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Archives for June 2012

Does Factoring Receivables Give Your Small Business a Bad Image?

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By Adam Hoeksema

A very common problem for small businesses is managing cash flow when you extend credit to your customers.  Here is a common scenario:

You land a huge job for your architecture firm as a subcontractor.  The general contractor has hired your firm to design a new building.  Unfortunately, you aren’t able to invoice the general contractor until you have completed 50% of the work, but your expenses don’t wait.  While you spend 30 days to complete the first half of the design you have to pay your employees, your rent, utilities, internet and phone bills etc.  Then you bill the contractor, but they won’t pay for an additional 45 days while you continue to pay more expenses.

This is a difficult situation from a cash flow perspective, so a number of subcontractors utilize lines of credit to stabilize the situation.  In the 2008 banking mess, many banks reduced or eliminated lines of credit to small businesses, so many have been forced to factor their receivables.

According to Entrepreneur.com, “A financing method in which a business owner sells accounts receivable at a discount to a third-party funding source to raise capital.”

The problem is that there has been a negative connotation that goes along with factoring receivables.  It may look like you are unstable as a business, and it may scare away your customer.  Worse yet, the company that purchased your receivables may start calling and nagging your customer to pay up.

So the question is whether or not there is a way to factor receivables without sacrificing your customer relationships.

The answer is… It Depends.

Here are a couple of options that past clients of mine have used:

Interface Financial – This group is established and trusted, and can cater to smaller businesses more easily; however, they will contact your clients directly which may not work for you.

Receivables Exchange – This is a web based platform that is very powerful, but is currently only available for businesses that have rather large invoices.

Make sure to learn about each option yourself, but either one could solve your financing problems in a relatively efficient and elegant way.

How to Calculate Whether or Not a Loan is Worth It

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By Adam Hoeksema

In order to determine whether or not you should apply for a loan and how much you should ask for, you need to run some numbers.  The best way to test is by creating a cash flow projection.  There are a number of tools and spreadsheet templates you can use to create financial projections including:

  • ProjectionHub – Web based tool that helps you create financial projections
  • LivePlan – Business plan software that includes financial projections tool
  • EZnumbers – Extensive spreadsheet tool to create financial projections

Once you have a baseline set of cash flow projections you can start playing with some what-if scenarios.

So let’s look at 2 scenarios to determine whether a loan is worth it:

1.  Buy Larger Quantities of Inventory – This is a fairly straightforward calculation.  Let’s say that right now you are buying inventory in shipments of $1,000 at a time.  Each time you have to pay $100 for shipping.

If you were to secure a $25,000 loan to purchase inventory maybe you would purchase one large $25K order.  You might get a quantity discount from your supplier of 10%, so you immediately save $2,500.  You might also only pay $500 to ship the entire order together which is another $2,000 savings.  You are saving $4,500 by ordering in larger quantities, but you will have to pay interest on the loan.  Let’s say the loan is at 10% interest for a 12 month term because your small business is relatively risky.  For the life of the loan you would pay $2,500 in interest, but the cost savings makes this a no brainer.  Ultimately, you end up saving $2,000 which makes this loan worth it!

2.  Advertising for the First Time – Now let’s say you want to take out a 12 month $25,000 loan at 10% in order to advertise your product through Google Adwords.  This is the first time you have ever used Google Adwords to advertise your product which makes this situation very risky.  Let’s assume you make $50 of gross profit on each item sold.  Since this is your first time advertising you can’t know the average cost of customer acquisition.  Let’s say Google charges you $1 a click and you only convert 3% of visitors into customers.

So for $25,000 you would get 25,000 website clicks and you would convert 750 into customers.  You would make $37,500 in profit ( $50 x 750 ).  But you paid $25,000 + $2,500 in interest for the life of the loan.  Again, in this situation it would be worth it to take out a loan, but if your conversion rate went down to 1.5%, you would only make $18,750 which would make advertising a terrible use for the loan funds.

