
factor limiting growth potential. There are two methods of improving
your financial base: (1) grow gradually and allow profits to fund
additional growth and (2) seek outside funds (i.e., debt or equity
funding). Either approach will consume time and energy, and you will
experience some rejections. This is where persistence is important. Your
determination, combined with a willingness to adjust your plans, will
carry you through this process.

Sustained growth puts stress on you and the financial resources of your
business. Achieving growth goals often takes longer than you initially
planned. However, you are not alone in the quest for growth and
expansion. Many successful business owners have experienced the same
problems and frustrations. To understand the challenge ahead, visit
successful local business owners and read articles or books about their
experiences. *Inc*., the *Wall Street Journal* and some of the general
business publications, such as *Business Week*, *Forbes* and *Fortune*,
all contain stories about successful growing businesses. The business
section in your local newspaper features local success stories. Also,
area development corporations and chambers of commerce are excellent
sources of information on local businesses. Don\'t hesitate to take
advantage of these resources. You can learn valuable techniques and
concepts that will enable you to avoid many of the problems other
business owners have encountered.

Balance

The financial and operational aspects of growth must be balanced when
you expand your business. During a growth phase, for example, the
marketing function of the business may extend beyond the business\'s
financial capacity to sustain growth. To avoid this dilemma, devise
policies to balance the operational functions of the business with the
financial aspects of growth.

Here are several guidelines to help you balance the finances of a
growing business.

 *Growth should be attempted only in businesses already profitable*. To
attain profit potential, a balance must be maintained between asset and
liability items that are on the balance sheet and operating items that
are on the expense and income reports. For example, if accounts
receivable on a balance sheet average \$50,000 and sales average
\$500,000 per year, a balance of 10 percent exists between these items.
If growth is obtained in part by offering easier credit terms, the
balance could be altered if the accounts receivable average \$150,000
and are used to support sales of \$1,000,000. Thus, the balance needed
to maintain a profit has been altered. When growth is undertaken, profit
will be negatively affected, at least initially.

 *The existing debt position of the business must be balanced with
equity, or additional equity must be obtained to balance future debt*.
The rule of thumb is for the equity position on a balance sheet,
expressed as equity divided by assets, to range from 30 to 50 percent.
If your business has an equity position of less than 30 percent and you
wish to obtain financing for growth, a certain amount of money will have
to be injected as equity to finance additional debt.

 *Management skills and abilities must be balanced with the increasing
demands on management in a growing business.*

There are several simple examples of balancing opposing forces that can
be applied to business. One example is the financial management concept.
Financial management compares your company\'s growth potential when
financing the entire growth phase by reinvesting profits to financing
through an infusion of cash from outside sources. The latter option
accelerates growth; it follows the concept of leverage and allows you to
use equity to obtain additional money so the business can grow faster.
For example, if you can use a 33-percent equity position and invest
\$100,000 in a business, you can borrow \$200,000 for a total investment
of \$300,000. This allows the business to grow faster than using only
the \$100,000.

When accelerating growth, the financial leverage concept works only as
long as the business is profitable or the return on investment exceeds
the debt expense. When this happens, the rate of return received on the
equity investment is greater. For example, if you invested only the
\$100,000 and did not borrow any additional money, the rate of return
might be 10 percent. However, if you used the \$100,000 to obtain
\$200,000, and if the debt is 12 percent and you make a return of 15
percent on the entire project, the resulting rate of return on the
\$100,000 is higher. The 3 percent made on the debt results in a total
dollar value of \$6,000. The 15 percent made on the existing equity
(which would be \$15,000), combined with the \$6,000 made on the debt
would result in a final return rate of 21 percent on the equity portion.

Profitability is important to business growth because it makes it easier
to obtain the financing needed to expand. This is the opposite of how
accounting systems are normally operated for tax purposes. To reduce
taxes, accountants and business owners often try to show a loss or as
little profit as possible, which allows the business to retain more
cash. From this standpoint, perhaps your business should be profitable
for several years before initiating a growth phase. In many cases,
however, you will not or cannot take the time to accomplish consistent
profitability. If you are planning to expand your business, discuss this
process with the accountant who prepares your income statements or taxes
in order to legitimately transfer forward some of your current operating
expenses, thus increasing your current profits.

Other Considerations

The time you spend preparing for growth can also improve your business
in several other areas, including management. Therefore, you should not
implement growth procedures without thoroughly examining all aspects of
your business operations. Listed below are several factors you should
consider before initiating a

growth plan.

 Expect that your personal involvement and commitment to the business
will increase during a growth cycle.

 Consider personal sacrifices and the sacrifices of people you
associate with, including family. The rewards of growth can be
substantial and, thus, are deemed adequate rewards for these sacrifices.

 Expect additional pressure on the time and resources needed to run the
business, because it will take time and energy to organize the financial
aspects of growth.

Before initiating a growth phase, be sure you have the time, adequate
personnel and financial resources to complete the process.

**There Is No One Right Way**

Before you look at the different categories of financial management for
a growing company, remember there is no one right way or easy method.
Accept that you operate in a world of uncertainty, in which decisions
often are made without complete knowledge of all the consequences. This
approach can make managing a growing business challenging and rewarding.

When financing a growth cycle, seek assistance from professionals who
know the process. Assistance is available through consultants,
accountants and lawyers and through services provided by the government,
such as the U.S. Small Business Administration (SBA) and its resources
(e.g., the Service Corps of Retired Executives \[SCORE\], the Small
Business Development Centers \[SBDCs\] and the Small Business Institutes
\[SBIs\] listed in Appendix F: Information Resources).

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**SECTION 1: OBTAINING CAPITAL FOR GROWTH**

**Deciding To Actively Pursue Growth**

A primary reason for pursuing growth is to increase profit. There are
two components that can be increased \-- the absolute dollar amounts of
sales or the profit as a percentage of sales. If these two can be
achieved simultaneously, the resulting growth will be very rewarding. A
more careful decision process must be completed in situations where
there is a trade-off, such as between decreasing the percentage of
profit to sales (through reducing prices) or increasing the dollar
volume of sales (through increasing prices).

Reducing prices to achieve growth is a strategy you might not initially
plan but must do to sustain growth after commitments have been made. By
charging lower prices to increase sales, you usually decrease the gross
profit margin. However, lower prices may result in significant increases
in the purchase quantity, which then enables the business to earn a
profit. The same concept, only reversed, can apply to costs. For
example, if you increase costs in order to increase dollar sales volume,
you still decrease your profit margin. This latter approach is feasible
if you plan to increase marketing expenditures to gain additional
business.

Costs also can be increased from an accounts receivable standpoint. A
new business activity might increase sales by adding customers with poor
credit ratings, thus resulting in a higher accounts receivable cost.
Many managers of unprofitable businesses believe the solution to their
problem is to grow in order to spread fixed costs over a larger number
of units, thereby improving the gross margin of the business. (A
detailed explanation of this concept is provided in the section
Determining the Break-even Point.)

Understanding Financial Statements

The balance sheet, income projection statement and the monthly cash flow
projection of funds are the statements used to manage and report a
business\'s financial operation. The balance sheet and income statement
will be explained in this section. The cash statement is not always
completed as the checking account register provides the same information
except that it isn\'t summarized by categories.

The balance sheet and income statement contain meaningful information
about the business. The balance sheet indicates the value of the
business at a given point in time and is usually prepared for the end of
a typical reporting (or accounting) period. The income statement covers
a period of time (month, quarter, year) and indicates the level of
profit or loss based on sales less expenses. (Examples of a balance
sheet and income statement are included in Appendix A.)

Balance Sheet

The balance sheet provides a summary of the owner\'s net worth at a
given time. The first section, labeled *assets*, usually appears on the
left side or at the top of the statement and includes the business\'s
assets in declining order of liquidity. The right side or lower portion
lists the *liabilities* and the owner\'s equity or net worth.
Liabilities include all commitments or contractual agreements to be paid
in the future. Examples of liabilities include loan principal balances
and accounts payable (money owed for goods or services already
received). The owner\'s equity is the asset value that actually belongs
to the owner. In a corporation, this is usually divided into original
capital and retained earnings. The capital assets (i.e., equipment and
buildings) are valued at their original cost minus any depreciation that
has been taken in the past. This results in a book-value balance sheet,
because the real value of capital items could be more or less than this
calculation indicates.

Note that on the balance sheet the total assets equal the total
liabilities plus the owner\'s equity. The owner\'s equity position is
the relationship between the total assets and the total liabilities. In
the sample balance sheet in Appendix A, the equity position is a
percentage, 28.3 percent, that is calculated by dividing the owner\'s
equity (\$57,945) by the total assets (\$204,945).

Income Statement

The income statement (sometimes called profit and loss statement) brings
together the income generated and expenses incurred from business
activity over a specified period of time. This time period can be a
month, a quarter, a year or the year-to-date.

The difficulty in developing an income statement is in allocating
certain costs to the period of time covering the statement. One example
is depreciation. Many fixed assets, such as equipment and building
costs, cannot be included under expenses. To allocate these costs
properly, their purchase price must be divided by the expected life in
years or months, whichever corresponds to the period covered by the
income statement. Using the straight-line method of calculating
depreciation, their purchase price is charged uniformly over the life of
the assets. However, the depreciation rate often is accelerated for
income tax purposes.

Another difficulty in cost allocations are loans in which payments are
divided into interest and principal components. Only interest is
included on the income statement; it is treated like a rent or lease
payment. The principal is neither income when a loan is received nor an
expense when it is paid back.

The balance sheet and income statement are related to each other. Your
equity on the beginning balance sheet plus the profit (or minus the
loss) from the income statement equals your equity for that period.
Profit needs to be adjusted for any withdrawals that are not expenses,
such as payment of the loan principal or income tax.

Developing Projections

The first step in undertaking growth is to develop projected income
statements, cash flow statements and balance sheets. All potential
lenders require these projections before approving loans. These
estimates also can be used to help you decide whether to seek outside
funding, even though this decision may seem obvious based on your
current market activities.

These projection statements, sometimes called *pro forma statements*,
should be developed for at least one year and perhaps two to five years
into the future. (Examples of pro forma statements are included in
Appendix B. Blank forms are included in Appendix C.) You may wonder: How
can I know what will happen? To answer this question, divide the
projections into steps. The most critical step is balancing costs to
sales in order to determine a profit margin.

Profit margins for income projections should always be reasonable,
especially if outside financing is used. If the first years of the
projections show a loss, it will be difficult to convince potential
investors to invest in your business. If, however, the projections show
excessive profits, potential investors may feel the project is
unrealistic. This means that your figures must be fairly conservative.

What is a reasonable profit margin? It is a profit margin that is in
line with the profit margins of the industry. For example, \$80,000 on a
projected income statement is a reasonable before-tax profit margin in
the following case. First, all income tax is subtracted at an estimated
rate of 25 percent, leaving \$60,000. You quit a job that paid \$40,000
to start this business; therefore, you maintain this salary as being
consistent with your personal living expenses. This leaves \$20,000 of
profit. The next step is to compare the remaining profit to the amount
of equity invested or the amount of your equity on the current balance
sheet. For this example, we will assume the equity level is \$200,000.
The profit of \$20,000 is divided by the equity of \$200,000, which
results in a 10 percent rate of return. This rate of return is
reasonable for a growing business; however, the rate of return could
increase in the future because of the growth process. Phenomenal rates
of return, such as 100 to 1,000 percent or higher, are possible in
smaller businesses. (See *Inc.*\'s list of the 100 fastest growing
companies.) Even though this is possible, the rate of return should be
conservative on a projection.

Deciding the rate at which your company should grow is challenging and
demands flexibility. Flexibility can be difficult if you already have a
preconceived idea of the growth level you want. Your idea may exceed the
capacity of the business\'s management and equity positions. It is
helpful to develop several projections because different levels of
growth will have different investment requirements and profit results.
For example, if a business is expected to grow to \$500,000 in sales per
year, you may be able to continue renting a facility. However, if the
business is expected to grow to \$800,000 in sales per year, a new
facility may be required and its cost will affect the projected profit.
The same can be true with items of equipment, which also depend on the
relationship between the short- and long-term potential. The addition of
a new building can have a short-term, negative impact on profitability,
but it also can result in an improved profit margin for the business
within three to five years. Because input into a business operation is
not always proportional and can come in steps, completing several
projections based on different options will help determine which
projection is best.

Individual circumstances may require growth to be pursued at a slower
pace, yet you can end up with similar profits. For example, you
currently operate a business with sales of \$600,000 per year, and you
want the business to grow to sales of \$2 million by the third year. You
might project both of the following growth trends:

**Example A**

Year 1 \$1.0 million

Year 2 \$1.5 million

Year 3 \$2.0 million

**Example B**

Year 1 \$1.8 million

Year 2 \$1.9 million

Year 3 \$2.0 million

As you can see, the result is the same. Example B illustrates an initial
high, fixed investment, used to support expansion, with slower growth
following. For example, a successful restaurant with sales of \$600,000
may build two more restaurants in different cities and thus triple its
total sales. Example A reflects a situation in which growth is obtained
more gradually by incurring variable costs and reinvesting profits in
the business. For example, a restaurant may attempt to increase its
growth by maintaining the same single location, but adding new services
or additional operating hours.

