C-Store Exhibitions | January/February 2000 - Accounting : Keeping liquid

Despite the way some dealers may view and interpret the New Tax System, one thing is for sure: there is no excuse for any small business not to receive timely and up to date financial information on their business.

Business owners must now lodge BAS reports on a monthly or quarterly basis. If the BAS is prepared correctly then it stands to reason that financial statements ie profit & loss and balance sheet would have been prepared in order for the BAS to be produced.

Previous to GST, some dealers were in a position where they could monitor their own financial performance on a regular basis whilst others preferred to do it on a less regular basis.

Now there is no excuse for small business operators not to receive up to date financial information on their business. And this should not just be used to comply with GST legislation to get your BAS in on time.

Utilising information
Here are some pointers to help you utilise this information in running your business.

Look at your trading statement to determine whether your business is achieving the required margins and percentages.

The profit & loss statement should relate how certain expenditure relates to gross profit.

But the P & L and trading statement only tell part of the story. These reports will tell you how much money you have won or lost over the period. But only the balance sheet will tell you how the business looks at any point in time.

For example, you may have made money but does your monthly profit cover your monthly loan payment?

If it doesn't, what is your current working capital?

Is it positive or negative?

Erosion of working capital
Last month, Con's Convenience Store made a profit of only $500 after paying directors wages and superannuation of $6,000 and interest on loans of $2,500.

Unfortunately, this profit was insufficient to cover the monthly loan repayment of $4,000 on the business loan which currently stands at $200,000.

Looking at this another way the business made $3,000 profit before bank interest with loan repayments of $4,000 giving a reduction in liquidity of $1,000.

The current earnings of the business are no longer sufficient and future repayments will eat into the working capital of the business unless profits are increased or loan payments renegotiated.

The current working capital of the business is such that current assets of $110,000 equal current liabilities of $110,000. This is a ratio of 1.00 to 1.00.

This may seem to be a healthy situation, but it would only take 12 months at the current rate of profit performance before the excess of the loan repayments would eat into the business working capital to such an extent that current assets are eroded away.

The likely situation would see current assets remain at $110,000 and current liabilities increase to $122,000 for a ratio of 0.90 to 1.00.
Once the short-term liabilities exceed short-term assets, more pressure is placed on the business assets to turn over more quickly - in order to meet short term commitments such as trade creditors and to keep the overdraft in line with bank limits.

If other payments were made for taxation liabilities, capital expenditure, personal drawings or dividend payments, then this would see the financial position of the business deteriorate even quicker.
Fully drawn advance

Most businesses start with an overdraft and term loan. Due to poor trading performances, the overdraft can exceed its limit and the bank will pressure the customer to convert that part of the overdraft exceeding the limit onto the fully drawn advance (FDA).

This is because the FDA can be restructured with monthly repayments that reduce the debt, whereas the overdraft has less urgency for reduction and its balance is monitored on a daily basis.

Debt to Equity ratio
Another ratio that is used to analyse the business is the Debt to Equity ratio. This ratio measures the extent to which borrowings are used in the business.

It expresses the relationship between funds contributed by creditors and lending

institutions to the capital contributed by the owners.

A low ratio indicates the business could easily borrow more money. It can also indicate the business is too conservative.

A high ration indicates most of the risk is taken by the creditors and obtaining further funds may be more difficult.

The assets obtained by Con have been funded 64% by creditors and 36% by the proprietors and retained earnings or a ration of 1.77 to 1.00. This information indicates that the creditors are putting up the majority of the risk in the business.

Although the business is not in any immediate financial trouble the balance sheet indicates that depending on security further funds could be difficult to obtain from the bank if needed.

For Con's situation to improve and given the current working capital ratio and level of debt to equity it is most likely that Con would need to introduce his own funds into the business or review the level of salary he is drawing from the business.

It only takes a hiccup in the way of a slow month, lower than expected sales, slow paying debtors, slow moving stock or a large unexpected bill to play havoc with your cash flow.