When you are looking to secure a loan for your small business, make sure to run through various scenarios.  If you aren’t sure whether you will be able to make a profit from the loan, then you should do more testing and analysis until you are certain the loan is worth the risk.

About the Author:  Adam Hoeksema is the Co-Founder of ProjectionHub.  ProjectionHub is a web application that helps entrepreneurs create financial projections without the need to have a PhD in spreadsheet modeling.

ProjectionHub Announces Free Financial Projection Tool For Student Entrepreneurs

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ProjectionHub, a web application that helps entrepreneurs create realistic financial projections without the need for a PhD in spreadsheet modeling, has announced the availability of the ProjectionHub web application for student entrepreneurs.  Now, any college student with a .edu email address can create a set of financial projections using the ProjectionHub web application at no cost.

Student entrepreneurs can simply answer questions about their business, input sales and expense projection data, and the tool will automatically create a bank or investor ready set of financial projections.  Students can create a 1 to 3 year cash flow or profit and loss projection.  The projections will automatically be delivered to the student via email as an Excel Spreadsheet that can be edited or revised in the future.

24 year old Co-Founder Adam Hoeksema explained, “I wanted to offer ProjectionHub as a free tool for university entrepreneurship programs and student entrepreneurs to utilize as they complete business plan financial projections for class, business plan competitions, and potential investors.  I want ProjectionHub to become the leading educational resource on how to create realistic financial projections for startups and small businesses, and I think this is a great first step.”

ProjectionHub is a web application that helps entrepreneurs create financial projections for their business without the need to have a PhD in spreadsheet modeling.  For more information visit ProjectionHub or email Adam Hoeksema adam@projectionhub.com.

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Why Banks Require Pro Forma Statements | Learn What A Pro Forma Bank Statement Is Why Banks Require Them – ProjectionHub

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What Is A Bank Pro Forma Statement & Why Do Banks Require Them?

What is a pro forma statement and why are pro forma statements required at banks? A pro forma bank statement is a financial statement that serves as a prediction tool used to help companies make future business plans and conduct comparisons between strategies.

When you apply for a small business administration (SBA) loan or other commercial loan you are often required to provide financial projections. In fact, the SBA requires a 1 year pro forma income statement and narrative explanation of how you will reach your projections with an application for the following loans:

  • SBA 7(a) Loans
  • SBA 504 Loans
  • SBA Express Loans

Why do banks require pro forma financial statements? There are two core reasons why banks require pro forma statements in addition to the fact that the SBA requires it.

1. Have A Pro Forma Bank Statement History Based on Cash Flow

The bank does not want you to have to borrow additional funds from another source in order to make your loan payment each month.  Your pro forma bank statement history should demonstrate that you have sufficient cash flow from operations to make your loan payment.  Your pro forma financial projections should also show 2 scenarios.  The first scenario is your business without the loan, while the second scenario shows how your numbers change when you do take out a loan.  The idea is to show positive cash flow and profits due to the use of the loan.

2. Demonstrate Competence In Your Pro Forma Bank Statement Data

Your pro forma bank statement data should demonstrate to the lender that you know what you are talking about.  If your projections are completely unrealistic and out of line with the industry, the bank is going to slap a denial on your application immediately.  Do some research.  If you are opening a coffee shop, and the average coffee shop has profit margins of 3%, then your projected  profit margins shouldn’t be 30%.

Check out ProjectionHub’s services or choose an excel financial projection template to prepare the necessary materials for your pro forma bank statement and get ahead of the game.

3 Ways to Reduce Cost of Goods Sold

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By Adam Hoeksema

Cost of Goods Sold, also known as COGS, is one of the most difficult, yet important elements of your business to understand.  The basic definition of cost of goods sold is as follows:

“The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good.”

Today, I want to focus on 3 simple ways you can reduce your COGS which will translate directly to your bottom line.

1.  Buy in Larger Quantities – When you buy in larger quantities you will often be able to take advantage of quantity discounts.  You may also benefit from shipping discounts.  It is much, much cheaper per unit to ship a truckload full of product than it is to ship a pallet full of product.  This is a no brainer, but some entrepreneurs never even ask their supplier what sort of discounts they could benefit from if they were to purchase in larger quantities.