You can further control your growth rate by recognizing that all fixed
costs are variable over time. Strictly speaking, fixed costs are those
costs that are stable for a given period (e.g., one year). However, when
you consider growth over a three- to five-year period, fixed costs can
be treated more like variable costs. For example, alternatives to
purchasing a new, full-size facility may include leasing facilities,
constructing a smaller facility or creating unique distribution
channels.

Computer spreadsheet programs are excellent to develop projections as
they easily allow what if analysis in determining different levels of
growth. If such programs are not available, seek help from professionals
who provide services to small businesses, such as SBA, SCORE, SBDCs and
SBIs.

The costs of a growth cycle can be incurred in blocks or steps. This is
especially true for equipment and buildings; however, it can also apply
to marketing costs. For example, a manufacturing company may have only
one machine that completes a process required of all its products. To
double production capacity, the company must decide between adding a
second shift or adding a second machine. Adding a second machine doubles
costs in the form of depreciation and other operating costs; adding a
second shift doubles personnel costs. Either way, the company must
consider the marketing option of adding a salesperson in order to
increase its sales volume to in turn support higher fixed costs.

Determining the Break-even Point

Break-even analysis can help you make decisions because it allows you to
visualize the relationships between costs that are spread over time.
Such analysis involves dividing costs into two categories: fixed costs
and variable costs.

*Fixed costs* are those costs that do not vary over a period of time, or
generally do not fluctuate with changes in sales volume. These costs
include the purchase price of buildings and equipment. *Variable costs*
are costs that vary depending on the time period or the sales volume
generated. These costs usually include the cost of materials purchased
for retail operations and labor costs.

The textbook approach to break-even analysis is based on the units of
production. For business activities, it is better to base such analysis
on the dollar volume of sales of the business. Break-even analysis can
be expressed as a dollar amount and can be displayed on a graph. On a
projected income statement, a convenient way of breaking out fixed costs
and variable costs is to treat the cost of goods sold and labor as
variable costs and all other expenses as fixed costs. Below is a sample
income statement:

Sales \$100,000

Cost of goods sold \$ 30,000

Wages \$ 20,000

Fixed expenses \$ 40,000

Profit \$ 10,000

The break-even point can be calculated as follows. First calculate the
contribution margin, which is defined as the percentage of sales
available for use toward fixed costs and profit. In the above sample
income statement, the variable costs (goods plus wages) are 50 percent
of sales, so the *contribution margin* is 50 percent. The actual
break-even point is the fixed costs (\$40,000) divided by the percentage
of sales the variable costs represent (50 percent), which equals
\$80,000. At this point, all fixed costs as well as variable costs are
covered. To verify your answer, multiply 50 percent by \$80,000. The
answer is the amount of the fixed costs, or \$40,000. The variable cost
at this rate is \$40,000 or 50 percent of \$80,000.

The break-even point can be calculated using different assumptions of
what should be included in the fixed-cost portion. If the business needs
to generate enough profit to pay the owner\'s wages plus the recovered
debt principal and income tax obligations, these costs should be
included with the fixed-cost amount; thus, the break-even point will be
higher. The break-even sales level usually covers a year; however, the
time increment can be broken down into months, weeks or days. In the
above example, the break-even point of \$80,000 is equivalent to \$266
per day (assuming a 300-day work year). This figure should be set as
your average daily goal; however, don\'t forget to consider seasonal
sales and daily fluctuations as well.

It is difficult to assure accurate projections, but if each dollar item
in a projection is carefully considered with regard to the volume or
capacity of the business, the resulting figure should be relatively
accurate. Final income statements tend to show costs higher than what
was projected. If plans are made carefully, the result might be that
profit is very similar to what was projected; but some of the items will
be higher or lower than planned.

In projecting income in order to obtain financing, compile figures
conservatively. Bankers know it is very easy to come up with lofty
profitability projections and may discount an application on that basis.
Projections should indicate the ability of the business to pay off debt
while earning a reasonable return on labor and investment.

Decisions on whether to grow and the rate at which to grow should be
based on the concept of improved value. Profits can be drawn by the
owner or reinvested in the business where they can increase the asset
basis of the business. A recommended strategy for the owner-manager is
to consider a combination of these options.

**Estimating Expansion Costs**

An important part of growth is the budget, or the allocation of funds to
those activities that will bring about growth. There is a fine line
between not having enough money and having too much money. The
disadvantages of borrowing too much are (1) the increased interest costs
and (2) exceeding equity limitations. The disadvantage of not borrowing
enough is getting halfway through a project and discovering there are
not enough funds available to complete it. The problem usually
associated with expansion is underestimating costs. The following
sections address the costs of buildings, equipment and inventory and the
cash tied up in accounts receivable and operating capital, as they
relate to estimating expansion costs.

Building Costs

To determine the cost of a building, choose a layout that can be reduced
to a blueprint or a sketch for contractors to bid on. (Many contractors
provide blueprints in conjunction with the bidding process.) After you
have blueprints or a layout, obtain competitive bids from several
contractors. Bids will allow you to compare the abilities of individual
firms to build efficiently and ultimately can help you achieve lower
costs. Be sure the contractors are bidding on identical specifications
and quality. Many construction companies have specialty projects that
may match your company\'s project, possibly resulting in a lower price.

If you do not know a contractor, check his or her credentials with the
bank and other references, such as customers and suppliers of building
materials. Reputable contractors are accustomed to working under
performance bonds. You should investigate this option. Bonding is a
system in which the contractor promises to complete the work at a time,
quality and price specified in the contract. If the work is not so
completed, the contractor forfeits the bond and the proceeds are used to
reimburse the customer\'s loss. Bonding is usually handled through an
insurance company. If you request a bond, you should receive a copy of
the agreement directly from the insurance carrier.

Next, discuss with the contractors their relationship with
subcontractors. Usually a general contractor will negotiate and work
with subcontractors in the electrical, plumbing, heating, and certain
other trades. Subcontractors are usually coordinated by the general
contractor and complete and invoice their work through the contractor.
Should you choose to directly employ subcontractors, you will be
responsible for coordinating their work. This can reduce costs in some
cases. If this is done, the subcontractors should also be asked to
submit a bond for the work performed. (Also, be sure to check with
utility companies to determine hookup costs and whether deposits are
required.)

Scheduling is another aspect of construction that should be carefully
planned to reduce costs. Often unknown factors \-- mainly the weather
\-- can affect the schedule. Such factors should be figured into the
time allowed for the construction process, as increased construction
time can result in additional interest charges. It is customary for a
construction contractor to receive periodic payments during a project to
cover costs. The new building owner usually pays 90 percent of the cost
of work completed until the project is done. Thinking through this whole
process in advance will reduce the need for any change in orders, which
can result in additional costs.

Equipment Costs

New equipment purchases often accompany an expansion. Contact several
equipment suppliers to discuss your needs, the capabilities of specific
equipment and prices. Other related expenses associated with equipment
should be investigated, such as delivery, hookups to utilities,
installation costs and unusual operating expenses.

Leasing should be considered as an alternative to purchasing equipment.
Usually leases can be obtained from the company that sells the
equipment, but there are also leasing companies and leasing divisions at
banks. The disadvantage to leasing is that the rate usually is higher
than the interest rate for purchasing equipment. The major advantage of
a lease, however, is the low down payment or equity position required to
initiate the lease. Most leases place the responsibility for repairing
equipment with the lessor. This can reduce the risk of having to incur
repair expenses at a time when your cash flow is tight and repair costs
difficult to cover. Be sure you understand all provisions of the lease
agreement. Many companies offer lease-to-purchase plans that enable you
to eventually purchase the equipment. This can be a viable option.

Delivery of equipment, whether new or leased, should be carefully timed
with completion of other construction activities so the equipment is not
sitting idle.

Inventory Costs

Inventory is the product, in its various stages of completion, that is
finally sold to generate revenue and receivables. It is an important
aspect of a company\'s operating cycle because it is a window into the
company, i.e., it will tell how well the company produces the goods and
services it sells. Inventory should always be valued at the lower cost
or market value to ensure that its value is not overstated on the
balance sheet.

The level of inventory in an expanding business should be easy to
determine because it is based on a comparison of past inventory levels
to past sales. The inventory turnover ratio is the cost of goods sold
divided by the average inventory and is the ratio that is often used
when a growth phase is initiated. The cost of new inventory should be
considered because it might be higher than the cost of existing
inventory. It is usually assumed in an expansion process that the
existing inventory can be easily liquidated and, therefore, the
inventory turnover ratio will increase. However, the opposite could
occur if you attempt to increase sales by offering an increased
inventory. Also, it is usually assumed that, as inventory increases,
carrying costs will decrease because of the additional economies of
scale gained with the additional inventory. Again, this should be
carefully determined by investigating actual carrying costs.

Inventory is important to both new and expanding business because,
before it is sold and becomes a receivable, it represents invested cash.
When separated into its parts (raw materials, work in process and
finished goods), the inventory cycle will identify lags and structural
difficulties a company has in the production process.

Accounts Receivable

Like inventory, future accounts receivable are projected from the
existing receivables on the balance sheet and are normally in the same
proportion to future sales as current receivables are to current sales.
For example, past sales of \$100,000 and accounts receivable of \$5,000
represent a relationship of 5 percent of accounts receivable to sales.
If growth is projected to \$500,000, then projected accounts receivable
at 5 percent would be \$25,000.

It is possible for accounts receivable to increase out of proportion to
the existing figure. For example, accounts receivable could easily be a
higher proportion if, in the process of increasing sales, relationships
with slower paying customers were established. To illustrate this, if
actual accounts receivable average \$5,000 when sales are at \$100,000,
a variance of 1 percent would result in accounts receivable of \$6,000,
a difference of only \$1,000. However, at an operating level of
\$500,000 sales, a 1 percent negative variance translates into a \$5,000
difference. If this is not planned for, it would be more difficult for
you to come up with \$5,000 than it would be to come up with \$1,000.

Estimated Expansion Expenses

The last and most difficult cost category to project is the additional
cash needed to support increased activity. The best method for
calculating this amount is to use a cash flow projection. Cash flow
forms (see cash flow projection in Appendix B) are available through
local SBA, SCORE, SBDC and SBI offices. To complete the form, distribute
the cash income over the months when the sales growth should occur (cash
expenses are calculated the same way) and then determine the expenses
needed to generate the desired increase in income.

During a business expansion, cash balances will normally decrease for a
while, and then show a gain. This gain will occur only if the business
is profitable. It can be difficult to predict when a growth in cash flow
should begin. As a general rule, it should be within the first operating
year, preferably by the third or fourth month; however, this may vary.

Seasonal fluctuations in cash receipts and cash expenditures should be
built into the cash flow projection. This will indicate those months
cash should be reserved to cover excess expenses when cash out exceeds
cash in. If the business is profitable and some portion of profit is
reinvested in the business, then the cash flow projection should account
for this as well. The impact of income tax on cash flow also should be
included.

For each level of sales volume, a certain residual amount of cash should
be retained in the business. For example, if sales have been \$50,000
per year, the cash balance carried might be \$1,000; if sales are at
\$500,000 per year, the cash amount carried might be \$10,000. These
amounts are somewhat arbitrary and depend on the nature of the business;
however, each increase does not have to be proportional to sales.
Instead, the residual cash amount should be based on the cash flow
projection for operating the business.

After determining cash needs, a certain amount could be budgeted to
cover unexpected contingent liabilities or to compensate for slow
turnover in receivables. Select this figure carefully because investors
may be skeptical if it is too large. It is better to estimate a little
higher on some of the account categories that have definite needs, thus
reducing the need for a large contingency amount.

Purchasing Another Business

At times expansion can be accomplished by purchasing another business.
In this situation, the expansion costs equal the costs of purchasing the
business plus the amount of money needed for improvements and operating
expenses. Many industries have standard rules that should be considered
on how to determine the purchase price of a business.

**Obtaining Financing**

Bank Requirements

To obtain bank financing for your business, the relationship between
your company and the banker should be open and honest. If this is not
the case, perhaps it is time to consider a different bank. When shopping
for a new bank, do not make a decision based upon a particular loan
officer, because this relationship can change if the loan officer is
replaced. Therefore, consider both the relationship with the loan
officer and the relationship with the bank. It is also possible for your
business to grow to the extent it does not fit the capacity of its
existing bank. If this happens, consider establishing a new relationship
with a larger bank that can handle your company\'s future needs.

The first step in obtaining financing for an expanding business should
be to understand and meet the exact requirements and concerns of the
bank. To avoid risks and make safe investments, bankers primarily base
their decisions on the collateral and equity positions. Other concerns
of a banker include cash flow, profitability and management ability.

Collateral

Debt can be either secured by collateral or covered by a firm\'s assets.
A bank considers collateral the final alternative (last resort) for
collecting money if payments are not made on loan principal. The Uniform
Commercial Code^\*^ establishes procedures whereby a bank can seize any
collateral pledged in a loan agreement in case of default on the loan.
The value of collateral is usually listed in the asset section of the
balance sheet; its value should always equal or exceed the amount of the
loan.

^\*^ American Law Institute, *Uniform Commercial Code*, written by
National Conference of Commissioners on Unified State Laws, 1987.

Often in a business start-up, the initial balance sheet will show an
adequate collateral position; however, six months to a year later, the
balance sheet may show a decreased collateral position. One example of
this is getting a loan to purchase a vehicle. The depreciation rate for
the first six months to one year will exceed the amount paid on the
principal. Thus, depreciation is usually computed on an accelerated
basis. If you purchase a vehicle for \$20,000 and borrow the full amount
at 10 percent for four years, the monthly payment would be \$507.25 per
month. The day you purchased the vehicle and took out the loan, the
collateral value matched the loan amount exactly. If you use a
straight-line rather than an accelerated method of calculating
depreciation, the vehicle will last four years, and cost \$5,000 per
year. At the end of the first year, the book value of the vehicle, which
often equals its real market value, is \$15,000. However, the amount
owed on the principal at the end of one year is \$15,720.36\$720.36 more
than the book value. This point clearly illustrates why banks require a
down payment on this type of loan. The down payment usually ensures that
the asset value always exceeds the loan principal balance.

It is also possible to lose collateral in the first years of a business
by borrowing money and then gradually using that money to pay for
expenses (such as utility bills and marketing costs) that do not result
in asset appreciation. For example, if you are planning to spend \$1,000
to have brochures printed, the cash in the bank before the brochures are
printed is good collateral because it can be used by the bank if you
default on the loan. However, once this money is spent to buy the
brochures, the collateral value is much weaker because the expenditure
has value only for your business and cannot be easily transferred to
others.

When a bank forecloses on a failing business, it is often unable to
recover the full amount the owner paid for the assets, because of
depreciation and the nature of a force sale. As a result, foreclosure
leaves the banker with assets worth less than the dollar value indicated
on your balance sheet. For these reasons, you can understand why it is
easier to borrow money to buy fixed assets (such as inventory,
equipment, buildings and accounts receivable) than it is to borrow money
for marketing expenses or general operating costs.

Equity

Bankers also review the current and projected equity position of a
business. Equity is listed as owner\'s equity or a combination of
capital and retained earnings. The owner\'s equity is usually calculated
by subtracting all liabilities from all assets. The important aspect of
equity is not so much the dollar amount but the ratio of equity to
assets or debt.

A growing business usually shows an equity position of 30 to 50 percent
in relation to total assets, i.e., the owners own 30 to 50 percent of
the company. Initially, such an equity position may be adequate, but it
may become inadequate when additional money is needed for growth.
Because of the need to maintain the equity ratio in its relative
position, additional equity may need to be brought into the company. For
example, suppose a company\'s total assets are \$100,000; total debt,
\$70,000; and owner\'s equity, \$30,000. The equity-to-assets ratio is
30 percent. For this business to grow to an asset level of \$200,000,
the owner needs to provide an additional \$30,000 of equity and then
borrow another \$70,000 (debt). Ways to bring equity into a business
include

 Venture capital funds

 State and federal financing programs

 Private investment

 Owner\'s personal investment

An alternative to obtaining equity is to wait and reinvest the
business\'s profits to finance the growth.

Cash Flow Projections

For any business growth cycle, cash flow projections that compare cash
receipts and cash expenses should be completed. Bankers realize that
bank loans are paid from the business\'s cash flow, so you must convince
them that there is adequate potential to repay the loan. A detailed
explanation of the cash flow projection is included in the section
Effective Cash Flow Management on page 10 or see Instructions for Cash
Flow Projection in Appendix C.

Income (Profit and Loss) Projection Statement

The profit and loss statement, more commonly known as an income
statement, reflects the dynamic changes that occur over time between two
balance sheets. It reflects the company\'s operation as a result of
management\'s efforts to generate a profit. The income statement matches
all revenues with corresponding expenses for a specific period of time
and reports the company\'s ability to generate profits (excess of
revenues over expenses).

Income projections should indicate when profitability will occur. Even
though profit and cash flow can be unrelated, the possibility of having
an adequate cash flow definitely increases when a projected income
statement shows a profit. Bankers generally assume that a loan can be
repaid if the business is profitable. The banker\'s concern in this
process is, Where is the profit going? If the profit is being reinvested
into expansion activities, such as increasing inventory or marketing
expenses, the banker\'s concern is whether or not loan payments can
still be made. See Appendix C for Instructions for the Income Projection
Statement.

Management Ability

A growing business usually has the advantage over a new business of
having records on past performance that reflect the owner\'s management
ability. Management and the organization must be flexible to allow for
growth and change. Consider the following question: If growth occurs,
will management be able to handle the new situation? Your answer should
help you determine whether you will need to hire additional managers or
develop current management skills.

Simply developing and implementing a strategic plan to obtain additional
funding will test management\'s ability to plan and handle growth. The
activities involved in obtaining needed financing are in themselves a
new challenge to management. Management weaknesses should be addressed
as a part of the growth process.

Personal Financial Statement

Usually banks will require personal financial statements from all
owners. Personal financial statements are the balance sheets of the
business\'s owners. They are an important part of a business\'s
financial package because (1) they verify the company financial
statements, (2) they identify hidden company liability or equity and (3)
they reveal other activities vying for an owner\'s attention. Strong
company financial statements are generally reflected in strong personal
financial statements; therefore, the stronger an owner\'s financial
statements, the better his or her chances of obtaining the loan.

Wealth accumulated on a personal balance sheet is an informal method of
judging an owner\'s ability to obtain, manage and keep money. Personal
financial statements should not include existing business activities;
these figures should be supplied separately. As indicated above, the
banker is looking at potential collateral and adequate equity.

Market Value Balance Sheet

One of the problems in a growing business is that the existing equity or
collateral position can be artificially low because of accelerated
depreciation. Using accelerated depreciation results in a book-value
balance sheet that has less equity or collateral than a market-value
balance sheet. The former shows assets at their depreciated value
whereas the latter shows the assets at their current market value. Thus
it may be important to provide a banker with a market-value balance
sheet.

A typical way to develop a market-value balance sheet is to present your
current book-value balance sheet with an additional column for the
market value. At the bottom of this balance sheet explain each column.
Documentation of market value can be provided through appraisals or
advertisements that include prices on similar equipment or assets. The
market-value balance sheet usually increases the equity dollar amounts
and the equity-to-assets ratio. This should result in a banker\'s
willingness to loan a larger amount for growth activities.

Business Plan

A business plan is the blueprint or road map for the owners to
successfully carry out growth in a business. This plan communicates the
intentions of the owner to others and can be used to obtain financing.
The content of the business plan is determined by the planning process
itself, and includes research documenting growth potential. Business
plans include

 Cash flow projections

 Income statements and balance sheets with a detailed narrative of how
growth must be attained

 Justification for numbers used in financial statements

Details on writing a business plan can be found in many sources. See the
outline of How to Write a Business Plan in Appendix E. In addition, the
SBA, SBDCs, SCORE chapters and SBIs can provide assistance in developing
business plans.

Other Sources of Financing

*Small Business Administration Loan Guarantee Program*

The SBA Loan Guarantee Program provides financing in cases in which
banks feel uncomfortable with the risk by allowing banks to recover
their money from the SBA if the borrower defaults. The SBA guarantees 90
percent of the loan up to \$150,000 and 80 percent up to the maximum of
\$750,000. Terms for the loan are usually better than those for regular
bank loans. Compared to a conventional bank loan, the life of the loan
can be longer, the equity position less and the interest rate slightly
lower. The interest cost is usually less for two reasons. First, SBA has
established an upper limit of 2 percent above the prime rate for the
program; second, bankers are usually willing to offer lower interest
rates because of the SBA\'s guarantee.

The life of an SBA loan can be longer than that of conventional bank
loans. This results in a lower monthly cash payment, which can enhance
the cash flow of the firm during the early years of the loan. The equity
position for an SBA loan can be 30 percent compared to the 40 to 50
percent required by banks. (The SBA percentage can vary depending on the
type of business and your past credit history.)

The bank loans the money and the SBA guarantees the loan. Because of the
guarantee, banks can loan over their normal limit, which can be an
incentive for small banks. The guaranteed portion of the loan is not
considered part of the banks\' regular loans. There is a 2-percent fee
for the guarantee, which is sometimes reduced to 1 percent for loans
under \$50,000. This fee is paid from proceeds when the loan is
allocated. The upper limit for an SBA loan guarantee is \$750,000. There
is no lower limit, however, most banks prefer to work with amounts over
\$10,000.

*Other State Financing*

State financial programs are also available to small business owners who
need financing. Most programs are justified by the economic development
and the jobs created within the state by the business. At times these
programs can take a second mortgage position compared to banks or other
sources of debt and can charge lower interest rates. Many state programs
have special programs for women, minorities or manufacturing businesses.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**SECTION 2: MANAGING CAPITAL**

**Effective Cash Flow Management**

Cash flow analysis shows whether your daily operations have generated
enough cash to meet your obligations, and if major cash outflows combine
with major cash inflows to form a positive cash flow or a net drain. Any
significant changes over time will also appear in this analysis.

It is extremely important to have enough cash on hand each month to pay
the cash obligations of the following month. A monthly cash flow
projection helps to project funds and compare actual figures to those of
past months and enables you to eliminate cash deficiencies or surpluses.
Cash flow deficiencies indicate a need to alter plans to provide more
cash. Cash surpluses may indicate excessive borrowing or idle money that
could be invested.

Cash itself does not create new income for the business. Therefore, the
cash account balance on a balance sheet actually should be small
relative to other assets. The object is to develop a plan that will
provide a well-balanced cash flow.

Cash flow analysis establishes a budget for the cash requirements for
the business. During stable business conditions, there is little need to
develop a budget because future business activity can be predicted from
past trends. For growing businesses, the relationship between sales and
expenses changes, thus establishing the need for a cash flow projection.
The cash flow projection indicates a flow of dollars; therefore, if
dollar amount changes early in the year, it is going to affect the
remaining months by the same amount. Understanding cash flow and how it
is computed is a very important part of cash flow projections.

SBA has an excellent cash flow form (See Appendix B). The SBA\'s version
is a simplified form; it allows for only one sales entry and one
accounts receivable entry per month. Completing this form will enable
you to compute projections correctly, and better understand the
relationship of cash flow in the finances of a company. This form is
available at SBA area offices and through SCORE chapters and SBDCs.

Unfortunately, cash flow management is often limited to keeping track of
the checkbook balance. The problem with relying on this system is that
it can result in your using cash that should be reserved for something
else. Some practical steps can be taken to improve your ability to
manage cash flow, especially during the changes brought about by growth.
These include

 Collecting receivables

 Tightening credit requirements

 Increasing sales

 Pricing products

 Securing loans

If your company has multiple divisions, products or locations, develop
individual cash flows and then consolidate them to determine the
complete cash flow picture. The SBA form has a column for actual results
in addition to the estimated column. This allows you to record what you
actually have spent and compare it against the estimate. A cash flow
projection is usually computed on a yearly basis. To compensate for
changes occurring after the projection, it is advisable to update it
periodically to determine if there will be a detrimental effect later.
If your company\'s new area of growth is an activity that is seasonal,
i.e., opposite the current season, the cash flow projection will help
determine the combined impact.

In a cash flow statement it is important that all sales and expenses
listed for a particular month are balanced. To compensate for situations
in which expenses are due at the first of the month but revenue does not
come in until the end of the month, complete a daily or weekly cash flow
statement. Another way to compensate in these situations is to change
your month\'s beginning and ending dates; for example, go from the 15th
of the current month to the 15th of the next month. This will resolve
the problem because it will ensure that one month\'s cash from

sales arrives before expenses are due.

Computer spreadsheet programs can be extremely helpful for computing
cash flow projections. They allow for what if analysis, which provides
several possible outcomes. If you have the software, you can design your
own spreadsheet, or you can get templates from business service
providers.

Good accounting records and good projections are important tools for a
small business. Qualified accountants are necessary to help keep your
records accurate and current. However, you can reduce your accounting
expenses by producing your own summary statistics and projections. With
the help of a personal computer and a good financial management plan,
you can successfully project future activity and use the what if
analysis to test various management decisions.

Cash Flow Versus Income Projections

One of the major distinctions between cash flow and income projections
is that the two can appear unrelated. The differences result from how
principal payments and depreciation are recorded. Loan principal
payments are included as cash outflow but are not recorded on the income
statement. On the other hand, depreciation is included as a business
expense of the income statement but not as cash outflow.

In a business in which sales are growing, the inventory and accounts
receivable are also probably growing. These different areas of growth
can affect the income and cash flow. For example, if inventory increases
during the year, the dollar amount used to purchase materials will
increase, and thus the cash flow or available cash will decrease. This
can cause an inadequate cash level during a slow period. A similar
situation can occur with accounts receivable. If accounts receivable
increase, then expenditures to provide services to customers will
increase, but there will be no incoming cash to cover these increased
costs. The accounts receivable, inventory and cash-on-hand amounts are
all represented on a business\'s balance sheet.

In a growing business in which the accounts receivable and inventory are
fairly constant, the cash flow should be adequate if the business is
operating profitably. In this situation, any depreciation amounts should
be retained for future expansion, and profits should be used to retire
the loan principal. Such a strategy is important for a growing business.
If depreciation and money from accounts receivable are used for
operating cash flow, this can result in a lower equity position, making
it difficult to borrow money to replace worn-out assets.