2.  Automate – In a world where we need jobs, this might not be a popular answer with the governments of the world, but for each job you can replace with a machine, your cost of goods sold will decrease drastically.  Machines don’t form unions, they don’t go on strike, they don’t need health insurance, and they get to work on time.  If you don’t automate in the areas that you can, your competitors will, and you will ultimately go out of business because you simply won’t be able to compete with their prices.

3.  Lock in Long Term Pricing for Raw Materials – This is a bit of a risk, but for some companies this strategy really pays off.  For example, Southwest Airlines locked in pricing for jet fuel in a long term contract right before fuel prices spiked exponentially.  This gave Southwest a huge advantage over their competitors.  On the other hand, what if Southwest locked in the prices right before the price of fuel crashed?  Their COGS would have been awful compared to the industry.  If you think the price of a raw material that is core to your business is poised to increase, you may consider entering into a long term agreement with a supplier.

If you would like to play around with some numbers and project how your cost of goods sold would be impacted by various scenarios, then create a quick set of financial projections with ProjectionHub and we will walk you through the process of projecting cost of goods sold.  Good luck!

Year 2020: Small Business Lending Predictions

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Small Business Lending in 2020

By Adam Hoeksema

The financial services industry is ripe for disruption on a number of fronts.  In my opinion, small business lending is one of the most likely sectors to see a complete transformation.  I have listed 5 predictions that I believe will impact small business lending by 2020.

1.  Personal Credit Scores Will Have LITTLE to do With Small Business Loan Approval – Currently, lenders look at the personal credit score of the business owner as a major factor in the creditworthiness of the business.  Clearly, the personal credit score has no bearing on the quality of your business model, marketing plan, or profit margins.  In the past, banks have had no other option because other (more relevant) data was not readily available.

New data is becoming available.  For instance, Intuit can provide data to banks including:

  • Accounting Data through Quickbooks
  • Industry Data through Quickbooks
  • Personal Budget and Financial Data through Mint.com
  • Personal and Business Tax Data through TurboTax

If a bank can access this data for individual borrowers and compare to the aggregate numbers provided by Intuit, the personal credit score starts to become the least relevant piece of data.

2.  Peer to Peer Lending and Crowdfunding will Dominate the Traditional Bank – Major platforms like Prosper.com, LendingClub.com, and Kickstarter have such an incredible advantage over traditional banks when it comes to small business lending.  A bank may not even be able to make a profit on a loan that is $50,000 or less because of the incredible overhead costs.  Web-based platforms don’t need a physical branch location in every city to get distribution of their loan products.  Without that overhead these online lenders will be able to start lending profitably at a much lower dollar amount.  Right now a borrower might only be able to borrow up to $30,000 on these platforms, but by 2020 I am certain these lenders will find a way to increase their loan capacity in order to eat away market share from the traditional bank.

Online lending is simply more efficient, it is only a matter of time before online lenders will do to the banks what Amazon.com is doing to retailers.

3.  Cash Flow Will Still be King –  On Deck Capital is already proving this to be true.  On Deck looks for businesses with a large number of smaller clients.  For example, a grocery store has a large, diverse customer base that is consistent.  On Deck can look at their credit card deposit data and feel very comfortable lending based on the fact that they are generating cash, and it is protected from a major shortfall because of the diverse customer base.

4.  Factoring Receivables Will Become Incredibly Efficient For the Small Business – New web based technologies and data will make it much easier to factor smaller invoices.  The Receivables Exchange is already proving that it is possible to factor receivables much more efficiently.  In the past a business owner might give up 10% of their sale for cash today instead of waiting 45 days to get paid.  If you annualize this interest rate, you will see that it is a terrible way to finance a business.  The Receivables Exchange is ultimately much cheaper because it diversifies risk for everyone.  I might purchase a small portion of your invoice along with 100 other people.  You end up paying a small percentage of the invoice in exchange for getting your cash up front.