Borrowing Money

Loans from various financial institutions are often necessary for
covering short-term cash flow problems. Revolving credit lines and
equity loans are common types of credit used in this situation.
Short-term borrowing works fine as long as everything goes well.
However, if your business experiences a downturn in volume, short-term
borrowing can cause a bank to call in a loan or cancel its credit line,
leaving your business without adequate operating cash.

Long-term loans amortized monthly can improve a business\'s operating
cash position. Amortized monthly means the monthly payment is constant
and includes interest and principal portions that change in proportion
as the loan is paid off. During the early stages of the loan, the
interest portion is high and the principal is low; however, this
situation reverses itself over the life of the loan.

In a situation in which long-term debt is used and the business has a
seasonal peak demand, the excess cash should be invested in easily
accessible, interest-bearing, low-risk accounts, such as savings
accounts, a short-term certificate of deposit or a U.S. Treasury note
(commonly called a T-bill). The money should not be used for cash
operating expenses or to avoid a shortfall when cash is needed. Keeping
excess cash on hand reduces both the growth and the return on
investment.

Tax Obligations

Income and payroll tax obligations can also affect cash flow. If a
business is profitable and growing, the cash that should be retained for
income tax payment and payroll tax can easily be spent for other items
that support growth. This results in a cash shortage when income taxes
are due. To avoid this shortage, make adequate projections and analyze
current income statements to determine future tax obligations. As these
obligations are determined, cash should be set aside to meet them.

Managing Credit

The credit a company extends to its customers can be crucial in its
impact on cash flow if the customers do not pay on time. New businesses
and growing businesses often do not have the advantage of previous
experience with their customers and can find themselves extending credit
to high-risk customers. Research should be done in advance to determine
a customer\'s ability to pay bills on time. Methods of determining this
include obtaining a copy of a Dun & Bradstreet report on a potential
customer and requiring potential customers to complete a credit
application that asks questions about the business\'s ability to pay.
References should be checked to get others\' perceptions of customers
and their integrity. (There are several publications available through
the U.S. Government Printing Office that discuss credit. Complying With
the Credit Practices Rule and How to Write Readable Credit Forms are
both published by the Federal Trade Commission and are available through
the Superintendent of Documents, U.S. Government Printing Office, listed
in the Information Resources in Appendix F.

When working in a business activity that sells directly to customers, it
is advisable not to extend store credit but to use charge cards.
Information on offering credit card purchases can be obtained through
your company\'s bank. Banks charge businesses different rates for credit
card sales, based on the dollar volume of the sales, so check several
bank sources. The disadvantage of the credit card is it costs you a
specified percentage, ranging from 2 to 5 percent, of the total dollar
volume customers charge. On the other hand, customers often expect the
convenience of credit cards.

As credit and terms are tightened, more customers will pay cash for
their purchases, thereby increasing your cash on hand and reducing your
potential for a bad debt expense. While tightened credit is helpful in
the short run, it may not be advantageous in the long run. Looser credit
allows customers more opportunity to purchase your products or services.
Just be certain the increase in sales is greater than the increase in
bad debt expenses.

Discounts for Early Payment

The practice of receiving cash discounts for early payment illustrates a
major difference between the cash flow and projected income statements.
Not taking advantage of a cash discount by paying bills promptly can
improve your immediate cash flow, but can also negatively affect
profitability. On the other hand, by paying early, your costs will be
lower and profit margin higher, but your cash flow could be strained.
Certainly a business should consider taking advantage of discounts, but
should also know when and how to capitalize on them. Your company might
also consider offering these discounts to help its cash flow.

Increasing Sales

Increasing sales appears to increase cash flow, but be careful. For many
companies, a large portion of sales are purchased on credit. Therefore,
when sales increase, accounts receivable, not cash, increase.
Receivables are usually collected 30 days after the purchase date. Sales
expenses are most often incurred before receivables are collected. When
sales rise, inventory is depleted and must be replaced. Because
receivables have not yet been collected, a substantial increase in sales
can quickly

deplete a firm\'s cash reserves. With a computer, you can monitor this
critical data and increase the time required to consider alternate what
if scenarios.

**Techniques for Reducing Costs**

Techniques for reducing costs will be discussed in two sections: the
first suggests methods for reducing the cost of normal operations and
the second shows how to evaluate and deal with risks that can increase
costs.

Analyzing Your Costs

Keeping Costs within Industry Averages

There are several studies available comparing industry averages and
financial ratios. Three popular ones are *Annual Statement Studies* by
Robert Morris Associates, One Liberty Place, Philadelphia, PA 19103;
*Almanac of Business and Industrial Financial Ratios* by Leo Troy, PhD,
Prentice-Hall, Englewood Cliffs, NJ 07632; and *Financial Studies of the
Small Business* by Financial Research Associates, P.O. Box 7708,
Winterhaven, FL 33883-7708.

These studies usually are published annually and can be purchased from
the publishers, or you can get the information through small business
service providers, including libraries, banks, SBDCs, SBIs and SBA
offices. Membership in a trade association includes access to financial
averages for the industries in that association. Comparing financial
ratios allows a business to identify costs and relationships that are
out of line with others in the industry. Reducing these costs will
produce a more competitive situation.

Determining Highest Costs

All expense categories on an income statement should be reviewed to
identify opportunities to reduce expenses. The first place to look for
cost reduction opportunities is those cost categories highest as a
percentage of sales this is often the cost of sales (COS). For example,
if COS is 50 percent of sales, a 10-percent reduction in this category
will result in a 5-percent reduction in overall costs. This can be
compared with some of the fixed costs in the operation, such as
interest, rent or depreciation costs, which are often in the area of 5
to 10 percent of sales. If you reduce an expense item that is only 10
percent of sales by 10 percent, you only reduce your overall expenses by
1 percent. Determining your highest costs can guide you on how to
allocate time and resources toward cost reductions and will result in a
substantial decrease in costs.

Buying Groups

Often small businesses have trouble purchasing goods at a discounted
price because they do not have the volume buying power of larger
companies. One method of reducing purchasing costs is to join or create
buying groups of like businesses that purchase the same products but are
not in direct competition with one another. This type of relationship
can result in quantity discounts and a better selection of merchandise.

Inventory

Inventory has several associated costs in addition to its purchase
price. This is true for raw materials, work in process, finished goods
and retail/wholesale inventory. If inventory can be reduced and sales
maintained, the result will have a positive impact on profitability.

The inventory turnover ratio is a good measure of the relationship
between inventory and sales. This ratio is calculated by dividing the
cost of sales by the average inventory for that period of time. A high
ratio normally indicates an efficient use of inventory. However, a high
ratio can also mean you are missing sales opportunities because items
that customers are requesting are not in stock. The proper relationship
must be determined for each situation.

Inventory carrying costs usually include interest, storage, insurance,
obsolescence, physical damage and deterioration. These costs can be
reduced by applying just-in-time inventory and manufacturing techniques.
For a manufacturer, just-in-time techniques involve structuring the flow
of materials through the plant to reduce inventory in all categories.
The benefit of this technique is that it reduces holding costs.
Just-in-time inventory results in better management and scheduling of
both raw materials coming into the plant and inventory leaving the
plant. These techniques are usually associated with manufacturing but
can also be applied to retail/wholesale businesses.

The economic order quantity formula is one method of calculating the
optimum amount of inventory to order.

The formula is

x equals the square root of 2 times r times o divided by c

r = number of units used/sold per period;

o = cost of placing the order and

c = cost of carrying the inventory per unit per period.

This formula compares the cost of ordering inventory to the cost of
carrying it and identifies the minimum cost point, thus balancing the
two costs against each other. The formula indicates the number of units
to be ordered. The lead time to place the order can be determined based
on usage and the time it takes to receive the order. In a growing
business, where inventory is increasing, the economic order quantity
formula can help determine the new quantity to order. Economic order
quantity is explained in inventory, finance or operations management
texts.

Use Contracts

If business activity is generated by contracts, consider negotiating the
payment time as well as the price. This technique will improve overall
cash flow. It also will affect expenses because less cash is needed to
carry the activities of the business, thus reducing interest costs.
Instead of requesting payment at the end of the project, schedule
monthly or weekly payments for completed work. This is also accomplished
by requiring deposits for materials purchased during the production
process.

Overhead Costs

Reducing overhead costs, such as rent, utilities and interest,
immediately lowers a company\'s break-even point. When the break-even
point is lowered, the company can reach profitability sooner and
experience profitability over a larger range of sales. As sales
increase, you will be able to retain a greater percentage of sales
dollars as profit. One of the keys to managing overhead costs is to keep
these costs in balance with the sales level. Often overhead costs are
spent up front to generate the desired sales.

Management Compensation

One way to reduce costs during an expansion phase is to reduce the
owner\'s compensation until the business is in a position to pay the
owner better. Compensation should match an owner\'s living expenses.
Profit returned to a business that is growing should be a good
investment for the owner.

Use of Bar Code

Expanding businesses need to carefully balance the costs associated with
increased business activity. The bar code system for inventory and
pricing can reduce costs in selling and controlling inventory. When this
system is used for checkouts, labor costs are reduced, as are chances
for error. Also, through its increased accuracy in controlling
inventory, the bar code system can decrease the number of dollars tied
up in inventory. This common system is called the Uniform Product Code
and is available through the Uniform Code Council, Inc., 8163 Old Yankee
Street, Dayton, OH 45458, (513) 435-3870.

Leasing Equipment

Leasing is a way of reducing costs if the equipment can be leased when
you need it, or if the time period you need the equipment is less than a
normal ownership period. Equity or net worth requirements may be less if
leasing is used to expand the business. The disadvantages of leasing are
that it does not allow net worth to build over time (unless it is a
lease/purchase arrangement) and it is usually more expensive than an
equal period of ownership.

Training Employees

An expanding business may need to add employees who lack experience in
its business area and need training. There are several ways to reduce
training costs. One option is the Job Training Partnership Act (JTPA), a
federally funded program that assists in finding employees and that will
reimburse up to 50 percent of employees\' wages for the first 2 to 26
weeks of employment. People hired must meet certain eligibility criteria
because this program is intended to provide an incentive for hiring
individuals who either are unemployed or have low income. The program
also compensates for training expenses, but only when such training is
merited. For specific information on the program\'s requirements,
contact your local JTPA office.

State governments have other job-related training programs based on job
specifications. These programs can be researched by contacting local
employment agencies, state and federal departments of labor or community
colleges. If employees need to learn a specific skill, the U.S.
Department of Labor has an apprenticeship program that allows training
to be provided at a reduced cost to the employer. You can obtain
information on this program by contacting the U.S. Department of Labor
office in your state.

Reducing Costs by Changing Business Organization

Expansion

At times an expansion can result in spreading existing fixed costs over
a larger sales volume. In this case, the decision to increase size is
justified. Whenever you have to increase fixed costs to attain higher
sales levels, investigate the proportion of the increase before
proceeding with growth plans.

An example is operating a wholesale business from a warehouse. Once the
warehouse is established, it becomes a fixed cost and you can increase
sales by adding a salesperson \-- a variable cost. The variable cost per
unit of sales (i.e., salespeople productivity) should remain constant in
order to result in a lower fixed cost per unit sold. Increased variable
costs can take away the benefit of lower fixed costs per unit. This is
true until the warehouse reaches its capacity to function. One of the
concerns here is that variable costs remain constant. For example, if
the additional salespeople cover a territory farther from your base
operation, there are additional costs associated with travel and
unproductive sales time. If the variable costs deplete the advantage,
then the decision to expand is unprofitable.

Diversification

Diversification is traditionally considered an option for business
growth. One of the major advantages of pursuing diversification is that
it can balance seasonal or yearly cycles in your business, or it can be
used to balance a multiyear cycle influenced by economic conditions.
Usually the area selected for diversification should be related to your
current business activity.

There are two types of diversification: vertical and horizontal.
*Vertical diversification* involves expanding either up or down the
channel of distribution. An example of vertical diversification is a
manufacturer who has been selling to independent wholesalers and then
starts his or her own wholesale operation. *Horizontal diversification*
involves adding other similar products or business lines. An example of
horizontal diversification is a business that manufactures and sells ice
and then starts bottling water. The bottled water is related to its
current activity and uses some of the same equipment, thus reducing
overhead costs. These two examples of diversification provide a
framework for identifying methods for creating additional business.

Joint Ventures

Joint ventures also can be a method for cutting expansion costs in
production processes, purchasing and sales. These relationships should
be established carefully so they benefit both parties and allow a way
for either party to end the relationship. The cost savings often occur
in the area of fixed overhead expenses, as these costs are now shared.

Reducing Costs by Managing Risks

Risk is always associated with business activity. In a stable company
risk is manageable, but for a growing company risk can easily become
monumental. Unexpected occurrences may result in additional expenses
that increase the cash outflow. The following is a list of potential
risks and options to help reduce their impact on your business.

Lawsuits

Lawsuits usually can be avoided by complying with regulations or
policies and taking appropriate precaution not to harm others. Knowledge
of federal and state regulations is the responsibility of management.
Two potential areas for a lawsuit are relationships with employees and
the potential for physical harm to people or damage to their property. A
major cost with a lawsuit, in addition to legal fees, is the possibility
of bad publicity, which may take time, money and extra effort to
overcome. Discuss your concern over being sued with an attorney. Talking
to a business owner who has been sued may help avoid problems as well as
identify the courses of action to take if you are sued. Even if all
precautions have been taken, the risk of a suit remains. Liability
insurance is one means of reducing the potential impact of the risk. At
a time of growth, liability insurance should be evaluated to determine
if it is still adequate.