Right now, the invoices must be bundled in $10,000 increments at minimum, but I believe this type of system will ultimately allow you to sell very small invoices which will reduce your need for a line of credit from the bank.

5.  Two Years in Business Won’t Matter Anymore – Business moves fast these days, and it is only going to accelerate.  In 2 years Groupon went from nothing to hundreds of millions in sales.  In less than 2 years Instagram was launched and purchased for $1 Billion.  Not every business will move that fast in 2020, but I believe that banks will have the data and technology needed to analyze the creditworthiness of a loan applicant without considering whether or not they have been in business for 2 years.

If the business is growing, and can afford the loan, 2 years of operating history should not be required.

I am sure I am wrong on some of these points, but in my opinion the next 5 to 10 years is going to be a painful one for the traditional small business lender.  Small businesses will find other sources of funding that are becoming available at an accelerating pace.  I think most business owners are incredibly frustrated with their current bank, and would leave them in a minute if there was a better alternative.  Once they leave, it will be nearly impossible to get them back.

I would love to hear your thoughts on the subject.  What predictions do you have?

4 Key Ingredients You Need to Be Approved for a Bank Loan

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Every year small business owners waste months trying to apply for a small business loan when they never had a chance to begin with.  In 2012, it is difficult to satisfy all the requirements a bank is looking for as a small or early stage business.  There are 4 key ingredients that your business should have if you don’t want to run the risk of completely wasting your time and hurting your credit score by applying for a loan that you never had a chance to secure.

1.  Credit Score Above 650 – Each bank will have a different number, threshold or requirement, but if your credit score is above 650 you should be safe.  In this range your credit score probably won’t help you or hurt you.

2.  A Couple Years in Business – Many banks require that you are in business for at least 2 years before they will seriously consider you for a business loan or line of credit.  If you don’t have 2 full years of financial statements and business tax returns, you might run into a dead end at most traditional banks who will tell you to come back in a couple years.

3.  $400,000 in Sales – There are many different key milestones when it comes to sales.  Each lender will have their own policy, but lately it seems that many are willing to start lending once a business reaches $400,000 in annual sales.  If you have not reached $400,000 in sales it is unlikely that your business is producing sufficient cash flow to pay your salary and make the monthly loan payments for your proposed loan.

4.  A Stable Industry – Finally, banks want to lend to businesses in steady, stable industries.  If you are reliant on one big job, a large one-time event, a single customer that accounts for a majority of your sales, or if you require a raw material that is in short supply, a bank is going to be very nervous about approving your loan request.

If you are a small business considering applying for a loan at a traditional bank, but you don’t have these 4 ingredients, then work hard to meet these minimum requirements, and in the meantime you may need to secure financing from investors and friends and family.

How to Get More Out of Your SBA Microloan Pre-Loan TA

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One of the largest challenges for SBA Microlenders is the fact that only 25% of your Technical Assistance Grant funding can be used for pre-loan technical assistance.  As the Director of Microlending at an SBA Microloan Intermediary, I found that I was spending most of my time with clients on the pre-loan TA side, trying to help them create financial projections for their loan application.

Our microloan committee wants to see financial projections as part of the loan application from all of our borrowers, but most of our microloan borrowers do not have an accounting degree, or experience creating realistic, data-driven financial projections.  In the past, I would provide the business owner with an Excel spreadsheet template to fill out that would then automatically generate financial projections, but 9 out of 10 templates came back to me incorrect.

The problem is that the average business owner does not understand concepts like:

  • Cost of Goods Sold
  • Depreciation
  • Loan Amortization, etc

There is no easy way to explain these concepts within the Excel template, so I found myself explaining the same concepts over and over again, which ultimately uses up all of our Pre-loan Technical Assistance hours very quickly.  We figured that there had to be a better way, so we decided to create a web application called ProjectionHub.

ProjectionHub is a web-based application that helps business owners create financial projections without the need to have a PhD in spreadsheet modeling.

We have started to use ProjectionHub for all of our microloan applicants.  The results have been excellent.  The quality of the projections has improved, the amount of time I need to spend counseling each business owner has decreased substantially.