Patent Infringements

Owners of a manufacturing or product development business should
investigate the possibility of obtaining patents for new products.
Usually patent infringement occurs because owners didn\'t realize the
product was patentable. If there already is a patent on the new product
and the patent owners become aware of your product when it is marketed,
they could force you to stop production and sue you for patent
infringement. Because of this potential, even if obtaining a patent is
not being considered, it is prudent to conduct a patent search to assure
that no one else has a patent for the product you plan to produce. This
can be done through patent attorneys, patent depository libraries or
computer data base systems.

Machine Breakdowns

Most business activities use equipment that can break down unexpectedly.
Not only is there the possibility of additional repair costs but also
there is the likelihood of having to replace the equipment entirely.
These kinds of costs can be managed by implementing a preventive
maintenance program. The potential for breakdown is related to the age
of the equipment and the care it has been given. If you are purchasing
new equipment for a growth phase, the potential for unforeseen repair
costs should be reduced greatly. When expansion is started with used
equipment, the risk of the equipment breaking down increases.

In general, money should be allotted for equipment repair and
replacement; depreciation dollars are normally accumulated for the
purpose of replacing the depreciated assets. However, in a case in which
repair costs will prolong the life of the asset, the dollars set aside
for depreciation may be used to cover repairs. This should apply only to
unusual repairs, not normal maintenance. In a

business that has just begun to grow, the depreciation account has not
accumulated a significant amount; therefore, a reasonable amount should
be planned for later financing.

Usually manufacturers are concerned about this type of risk, but retail
businesses also have equipment that needs to be examined, including cash
registers, computers, air conditioners and delivery vehicles.

Supplier Problems

During an expansion phase, relationships with new suppliers will be
established or existing relationships will be expanded, especially for
volume purchases. It may be a good policy to consider using diverse
suppliers. Dependence on one supplier can jeopardize your potential
sales volume if that supplier develops a problem and cannot produce. As
supplier relationships expand, consider formal written relationships
instead of relying on verbal understandings. These can clarify any
issues that later could cause problems. Pass on to suppliers any
obligations you have with your customers in areas in which supplier
performance can adversely affect your business.

Customer Credit

In a growing business, establishing relationships with new customers and
expanding relationships with existing customers can create the potential
for noncollectible accounts. To obtain new customers, it may be tempting
to relax past credit policies. A careful determination of a new
customer\'s ability to pay should be considered and follow-up collection
procedures implemented. An amount should be set aside in financial
projections for bad debt expenses. This can be proportional to the bad
debt expense incurred in the past. However, the amount could become
higher as a portion of sales if credit terms are relaxed to obtain
increased sales.

Bank Failure

Banks are not fail-safe. They have had and will continue to have an
impact on businesses, especially when they close. Most banks are insured
by the Federal Deposit Insurance Corporation (FDIC), but you should
verify this. Banks financial statements are available for public review.
A good way to protect your company from the effects of a bank failure is
to obtain the bank\'s financial statements and compare the total
deposits to the number of outstanding loans. Even if your company\'s
bank is insured by the FDIC, should it fail, it takes time for the FDIC
to release the cash your company had in the bank. This could put a
severe strain on the cash flow of the business.

Physical Damage

Even though in most cases physical risks are covered by insurance,
whenever a disaster strikes \-- whether it is a fire, hurricane, flood,
earthquake or tornado \-- the disruption to the business will be greater
than the damage to the property. The major risk to a business is lost
sales because of (1) the business\'s inability to function and (2) the
time it takes to restructure the business.

Personnel Problems

There is insurance to protect against most risks involving people,
including you or a key employee becoming disabled or dying. Even with
the insurance, there are additional costs associated with the loss. In
the case of either death or disablement, the business can be named as
the beneficiary, but the dollars recovered cannot repair all of the
damage caused by the business\'s inability to serve its customers\'
needs.

Also consider the risk involved with losing company secrets. Do you have
a system to protect your trade secrets? Is there the potential for one
of your employees to share your business secrets? If you don\'t have
procedures to protect trade secrets, take the time to develop and
implement such policies.

Unions

If your operation is non-union, employees may vote to establish a union,
which is their legal right. Responsible management, however, is one way
of deterring employees from forming a union. Unions usually are formed
when wage levels or other working conditions are unacceptable to the
employees.

Unknown Laws

The best way to avoid costs in this category is to conduct business
according to the law. Attorneys or state and federal regulating agencies
can help review the requirements that pertain to your business. Trade
associations also can be helpful in staying abreast of developments. Two
areas particularly important to a business are labor and environmental
laws. Violating the law can result in costly fines and penalties.

Tax Requirements

Whenever your business is growing and changing, you should investigate
the impact taxes will have on the business, such as property, sales,
payroll and federal and state income taxes. Pay particular attention to
sales tax if your company is expanding into new geographic areas. Each
state has its own sales tax system, and states are cooperating in
collecting sales tax from out-of-state businesses.

Warranty Claim Risks

Manufacturing companies have product warranty requirements. These
requirements can involve state and federal laws. A warranty claim on a
single product may not be devastating, but if a major flaw is detected
in your product and all the products sold are recalled, it can be quite
a challenge to overcome. For more information, obtain the publication
Product Warranties and Servicing published by the U.S. Department of
Commerce, Office of Consumer Affairs through the Superintendent of
Documents, U.S. Government Printing Office, Washington, D.C. 20402.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**SECTION 3: DOCUMENTING RESULTS**

**Your Accounting System**

The accounting system of a growing business must change and adapt to new
needs after growth. Changes in accounting may be resisted by employees
who are comfortable with the existing system. Also, when accounting
systems change, it becomes more difficult to compare past trends with
current results. Further, a new or improved accounting system can cost
time and money to develop and implement, placing an additional strain on
limited resources. Despite these negatives, a growing business usually
needs additional management information from the accounting system.

The purpose of most accounting systems is to provide management with
information, control and feedback. If your accounting system is used
only for providing information to the Internal Revenue Service (IRS), it
is not fulfilling its total purpose. If business growth is occurring in
existing product or service lines, the current system will apply to the
new growth cycle. However, because the number of transactions will
increase, the accounting system should be evaluated to ensure the data
are accumulated in an efficient manner. This evaluation should include
whether certain types of transactions need to be recategorized.

During growth or a change in the form of ownership, all previous
accounting standards need to be reconsidered to determine if changes are
necessary. Examples include

 Cash-based versus accrual accounting

 Single- versus double-entry accounting

 Fiscal year

 Form of ownership

Cash-based Versus Accrual Accounting

If you are using the accrual accounting system, there probably is no
need to change. If you have been using the cash-based accounting system,
perhaps the accrual system should be considered. In cash accounting,
transactions are recorded as income or expenses when the cash has
actually been transferred. (For a retail business in which only cash is
received on the income side, the cash and accrual systems are the same.)
In accrual accounting, transactions are recorded when they occur or when
the goods or services are transferred. In this system, payment is
usually received after the product or service has been delivered. For
example, your business sold and delivered \$10,000 worth of materials on
December 28 but was not paid until January 5. If you were operating on a
cash-based accounting system, you would record the income in January; if
you were on an accrual accounting system, you would record the income in
December. The accrual system can affect your tax obligations. However,
the main advantage of accrual accounting is that it results in more
meaningful information for controlling business activities. This is true
because expenses that generate income are brought together in the same
time period that the income is reported.

Single- Versus Double-entry Accounting

Growth might be better managed with a double-entry system. Single-entry
means that a transaction is entered only once into your system.
Double-entry involves entering a transaction twice: first as a debit and
then as a credit. For example, in a double-entry system, the payment of
an invoice would be recorded as a materials purchased expense and as a
deduction from the cash account. Double-entry accounting is more
accurate than single-entry accounting because each transaction is
entered as a balanced item \-- with offsetting increases and decreases
on each side of the asset/liability or revenue/expense ledger. Thus, the
resulting balances should be identical.

Choosing a Fiscal Year

When you begin a business, you choose the operating fiscal year, whether
it is a calendar year or some other 12-month period that is convenient
for you. When the business begins to grow, reconsider your fiscal year.
Perhaps the new activity will be seasonal, i.e., in a different season
than you currently use. You should consider some type of tax year that
matches the season and avoids splitting the season into two tax years.

Form of Ownership

The accounting system is slightly different for a sole proprietorship, a
partnership or a corporation. During a growth phase, you should perhaps
consider other forms of ownership and implement the accounting system
that matches that form.

Multiple Accounting Systems

Managers need guidance to make decisions. If you operate with a single
or a simple accounting system that produces a single income statement
and balance sheet, consider developing two or three separate accounting
systems, one for each area of your business, which can then be
consolidated into one income statement and balance sheet. The separate
systems will enable you to know what is happening.

This is similar to the concept of developing profit centers for a
business. If you operate a retail business, profit centers are divided
into different functional areas in your store, or, if you are a
manufacturer, they are based on your product lines. Accounting systems
for each profit center allow you to determine the profitability of each
product. If each product line or profit center category is generating a
profit, then the overall business will be profitable on a consolidated
accounting statement.

An example is a retail hardware store generating one income statement.
Management might benefit from dividing the business into functional
areas such as household, sports and tools, and developing income
statements for each of these areas. This information still must be
consolidated into one statement, but the individual statements provide
information that will help maximize profitability in each area. This
system also works for branch offices, which are often established to
increase business activity. Each branch office has its own operating
system, then they are pulled together into a consolidated system.

Accounting systems are set up so that information flows from a large
number of entries to a final income statement and balance sheet. Income
statements allow trends to be tracked by listing a current month\'s
sales and expense amounts, current month\'s percentages, year-to-date
activity and year-to-date percentages. The current month percentage is
the expense amount for the month divided by sales. For example, if sales
were \$100,000 and wages were \$10,000, the percentage for wages is 10
percent (\$10,000 wages divided by \$100,000 sales). This system must be
maintained, although categories may need to be added in a growing
business. The owner of a growing business should be able to access
reports that track the efficiency of the operation. If the information
is compiled appropriately, it will be readily available at minimal cost.

For example, on an income statement for a restaurant, the cost of sales
and labor are separate items, including their dollar amounts and their
percentage relative to sales. Combine these and compare them over a time
period. If prepared food is purchased, the food cost per meal served
will be higher but the labor cost lower. This is particularly true in a
restaurant in which the labor and cost of food can be inversely related.
The important factor overall may be the combined percentages of labor
and material compared to sales. (However, be aware that trends are not
always accurate for comparison because they may fluctuate seasonally.
Compare trends from the same time frame each year. This can be done by
using a table or a graph to express the comparison.)

Management can determine operational efficiency by several factors not
measured in dollars. Efficiency means that the business operation is
maximizing output levels for a given amount of time or resources. The
management information generated by the accounting system results in an
accurate measure of efficiency, but there is other information that can
be accumulated to measure efficiency. An example is the number of
prospect phone calls made over a certain time. By accumulating,
recording and tracking this information, the efficiency of the sales
staff can be calculated. In a manufacturing business, this can be the
number of hours it takes to perform certain tasks or the resulting data
collected from a statistical process control system.

Because these reports increase the fixed costs of your business, any
report request should be thought through carefully to ensure that the
result is of value to the user. With computerized data systems, it is
very easy to produce a lot of paper that isn\'t meaningful or usable for
management.

Computer Applications

During growth, many business owners-managers believe a computer is
necessary to complete accounting needs for the business. This can be
true, but there are certain pitfalls to consider before selecting a
system. If you have a system, future growth may cause you to exceed the
system\'s current capacity, which will require a reevaluation of your
system.

There can be costs associated with purchasing equipment and hardware,
but perhaps the most difficult cost to measure is the hidden cost
involved with implementing a computer system. Even though computers are
supposed to decrease the use of labor and add to the efficiency of the
operation, this often is not the case with a computer system. Before
installing a system, become familiar with how the system works and what
it produces by developing and implementing a manual or paper accounting
system. Once the manual system is completed and transferred to the
computer, you will know exactly what the system can and cannot produce.

One of the main criteria for selecting a computer system is that the
resulting information be usable based upon the company\'s needs. There
are software packages specifically designed for accounting. Even though
they are expensive, they may cost less overall compared to developing a
system of your own. There are usually four issues that should be
considered in developing a computerized accounting system:

1\. Design an accounting system programmed in a computer language.

2\. Purchase a software spreadsheet package and program the spreadsheet.

3\. Purchase software specifically designed for accounting systems.

4\. Purchase software designed for a specific accounting system for a
specific type of business.

All of these should be explored and reviewed carefully before you decide
to implement a particular system. Assistance should be sought not only
from computer and software vendors but also from accountants and
professionals with knowledge of accounting and computer applications. It
is sometimes tempting to purchase software that employees are familiar
with rather than to purchase a system tailored to the business. This may
work, but if the employees quit and the software was not the best for
the business, it could be challenging to keep the system going.

In addition to considering the computer equipment and software, explore
the availability of printing options as they can affect the usefulness
of the information produced. Computer printers vary in printing speed,
quality of print, cost and page layout and dimensions. All of these
factors have an impact on the appearance of your output information.

Relationship with Your Accountants

Changes in the accounting system will cause you to reevaluate your
relationship with accountants. If you are doing your own accounting, you
may need to consider whether you should hire assistants or seek
additional training. Either way, a growing company requires more complex
accounting decisions. Growing companies can find themselves in a
position of having outgrown their accountant. If this happens, search
for a professional service that matches the level of your business
activities.

Accountants can design new systems for managing your business
information. Be sure you get what you need because, occasionally,
accountants design systems for tax purposes and have difficulty
considering the broader need for information management in your
business. If you feel this happening, rely on the accountant for your
tax obligations but consider seeking assistance from others in designing
a system consistent with your business needs. Remember, the accounting
system should be designed so your business grows into it. When you are
making changes, try to anticipate what will be happening in the future
to avoid the need for further change in your system. The advantage of
this is it will be easier to maintain a consistent method of analyzing
trends from year to year.

**Tax Consequences of Growth**

Growth should produce additional profit, which will result in an
increasing tax obligation. Several aspects of taxes affect growth. Tax
reduction often does not result in a decreased tax obligation but
transfers payment of the obligations to a future time. In a real sense,
total tax dollars paid over a long-term period are going to be fairly
constant. The idea usually is to reduce taxes now, then invest the money
so that as taxes become due more money is available.

One of the primary tasks of tax planning is contemplating profitability
over the next 10 to 20 years. If projections show profits will be low in
the first years and higher thereafter, consider transferring profit to
the first years. Should projections indicate higher taxes or profit in
the first years, arrange to pay tax now. Several factors influence this
decision. One possibility is to amortize expansion costs that are
unrelated to capital improvements. According to IRS guidelines, a
capital improvement can be depreciated based on a determined life span.
This span usually involves physical assets that wear out, as compared to
expansion costs that can have a positive effect on sales volume in the
future. An example is any expenditure used to develop a channel of
distribution that is going to be in existence for some time. This cost
can be calculated and amortized over a minimum of five years, thus
reducing expenses in the current year. A reduction in expenses means
more profit, which means paying more tax currently. When higher profits
occur, amortization will transfer more expense to that time period,
resulting in lower profit and taxes.

The following areas are among those that should be investigated to
determine if their costs, when associated with an expansion, can be
amortized:

 Training for employees

 Travel and related expenses

 Advertisement related to the expansion

 Surveys and market research

 Salaries of those involved in the expansion

 Organization costs for the form of ownership

 Research, experimental and development costs

 Agreements not to compete

 Cost of acquiring leases

 Cost of commissions or finder fees

This list is not comprehensive.

Keep in mind the effect taxes will have on interest and depreciation.
During the early part of a business, interest and depreciation are
usually high, resulting in increased expenses and, thus, decreased
profits. Later, when the principal is paid down, interest is low and
depreciation is close to nonexistent, you will owe higher taxes, which
will result in a higher tax rate.

The current depreciation system used for all assets placed in service
after 1986 is Modified Accelerated Cost Recovery System (MACRS). This
system divides capital improvements into time periods of 3, 5, 7, 10, 15
and 20 years. The allowable rate of depreciation should be used when
projected income statements are developed to justify the growth
potential of a business.

If a change in the ownership structure of the business is contemplated
during a growth period, be sure to consider the subsequent tax
obligations. If you own several separate businesses (with various
situations of profit and loss), it may be more cost effective to control
them through a parent holding company so tax losses in one business can
be balanced against tax owed in another business. Also, the form of
ownership, whether it is a sole proprietorship, a partnership or a
corporation, can have an impact on personal income taxes. In certain
business situations, the corporation can be a means of reducing taxes
and in other cases the sole proprietorship can result in lower income or
payroll taxes.

During an expansion, consider the current tax status of programs, such
as investment credit, which allows acceleration of deductions for
capital improvements. In the past, these accelerated methods were called
investment credit. Currently they are available to growing businesses
through the Section 179 deduction. This allows an additional deduction
in the current year which means lower profits and less tax. This
deduction also is available through Section 38 property that has a
useful life of at least three years. (Check with the IRS for specifics
about the maximum allowance.) The amount of the deduction is subtracted
from the basis in order to begin calculating depreciation on the capital
assets. There are specific guidelines on the taxable income limit, the
carryover of an allowable deduction and the original cost of the asset.

Investigate the impact taxes will have on growth by talking with tax
accountants or by studying tax information provided by the IRS. Two IRS
publications that address growth issues are Publication 534,
Depreciation, and Publication 334, Tax Guide for Small Business. You can
obtain copies through your local IRS office or check the listing in
Appendix F: Information Resources.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**SUMMARY**

When future growth is anticipated by business owners, the excitement and
challenge often draw the owner\'s attention away from the financial
aspects of the business. Business history is full of examples of
businesses that accomplished growth but were unable to sustain their new
position, often because of lax attention to managing the finances that
support growth. Financial management needs to correspond to the
expansion activities being undertaken. Giving proper attention to
managing finances will enhance growth potential and sustain levels of
sales once they are obtained. Financial planning should be viewed not as
an obstacle but as a means of ensuring your success.

The challenge of a growing business should be carefully weighed against
your personal drive to achieve what you are attempting. It often seems
the time and effort it takes to achieve goals in business increase more
than what was originally anticipated. Part of a well-devised plan is to
have options open to compensate for possible areas that do not develop
as expected. To have these options identified so they can be implemented
immediately can often make the difference between success and failure.
To a great extent, growth potential is based on your ability to know
yourself. You must either have the personal abilities to complete the
growth, or you must know your limitations and have resources available
to cover them. (See the self-assessment questionnaire in Appendix D.)
Also, in some instances, business owners rely too heavily on outside
expertise or employees and are misguided or misunderstand their ability
to assist in obtaining growth.

The encouraging side of growth is that many others have undertaken and
achieved growth successfully in business. There are many success stories
in which people have improved their income potential and their net
worth.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**APPENDIX A: SAMPLE BALANCE SHEET AND INCOME STATEMENT**

The following balance sheet and income statement provide examples of the
information that should be currently available before attempting to
increase a business\'s sales. These statements are the standard that is
acceptable for communication of financial information to banks and are
the usual format developed by accountants. These statements result in
management information that helps management determine what action
should be taken for future business potential.

New Business Balance Sheet

(Current Data)

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Assets

Current assets

Cash \$ 2,174

Accounts receivable 28,459

Notes receivable 24,216

Inventory 143,000

Total current assets \$197,849

Property, plant and equipment

Equipment 17,988

Vehicles 8,000

Furniture and fixtures

Total cost of PPE 25,988

Less accumulated depreciation 18,892

Book value of PPE 7,096

Total assets \$204,945

Liabilities and Equity

Current liabilities

Accrued expenses

Accounts payable 71,000

Current portion of long-term debts 11,802

Total current liabilities 82,802

Long-term debt 64,198

Total liabilities 147,000

Owner\'s equity 57,945

Total liabilities and equity \$204,945

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

New Business Income Statement

(Current Year-To-Date)

Current Month Year-To-Date

\$ % \$ %

Sales

Beginning Inventory 38,000 100.00 450,000 100.00

Materials purchased 143,000 138,850

Ending inventory 23,500 286,150

Cost of goods sold 23,500 92.00 279,000 62.00

Gross profit 14,400 38.00 171,000 38.00

Operating and fixed expense

Wages 7,500 19.74 90,000 20.00

Payroll tax 750 1.97 9,000 2.00

Benefits 400 1.05 5,000 1.11

Accounting and legal 0 0.00 1,000 0.22

Advertising 475 1.25 5,265 1.17

Sales expenses 85 0.22 1,000 0.22

Interest 700 1.84 9,000 2.00

Utilities 275 0.72 3,000 0.67

Telephone 330 0.87 4,000 0.89

Supplies 400 1.05 5,000 1.11

Office supplies 140 0.37 1,570 0.35

Repair and maintenance 100 0.26 1,100 0.24

Freight 50 0.13 450 0.10

Insurance 833 2.19 10,000 2.22

Depreciation 425 1.12 5,100 1.13

Vehicles 200 0.53 2,600 0.58

Rent 0 0.00 0 0.00

Outside services 75 0.20 1,000 0.22

Miscellaneous 165 0.43 2,000 0.44

Total operating and fixed

expenses 12,903 33.96 156,085 34.69

Operating profit 1,537 4.04 14,915 3.31

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**APPENDIX B: SAMPLE PRO FORMA STATEMENTS**

 Income Projection Statement

 Cash Flow Projection

 Balance Sheets

The following projections are based upon the historical statements
provided in Appendix A. These are based on the actual situation and
include obtaining an additional loan amount to finance the growth of the
business. The income statement, cash flow and balance sheet items are
all balanced or in the proper relationship to the historical statements.
In these projections, growth in sales is expected to go to \$685,000
from a level of \$450,000 for the first year; the business is expected
to double in size within three years.

Income Projection Statement

Business Name Here

First Second Third

Year Year Year

Gross Sales 685,000 753,500 828,850

Beginning Inventory 161,000 177,100 177,100

Materials Purchased 440,800 484,800 533,368

Ending Inventory 177,100 177,100 177,100

Cost of Goods sold 424,700 484,880 533,368

Gross profit 260,300 268,620 295,482

Fixed Expenses

Wages 137,000 150,700 165,770

Outside services 0 0 0

Accounting and legal 1,600 1,600 1,600

Advertising 8,000 8,800 9,680

Travel and Freight 400 400 400

Rent 15,456 15,456 15,456

Depreciation 11,600 11,600 11,600

Supplies 10,000 10,000 10,000

Utilities 3,600 3,780 3,969

Telephone 4,700 5,170 5,687

Interest (new loan) 10,294 9,155 7,884

Interest (existing loans) 8,485 6,988 5,342

Repairs 2,000 2,000 2,000

Taxes 0 0 0

Insurance 12,000 13,200 14,520

Other 1,000

Misc. 3,000 3,000 3,000

Total 229,134 241,849 256,907

Net profit 31,166 26,771 38,575

Income Tax 6,856 5,890 8,486

Owner\'s withdrawal 0 0 0

Profit 24,309 20,882 30,088

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

 The Following Table is Presented in Two Sections. To

Red Properly, Please Match Line Numbers

Name of Business: Cash Flow Projection

Months Start‑up Sept. Oct. Nov. Dec. Jan. Feb.

1\. Cash on hand 12,174 2,821 1,829 1,248 6,606 28,112

2\. Cash receipts 51,431 9,141 52,997 57,785 71,240 45,895

Loan or other

injection

3\. Notes receivable2,018 2,018 2,018 2,018 2,018 2,018

4\. Cash available 65,623 53,980 56,844 61,051 79,864 76,025

Cash paid out

5\. Purchases‑goods43,497 30,273 34,681 34,681 30,273 25,865

6\. Gross wages 11,417 11,417 11,417 11,417 11,417 11,417

7\. Outside services 0 0 0 0 0 0

8\. Supplies 833 833 833 833 833 833

9\. Repair/maintenance 0 400 0 0 0 1,600

10\. Advertising 300 300 1,800 600 600 600

11\. Travel & freight 0 400 0 0 0 0

12\. Accounting/legal 133 133 133 133 133 133

13\. Rent 1,288 1,288 1,288 1,288 1,288 1,288

14\. Telephone 392 392 392 392 392 392

15\. Utilities 240 300 350 400 400 350

16\. Insurance 1,000 1,000 1,000 1,000 1,000 1,000

17\. Taxes 0 0 0 0 0 0

18\. Interest

(new loan) 898 891 884 877 869 862

19\. Interest

(existing loans) 760 751 741 732 722 713

20\. Miscellaneous 250 250 250 250 250 250

21\. Other 83 83 83 83 83 83

22\. Subtotal 61,091 48,711 53,852 52,685 48,261 45,385

23\. Loan principal

(new loan) 780 787 794 801 809 816

24 .Loan principal

(existing loans) 931 940 949 959 968 978

25\. Income tax 0 1,714 0 0 1,714 0

26\. Capital purchases

27\. Owner withdrawal 0 0 0 0 0 0

28\. Cash paid out 62,802 52,152 55,596 54,446 51,752 47,180

29\. Cash position 2,821 1,829 1,248 6,606 281,12 28,846

\_\_\_\_\_\_

Part 2 of Above Chart \-- Match Line Numbers

Time Period: Year One

Mar. Apr. May June July Aug. Total

1\. 28,846 25,540 24,382 29,347 34,996 38,932

2\. 53,430 61,650 61,650 62,335 62,335 58,225 688,114

3\. 2,018 2,018 2,018 2,018 2,018 2,018 24,216

4\. 84,294 89,208 88,050 93,700 99,349 99,175

5\. 39,089 43,497 39,089 39,089 39,089 34,681 433,800

6\. 11,417 11,417 11,417 11,417 11,417 11,417 137,000

7\. 0 0 0 0 0 0 0

8\. 833 833 833 833 833 833 10,000

9\. 0 0 0 0 0 0 2,000

10\. 600 600 600 600 600 8,000

11\. 0 0 0 0 0 0 400

12\. 133 133 133 133 133 133 1,600

13\. 1,288 1,288 1,288 1,288 1,288 12,88 15,456

14\. 392 392 392 392 392 392 4,700

15\. 300 250 250 250 250 260 3,600

16\. 1,000 1,000 1,000 1,000 1,000 1,000 12,000

17\. 0 0 0 0 0 0 0

18\. 854 847 839 832 824 816 10,294

19\. 703 693 683 673 663 652 8,485

20\. 250 250 250 250 250 250 3,000

21\. 83 83 83 83 83 83 1,000

22\. 56,942 61,283 56,857 56,839 56,821 52,605 651,334

23\. 824 831 839 846 854 862 9,842

24\. 988 998 1,008 1,018 1,028 1,038 11,802

25 . 0 1,714 0 0 1,714 0 6,856

26\. 0

27\. 0 0 0 0 0 0 0

28\. 58,754 64,826 58,704 58,704 60,418 54,506

29\. 25,540 24,382 29,347 34,996 38,932 44,669

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Balance Sheet

Business Name Here

First Year of Business Expansion

Assets

Current assets

Cash 12,174

Accounts Receivable 28,459

Notes Receivable 24,216

Inventory 161,000

Total Current Assets 225,849

Property, plant & equipment

Land 0

Building 24,000

Equipment 63,988

Vehicles 8,000

Furniture & fixtures 0

Total property, plant & equipment 95,988

Less accumulated depreciation (18)892)