Why does it work?

1.  We try to keep our language simple.  You don’t have to be a CPA to understand what we are asking in each question.

2.  We include instructional videos for the most difficult subjects.  We are constantly adding new instructional videos, but we have already developed videos that explain:

  • How to create sales projections
  • How to calculate cost of goods sold
  • How to determine depreciation

How to Create Financial Projections for an SBA 7(a) Loan Application

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The Small Business Administration works with thousands of local banks around the country to offer loan products to small businesses including:

  • Microloans
  • Express Loans
  • 504 Loans
  • 7(a) Loans

In 2011, the SBA 7(a) loan program provided $19.6 billion in loans to small business through nearly 38,000 loans.  If you are applying for an SBA 7(a) loan you will be required to provide the bank, at least, a 12 month profit and loss financial projection.

There are a number of Excel spreadsheet templates available on the internet that are meant to help you create a 12 month profit and loss projection, but after reviewing dozens of templates, I believe that spreadsheet templates are fundamentally limited, and will never be the best way to create financial projections.  So, my brother and I created ProjectionHub.

If you are small business owner looking to apply for an SBA 7(a) loan, then I encourage you to give our application a try.  You can create your projections and download a completed Excel Spreadsheet file.  Get started today.

3 Ways to Value Your Business

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By Adam Hoeksema

For many entrepreneurs there is a desire to know the true value of their business.  Unfortunately, business valuation for early stage companies is both art and science.  A great example is the recent $1 billion acquisition of Instagram.  This valuation makes any business valuation expert scratch their head.  I think there are essentially 3 techniques that can be used to value a business.

1.   Textbook Business Valuation – If you are an MBA student you will learn a couple different formulas and techniques for valuing a business.  These textbook equations will put a fair value on your business in many cases.  Rather than explain the details of each equation in this blog post I am simply going to point out two valuation options:

These are two of the most common valuation techniques you might learn in business school.

2.  Comparables Valuation – If you ever watch those TV shows where homeowners are trying to place a value on their house in order to sell it, you might hear the realtor talking about the price of comparable homes in the neighborhood.  Similarly you can value your business based on the sales price of a comparable business in your industry.  For example, if you own a McDonalds franchise that generates $2.5 million in annual sales, and a Burger King Franchise store with $2.5 million in sales that is located next door just sold for $6 million, then you should be able to make a strong case that your McDonalds store is worth at least $6 million.

3.  Defensive Valuation – I believe that Instagram was valued defensively.  What do I mean by this?  Some analysts suggest that 1/3 of Facebook page views and potentially 1/3 of Facebook revenues come from photos.  If you haven’t noticed, there are advertisements in the bottom right corner of the picture viewer on Facebook.

So here is my hunch.

Facebook realized that a rapidly increasing number of pictures viewed on Facebook came from Instagram.  If Facebook generated $1 Billion per year from advertisements in the picture viewer, and by the end of 2012 one third of those pictures viewed would come from Instagram, then Instagram would hold immense power.  What if Instagram decided to close off the ability to post photos to Facebook?  Instantly, Facebook would lose over 330 million in annual revenue due to lost ad clicks.  That is a HUGE risk that shareholders would not be willing to live with.  Facebook had to buy Instagram to stay in a position of control.  Even though Instagram had not earned a dime in revenue, it was a threat to Facebook.  They had to pay a premium because Instagram was a threat, and they were growing incredibly fast!

At Instagram’s current growth rate they might be worth $330 million in annual revenue in 2012, but they might double to $660 million in 2013.  Now the acquisition price starts to make sense.  The purchase of Instagram at $1 Billion will essentially breakeven in 2 years if those prior assumptions are correct.  That is the power of a defensive valuation.

Unfortunately, the value of your business is ultimately whatever a buyer is willing to pay.  Good luck as you work to determine the true value of your business!

About the Author:  Adam Hoeksema is the Co-Founder of ProjectionHub.  ProjectionHub helps entrepreneurs create financial projections without the need to have a PhD in spreadsheet modeling.