Total long-term assets 77,096

Total assets 302,945

Liability & equity

Current liabilities

Accrued expenses 0

Accounts payable 71,000

Current portion of debt (new) 9,842

Current portion of debt (existing) 11,802

Total current liabilities 92,644

Long-term loan (new) 88,158

Long-term loan (existing) 64,198

Total long-term liabilities 152,356

Total liabilities 245,000

Owner\'s equity 57,945

Total liabilities and equity 302,945

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Balance Sheet

Business Name Here

After First Year of Business Expansion

Assets

Current assets

Cash 44,669

Accounts Receivable 25,345

Notes Receivable 0

Inventory 177,100

Total Current Assets 247,144

Property, plant & equipment

Land 0

Building 24,000

Equipment 63.988

Vehicles 8,000

Furniture & fixtures 0

Total property, plant & equipment 95,988

Less accumulated depreciation (30,492)

Total long-term assets 65,496

Total assets 312,610

Liability & equity

Current liabilities

Accrued expenses 0

Accounts payable 78,000

Current portion of debt (new) 6,619

Current portion of debt (existing) 11,802

Total current liabilities 96,421

Long-term loan (new) 81,539

Long-term loan (existing) 52,396

Total long-term liabilities 133,935

Total liabilities 230,356

Owner\'s equity 82,254

Total liabilities and equity 312,610

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**APPENDIX C: BLANK FORMS**

**INCOME PROJECTION STATEMENT**

Industry J F M A M J J A S O N D Annual Annual

\% total %

Total net sales

(revenues) \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Cost of sales \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Gross profit \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Gross profit

margin \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Controllable

expenses

Salaries/wages \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Payroll expenses \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Legal/accounting \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Advertising \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Automobile \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Office supplies \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Dues/subscriptions \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Utilities \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Miscellaneous \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Total controllable

expenses \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Fixed expenses

Rent \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Depreciation \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Utilities \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Insurance \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Licenses/permits \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Loan payments \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Miscellaneous \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Total fixed

expenses \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Total expenses \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Net profit (loss)

before taxes \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Taxes \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

Net profit (loss)

after taxes \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_ \_

The income projection (profit and loss) statement is valuable as both a
planning tool and a key management tool to help control business
operations. It enables the owner-manager to develop a preview of the
amount of income generated each month and for the business year, based
on reasonable predictions of monthly levels of sales, costs and
expenses.

As monthly projects are developed and entered into the income projection
statement, they can serve as definite goals for controlling the business
operation. As actual operating results become known each month, they
should be recorded for comparison with the monthly projections. A
completed income statement allows the owner-manager to compare actual
figures with monthly projections and to take steps to correct any
problems.

Industry Percentage

In the industry percentage column, enter the percentages of total sales
(revenues) that are standard for your industry which are derived by
dividing

cost/expense items by total net sales x 100%

These percentages can be obtained from various sources, such as trade
associations, accountants or banks. The reference librarian in your
nearest public library can refer you to documents that contain the
percentage figures, for example, Robert Morris Associates\' Annual
Statement Studies (1 Liberty Place, Philadelphia PA 19103)

Industry figures serve as a useful benchmark against which to compare
cost and expense estimates that you develop for your firm. Compare the
figures in the industry column to those in the annual percentage column

Total Net Sales (Revenues)

Determine the total number of units or products or services you
realistically expect to sell each month in each department at the prices
you expect to get. Use this step to create the projection to review your
pricing practices.

 What returns, allowances and markdowns can be expected?

 Exclude any revenue that is not strictly related to the

business.

Cost of Sales

The key to calculating your cost of sales is that you do not overlook
any costs that you have incurred. Calculate cost of sales for all
products and services used to determine total net sales. Where inventory
is involved, do not overlook transportation costs. Also include any
direct labor.

Gross Profit

Subtract the total cost of sales from the total net sales to obtain
gross profit.

Gross Profit Margin.

The gross profit margin is expressed as a percentage of total sales
(revenues) it is calculated by dividing

gross profits by total net sales

Controllable Expenses

 *Salary expenses* \-- Base pay plus overtime.

 *Payroll expenses* \-- Include paid vacations, sick leave, health
insurance unemployment insurance and social security taxes.

 *Outside services* \-- Include costs of subcontracts, overflow work
and special or one-time services.

 *Supplies* \-- Services and items purchase for use in the business.

 *Repairs and maintenance* \-- Regular maintenance and repair,
including periodic large expenditures such as painting.

 *Advertising* \-- Include desired sales volume and classified
directory advertising expenses.

 *Car, delivery and travel* \-- Include charges if personal car is used
in business, including parking, tolls, buying trips, etc.

 *Accounting and legal* \-- Outside professional services.

Fixed Expenses

 *Rent* \-- List only real estate used in the business

 *Depreciation* \-- Amortization of capital assets.

 *Utilities* \-- Water, heat, light, etc.

 *Insurance* \-- Fire or liability on property or products. Include
workers\' compensation.

 *Loan repayments* \-- Interest on outstanding loans.

 *Miscellaneous* \-- Unspecified; small expenditures without separate
accounts.

Net Profit (loss)  Subtract total expenses from gross profit.

(before taxes)

Taxes  Include inventory and sales taxes, excise tax, real estate tax,
etc.

Net Profit (loss)  Subtract taxes from net profit (before taxes)

(after taxes)

Annual Total  For each of the sales and expense items in your income
projection statement, add all the monthly figures across the table and
put the results in the annual total column.

Annual Percentage  Calculate the percentage by dividing annual total by
total net sales x 100%

 Compare this figure to the industry percentage in the first column

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**MONTHLY CASH FLOW PROJECTION**

This is a form which cannot be reproduced in this format.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**BALANCE SHEET**

COMPANY NAME

As of \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_, 19\_\_\_\_\_

Assets Liabilities

Current assets Current Liabilities

Cash \_\_\_\_\_\_\_\_\_\_ Accounts Payable \_\_\_\_\_\_\_\_\_\_

Petty Cash \_\_\_\_\_\_\_\_\_\_ Notes Payable \_\_\_\_\_\_\_\_\_\_

Accounts Receivable\_\_\_\_\_\_\_\_\_\_ Interest Payable
\_\_\_\_\_\_\_\_\_\_

Inventory \_\_\_\_\_\_\_\_\_\_ Taxes Payable

Fed. income tax \_\_\_\_\_\_\_\_\_\_

Short-term Invest- State income tax \_\_\_\_\_\_\_\_\_\_

ments \_\_\_\_\_\_\_\_\_\_ Self-employment \_\_\_\_\_\_\_\_\_\_

Sales tax (SBE) \_\_\_\_\_\_\_\_\_\_

Prepaid expense \_\_\_\_\_\_\_\_\_\_ Property tax \_\_\_\_\_\_\_\_\_\_

Long-term invest- Payroll accrual \_\_\_\_\_\_\_\_\_\_

ments \_\_\_\_\_\_\_\_\_\_

Long-term liabil-

Fixed assets ities

Land \_\_\_\_\_\_\_\_\_\_ Notes payable \_\_\_\_\_\_\_\_\_\_

\_\_\_\_\_\_\_\_\_\_\_\_

Buildings \_\_\_\_\_\_\_\_\_\_

Total liabilities \_\_\_\_\_\_\_\_\_\_

Improvements \_\_\_\_\_\_\_\_\_\_
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Equipment \_\_\_\_\_\_\_\_\_\_ Net worth (owner equity)

Furniture \_\_\_\_\_\_\_\_\_\_ Proprietorship \_\_\_\_\_\_\_\_\_\_

or Partnership

Automobiles/ (name\'s) equity \_\_\_\_\_\_\_\_\_\_

vehicles \_\_\_\_\_\_\_\_\_\_ (name\'s) equity \_\_\_\_\_\_\_\_\_\_

or

Other assets Corporation

Capital stock \_\_\_\_\_\_\_\_\_\_

1\. \_\_\_\_\_\_\_\_\_\_ Surplus paid in \_\_\_\_\_\_\_\_\_\_

Retained earnings\_\_\_\_\_\_\_\_\_\_

3\. \_\_\_\_\_\_\_\_\_\_ \_\_\_\_\_\_\_\_\_\_\_\_\_

4\. \_\_\_\_\_\_\_\_\_\_ Total net worth \_\_\_\_\_\_\_\_\_\_

\_\_\_\_\_\_\_\_\_\_\_\_\_ \_\_\_\_\_\_\_\_\_\_\_\_\_

Total liabilities

Total assets \_\_\_\_\_\_\_\_\_\_ and net worth
\_\_\_\_\_\_\_\_\_\_\_\_\_

(Total assets will always equal total liabilities and

total net worth)

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**INSTRUCTIONS FOR BALANCE SHEET**

Figures used to compile the balance sheet are taken from the previous
and current balance sheet as well as the current income statement. The
income statement is usually attached to the balance sheet. The following
text covers the essential elements of the balance sheet.

At the top of the page fill in the legal name of the business, the type
of statement and the day, month and year.

**Assets**

List anything of value that is owned or legally due the business. Total
assets include all net values. These are the amounts derived when you
subtract depreciation and amortization from the original costs of
acquiring the assets.

**Current Assets**

 *Cas*h \-- List cash and resources that can be converted into cash
within 12 months of the date of the balance sheet (or during one
established cycle of operations). Include money on hand and demand
deposits in the bank, e.g., checking accounts and regular savings
accounts.

 *Petty cash* \-- If your business has a fund for small miscellaneous
expenditures, include the total here.

 *Accounts receivable* \-- The amounts due from customers in payment
for merchandise or services.

 *Inventory* \-- Includes raw materials on hand, work in progress and
all finished goods, either manufactured or purchased for resale.

 *Short-term investments* \-- Also called temporary investments in
marketable securities, these include interest- or dividend-yielding
holdings expected to be converted into cash within a year. List stocks
and bonds, certificates of deposit and time-deposit savings accounts at
either their cost or market value, whichever is less.

 *Prepaid expenses* \-- Goods, benefits or services a business buys or
rents in advance. Examples are office supplies, insurance protection and
floor space.

**Long-term investments**

Also called long-term assets, these are holdings the business intends to
keep for at least a year and that typically yield interest or dividends.
Included are stocks, bonds and savings accounts earmarked for special
purposes.

**Fixed Assets**

Also called plant and equipment. Includes all resources a business owns
or acquires for use in operations and no intended for resale. Fixed
assets, except for land, are listed at cost less depreciation. Fixed
assets may be leased. Depending on the leasing arrangement, both the
value and the liability of the leased property may need to be listed on
the balance sheet.

 *Land* \-- List original purchase price without allowances for market
value.

 *Buildings*

 *Improvements*

 *Equipment*

 *Furniture*

 *Automobiles/vehicles*

**Liabilities**

Current liabilities

List all debts, monetary obligations and claims payable within 12 months
or within one cycle of operations. Typically they include the following:

 *Accounts payable* \-- Amounts owed to suppliers for goods and
services purchased in connection with business operations.

 *Notes payable* \-- The balance of principal die to pay off short-term
debt for borrowed funds. Also include the current amount due of total
balance on notes whose terms exceed 12 months.

 *Interest payable* \-- Any accrued fees due for use of both short- and
long-term borrowed capital and credit extended to the business.

 *Taxes payable* \-- Amounts estimated by an accountant to have been
incurred during the accounting period.

 *Payroll accrual* \-- Salaries and wages currently owed.

Long-term Liabilities

*Notes payable* \-- List notes, contract payments or mortgage payments
due over a period exceeding 12 months or one cycle of operations. They
are listed by outstanding balance less the current portion due.

**Net Worth**

Also called owner\'s equity, net worth is the claim of the owner(s) on
the assets of the business. In proprietorship or partnership, equity is
each owner\'s original investment plus any earnings or withdrawals.

**Total Liabilities and Net Worth**

The sum of these two amounts must always match at of total assets.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**APPENDIX D: SELF‑ASSESSMENT, DECIDING WHETHER TO PURSUE GROWTH**

The following points should be considered when evaluating whether growth
is reasonable for your business.

**Personal**

1\. Do you have the time to undertake the activities associated with
growth and the time the larger business volume will consume?

2\. Does your family support your efforts to expand the business?

3\. Is your personal financial position congruent with the financial
situation of the company?

4\. Does your management ability correspond to that necessary to manage
growth?

**Finance**

1\. Does your business have the equity level to justify growth? If not,
do you have potential sources of equity?

2\. Has your business been profitable or shown the potential for
profitability?

3\. Will your bank be able to cooperate with you in your growth phase?

4\. Is the collateral position of the business adequate to meet the
requirements of lenders?

5\. Do accounting procedures allow you to maintain control of the
business?

6\. What contingency plans do you have if your initial attempts fall
short?

7\. Have you researched sources of government‑assisted funding?

8\. Do you have a knowledge of how cash flow interacts in your business
to ensure future cash flow?

9\. Do you have support people who understand finance?

10\. Will the rate of return justify the commitment of resources?

11\. Will the value of the business grow?

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**APPENDIX E: HOW TO WRITE A BUSINESS PLAN**

The following pages provide a suggested outline of the material that
should be included in your business plan. Your final plan may vary
according to your needs or because of the individual requirements of
your lender.

**What Are the Benefits?**

Every business can benefit from the preparation of a carefully written
plan. There are two main purposes for writing that plan:

1\. To serve as a guide during the lifetime of the business. It is the
blueprint of your business and will provide you with the tools for
analysis and change.

2\. A business plan is a requirement if you are planning to seek a loan.
It will provide potential lenders with detailed information on all
aspects of your company\'s past and current operations and provide
future projections.

**Business Plan Outline**

I. Cover sheet

Serves as the title page of your business plan. It should contain the
following:

 Name of the company

 Company address

 Company phone number (include area code)

 Logo (if you have one)

 Names titles addresses phone numbers (include area code) of owners

 Month and year your plan was issued

 Name of preparer

II\. Statement of purpose

(Same as executive summary.) This is the thesis statement and includes
business plan objectives. Use the key words (who, what, where, when,
why, how, and how much) to briefly tell about the following:

 What your company is (also who what where and when).

 What your objectives are.

 If you need a loan why you need it.

 How much you need.

 Why you will be successful.

 How and when you plan to repay your loan.

III\. Table of contents

A page listing the major topics and references.

IV\. The business

Covers the details of your business. Include information about your
industry in general, and your business in particular. Address the
following:

 *Legal structure* \-- Tell what legal structure you have chosen and
state reasons for your choice.

 *Description of the business* \-- Detail your business. Tell about
your history present status and future projections. Outline your product
or service in terms of marketability. Project a sense of what you expect
to accomplish in the next few years.

 *Products or services* \-- Give a detailed description of your
products from raw materials to finished items. Tell about your
manufacturing process. If you provide a service tell what it is how it
is provided and why it is unique. List future products or services you
plan to provide.

 *Location* \-- Describe site and why it was chosen. (If location is
important to your marketing plan focus on this in the marketing section
below.)

 *Management* \-- Describe who is behind the business. For each owner
tell about responsibilities and abilities. Support with resumes.

 *Personnel* \-- Who will be doing the work why are they qualified what
is their wage what are their responsibilities?

 *Methods of record keeping* \-- What accounting system will you use?
Who will do your record keeping? Do you have a plan to help you use your
records in analyzing your business?

 *Insurance* \-- What kinds of insurance will you need? What will these
cost and who will you use for a carrier?

 *Security* \-- Address security in terms of inventory control and
theft of information.

V. Marketing

Covers the details of your marketing plan. Include information about the
total market with emphasis on your target market. Identify your
customers and tell about the means to make your product or service
available to them.

 *Target market* \-- Identify characteristics of your customers. Tell
how you arrived at your results. Back up information with demographics
questionnaires and surveys. Project size of your market.

 *Competition* \-- Evaluate indirect and direct competition. Show how
you can compete. Evaluate competition in terms of location market and
business history.

 *Methods of distribution* \-- Tell about the manner in which products
and services will be made available to the customer. Back up decisions
with statistical reports rate sheets etc.

 *Advertising* \-- How will your advertising be tailored to your target
market? Include rate sheets promotional material and time lines for your
advertising campaign.

 *Pricing* \-- Pricing will be determined as a result of market
research and costing your product or service. Tell how you arrived at
your pricing structure and back it up with materials from your research.

 *Product design* \-- Answer key questions regarding product design and
packaging. Include graphics and proprietary rights information.

 *Timing of market entry* \-- Tell when you plan to enter the market
and how you arrived at your decision.

 *Location* \-- If your choice of location is related to target market
cover it in this section of your business plan. (See location in the
business section of this outline.)

 *Industry trends* \-- Give current trends project how the market may
change and what you plan to do to keep up.

VI\. Financial documents

These are the records used to show past, current and projected finances.
The following are the major documents you will want to include in your
business plan. The work is easier if these are done in the order
presented.

 *Summary of financial needs* \-- This is an outline indicating why you
are applying for a loan and how much you need.

 *Sources and uses of funds statement* \-- It will be necessary for you
to tell how you intend to disperse the loan funds. Back up your
statement with supporting data.

 *Cash flow statement (budget)* \-- This document projects what your
business plan means in terms of dollars. It shows cash inflow and
outflow over a period of time and is used for internal planning. Cash
flow statements show both how much and when cash must flow in and out of
your business.

 *Three‑year income projection* \-- A pro forma income statement
showing your projections for your company for the next three years. Use
the pro forma cash flow statement for the first year\'s figures and
project the next according to economic and industry trends.

 *Break‑even analysis* \-- The break‑even point is when a company\'s
expenses exactly match the sales or service volume. It can be expressed
in total dollars or revenue exactly offset by total expenses or total
units of production (cost of which exactly equals the income derived by
their sales). This analysis can be done either mathematically or
graphically.

*Note: The following are actual performance statements reflecting the
activity of your business in the past. If you are a new business owner
your financial section will end here and you will add a personal
financial history. If you are an established business you will include
the actual performance statements that follow.*

 *Balance sheet* \-- Shows the condition of the business as of a fixed
date. It is a picture of your firm\'s financial condition at a
particular moment and will show you whether your financial position is
strong or weak. It is usually done at the close of an accounting period
and contains assets liabilities and net worth.

 *Income (profit and loss) statement* \-- Shows your business financial
activity over a period of time (monthly annually). It is a moving
picture showing what has happened in your business and is an excellent
tool for assessing your business. Your ledger is closed and balanced and
the revenue and expense totals transferred to this statement.

 *Business financial history* \-- This is a summary of financial
information about your company from its start to the present. The
business financial history and loan application are usually the same. If
you have completed the rest of the financial section you should be able
to transfer all the needed information to this document.

VII\. Supporting documents

These are the records that back up the statements and decisions made in
the three main parts of your business plan. Those most commonly included
are as follows:

 *Personal resumes* \-- Should be limited to one page and include work
history educational background professional affiliations and honors and
special skills.

 *Personal financial statement* \-- A statement of personal assets and
liabilities. For a new business owner this will be part of your
financial section.

 *Credit reports* \-- Business and personal from suppliers or
wholesalers credit bureaus and banks.

 *Copies of leases* \-- All agreements currently in force between your
company and a leasing agency.

 *Letters of reference* \-- Letters recommending you as being a
reputable and reliable business person worthy of being considered a good
risk. (Include both business and personal references.)

 *Contracts* \-- Include all business contracts both completed and
currently in force.

 *Legal documents* \-- All legal papers pertaining to your legal
structure proprietary rights insurance titles etc.

 *Miscellaneous documents* \-- All other documents that have been
referred to but are not included in the main body of the plan (e.g.
location plans demographics advertising plan etc.).

**Putting Your Plan Together**

When you are finished: Your business plan should look professional, but
the lender needs to know that it was done by you. A business plan will
be the best indicator he or she has to

judge your potential for success. It should be no more than 30 to 40
pages long. Include only the supporting documents that will be of
immediate interest to your potential lender. Keep the others in your own
copy where they will be available on short notice. Have copies of your
plan bound at your local print shop, or with a blue, black or brown
cover purchased from the stationery store. Make copies for yourself and
each lender you wish to approach. Do not give out too many copies at
once, and keep track of each copy. If your loan is refused, be sure to
retrieve your business plan. For a more detailed explanation of each
section of the business plan outline, see SBA\'s publication, *How to
Write a Business Plan*, which includes step‑by‑step directions and
sample sections of actual business plans. Also available from the SBA is
a VHS videotape and workbook, The Business Plan: Your Roadmap for
Success.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

**APPENDIX F: INFORMATION RESOURCES**

**U.S. Small Business Administration (SBA)**

The SBA offers an extensive selection of information on most business
management topics, from how to start a business to exporting your
products.

This information is listed in The Small Business Directory. For a free
copy contact your nearest SBA office.

SBA has offices throughout the country. Consult the U.S. Government
section in your telephone directory for the office nearest you. SBA
offers a number of programs and services, including training and
educational programs, counseling services, financial programs and
contract assistance. Ask about

*Service Corps of Retired Executives (SCORE)*, a national organization
sponsored by SBA of over 13,000 volunteer business executives who
provide free counseling, workshops and seminars to prospective and
existing small business people.

*Small Business Development Centers (SBDCs)*, sponsored by the SBA in
partnership with state and local governments, the educational community
and the private sector. They provide assistance, counseling and training
to prospective and existing business people.

*Small Business Institutes (SBIs)*, organized through SBA on more than
500 college campuses nationwide. The institutes provide counseling by
students and faculty to small business clients.

For more information about SBA business development programs and
services call the SBA Small Business Answer Desk at 1‑800‑U‑ASK‑SBA
(827‑5722).

**Other U.S. Government Resources**

Many publications on business management and other related topics are
available from the Government Printing Office (GPO). GPO bookstores are
located in 24 major cities and are listed in the Yellow Pages under the
bookstore heading. You can request a Subject Bibliography by writing to
Government Printing Office, Superintendent of Documents, Washington, DC
20402‑9328.

Many federal agencies offer publications of interest to small
businesses. There is a nominal fee for some, but most are free. Below is
a selected list of government agencies that provide

publications and other services targeted to small businesses. To get
their publications, contact the regional offices listed in the telephone
directory or write to the addresses below:

**Consumer Information Center (CIC)**

P.O. Box 100

Pueblo, CO 81002

The CIC offers a consumer information catalog of federal publications.

**Consumer Product Safety Commission (CPSC)**

Publications Request

Washington, DC 20207

The CPSC offers guidelines for product safety requirements.

**U.S. Department of Agriculture (USDA)**

12th Street and Independence Avenue, SW

Washington, DC 20250

The USDA offers publications on selling to the USDA. Publications and
programs on entrepreneurship are also available through county extension
offices nationwide.

**U.S. Department of Commerce (DOC)**

Office of Business Liaison

14th Street and Constitution Avenue, NW

Room 5898C

Washington, DC 20230

DOC\'s Business Assistance Center provides listings of business
opportunities available in the federal government. This service also
will refer businesses to different programs and

services in the DOC and other federal agencies.

**U.S. Department of Health and Human Services (HHS)**

**Public Health Service**

**Alcohol, Drug Abuse and Mental Health Administration**

5600 Fishers Lane

Rockville, MD 20857

Drug Free Workplace Helpline: 1‑800‑843‑4971. Provides information on
Employee Assistance Programs.

National Institute for Drug Abuse Hotline:

1‑800‑662‑4357. Provides information on preventing substance abuse in
the workplace.

The National Clearinghouse for Alcohol and Drug Information:
1‑800‑729‑6686 toll‑free. Provides pamphlets and resource materials on
substance abuse.

**U.S. Department of Labor (DOL)**

**Employment Standards Administration**

200 Constitution Avenue, NW

Washington, DC 20210

The DOL offers publications on compliance with labor laws.

**U.S. Department of Treasury**

**Internal Revenue Service (IRS)**

P.O. Box 25866

Richmond, VA 23260

1‑800‑424‑3676

The IRS offers information on tax requirements for small businesses.

**U.S. Environmental Protection Agency (EPA)**

**Small Business Ombudsman**

401 M Street, SW (A‑149C)

Washington, DC 20460

1‑800‑368‑5888 except DC and VA

703‑557‑1938 in DC and VA

The EPA offers more than 100 publications designed to help small
businesses understand how they can comply with EPA regulations.

**U.S. Food and Drug Administration (FDA)**

**FDA Center for Food Safety and Applied Nutrition**

200 Charles Street, SW

Washington, DC 20402

The FDA offers information on packaging and labeling requirements for
food and food‑related products.

**For More Information**

A librarian can help you locate the specific information you need in
reference books. Most libraries have a variety of directories, indexes
and encyclopedias that cover many business topics. They also have other
resources, such as

 **Trade association information**

Ask the librarian to show you a directory of trade associations.
Associations provide a valuable network of resources to their members
through publications and services such as newsletters, conferences and
seminars.

 **Books**

Many guidebooks, textbooks and manuals on small business are published
annually. To find the names of books not in your local library check
Books In Print, a directory of books currently available from
publishers.

 **Magazine and newspaper articles**

Business and professional magazines provide information that is more
current than that found in books and textbooks. There are a number of
indexes to help you find specific articles in periodicals.

In addition to books and magazines, many libraries offer free workshops,
lend skill‑building tapes and have catalogues and brochures describing
continuing education opportunities.