Burn Rate and Runway: How Long Your Cash Will Last

calculating cash flow burn ratePeaks and valleys are the norm in business. A big part of whether your company has staying power is whether you can survive those tougher times when your cash inflows plateau. Understanding your cash burn rate is an essential piece of making it through.

Once you know your company’s burn rate, you can manage your cash flow more effectively. At PayPie, we’re strong believers that the more you know (cue the shooting star), the better you can position your business for growth and stability.

What’s a business’s burn rate?

Your burn rate is the amount of money you spend to keep your company going during a given period. (Burn rate is almost always measured monthly.) You can also think of it as your monthly net-negative cash flow.

Burn Rate

Burn rate isn’t just a metric for startups

Although you might often hear references to burn rate or cash burn in the context of startups, this metric is just as useful (and important) for businesses that have been around for years.

Startups pay extremely close attention to burn rate because:

  • Many of these businesses take several years to be profitable. That means that they have to be extremely diligent about how quickly they’re burning through the money in the bank because the company’s gross cash burn is the same as its net cash burn. (In other words, there’s no money coming in to offset any gross operating expenses.)
  • Burn rate is a metric that investors care a lot about. They want to know how far their existing funding will go — and how far the money they’re raising will go, too.

But these things are relevant to your mature business, too.

How to Read a Cash Flow Statement 

Why you should care about your burn rate: runway

The above is a really just a fancy way to get at understanding a business’ “runway.” And that’s important for every company. You want to know how long your company can last if you never make a cent again. (Don’t worry, you will! We’re just giving you the facts so you can hedge against worst-case scenarios.)

Runway is how long your business will be able to stay open at that current burn rate. That’s why every small- and medium-sized business needs to care about burn rate and runway.

Runway

Calculating your burn rate and runway

Luckily, this important metric isn’t too hard to figure out. We’ll calculate the monthly burn rate.

  • Step 1: Pick a period on your cash flow statement. Find the starting point of your cash balance, then locate the ending point for the period.
  • Step 2: Subtract the starting point from the endpoint. Then, divide the difference by the number of months in the period you’ve chosen.
  • Step 3: Access your bank balance. Divide your balance by the burn rate. Your product is your minimum runway, based on your cash burn. (Note that this number assumes stable net cash burn, aka you don’t bring in any additional revenue).

Cash Flow 101 — The Basics 

An example of calculating burn rate

Let’s say we’re examining the first quarter of the year. Your cash position at the beginning of January was $100,000 and at the end of March, you finished up at $70,000. Right now, April 1, you have $280,000 in the bank.

Calculating monthly burn rate:

$100,000 (starting balance)- $70,000 (finishing balance) = $30,000

$30,000 / 3 (months) = $10,000

Monthly burn rate = $10,000

Calculating remaining runway:

$280,000 (cash in the bank) / $10,000 (monthly burn rate) = 28

Remaining runway = 28 months

10 Best Businesses for Cash Flow

4 ways to manage your cash burn rate

You might find it a bit scary to see your business’s lifetime reduced down to a number of months. And, hey! With good reason. If you’re operating in the red, running with an end in sight can feel like receiving a terminal diagnosis if you’re running on reserves.

But it’s much better to know what’s wrong so you have the opportunity to fix it before it’s too late.

1. Cut your expenses

As you might expect, the easiest and most straightforward way to bring down your burn rate and add time to your runway is to spend less. Consider auditing your operating costs before anything:

  • Is there anything you can do to bring your monthly fixed costs down since those are the big, recurring expenses that cut into your runway?
  • Are you able to refinance any existing debts?
  • If your operating margins are extremely thin, are you spending on the right things? Did you try to kick into a period of high growth before you were ready?
  • Are you running as lean as possible?
  • Is there a way to get your costs of goods and services (COGS)down? Can you renegotiate contracts with suppliers, or swap out elements of your manufacturing with different, lower-cost materials?

There are a lot of questions you can ask of your business. Now’s the time to ask them.

2. Generate more revenue

If cutting your costs isn’t or won’t be possible, you might want to explore the possibility of earning more money for your business. Note: Opening new revenue streams often requires significant investment.

That said, you might be able to make smaller tweaks to existing systems to either tap into or build upon recurring revenue. Consider some of the following questions:

  • Is your business model a fit for any sort of subscription- or retainer-based services?
  • Can you offer an upgraded tier of service for an increased fee?
  • Do you have any unsold inventory that you can get rid of for cheap? (Cheap is better than unsold, and the cost is already sunk, remember.)

Recurring Revenue: 5 Proven Models

3. Raise funds or apply for financing

You have a couple of options here.

First, if you haven’t taken on investors before, maybe now would be a good time to consider them. Investors aren’t for every small business, but if you want to infuse capital into your business to give yourself more runway, you might look into raising money.

Second, and perhaps more practical for most small businesses, is to look into business funding. You can apply for several different types of financing to buffer your cash reserves, including business line of credit and term loans. Both of these traditional options are a great place to start.

4. Control your cash flow

Above all, controlling your cash flow is the best way to manage your burn rate without dramatically altering anything. There are a few ways you can do this operationally:

  • Can you collect on your outstanding invoices more quickly?
  • Evaluate your current trade credit relationships. Can you incentivize your customers to pay in cash more, and more often?
  • Can you pay your own invoices slower, or negotiate (or renegotiate) your own trade credit terms?
  • Do you need to take advantage of invoice factoring to free up unpaid or not-yet-due invoices?
  • Can you incentivize monthly customers to prepay yearly fees in full?

The second part of managing your burn rate is taking advantage of all of the financial data you have. PayPie’s insights and analysis, which contain a cash flow forecast and business risk score, help you fill in vital pieces of your financial puzzle.

By integrating directly with your accounting software, your insights and analysis from PayPie will automatically reflect the most current data in your system. (Once connected, PayPie checks for updates daily.)

Get started today. Create your account and connect your business.  

PayPie is currently compatible with QuickBooks Online and more integrations are in the works.

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Image via Pexels.

Trade Credit: How It Works for Buyers and Suppliers

trade credit main image

Having the cash on hand at any given time to finance major business operations is tricky. We’re particularly talking about inventory, raw materials, or supplies to drive operations. That’s why trade credit exists: To help you gather the cash needed to pay off those bills over time.

Because, yes, although you’d love to have thousands — or maybe hundreds of thousands — of dollars immediately available to pay your vendors as soon as you purchase goods, it’s unlikely that you do. Or, at least, that you can constantly do it that way. Again, this is why trade credit exists. Here’s how it works and how it affects both buyers and suppliers.

Know how much cash you have on hand.

Trade credit: Defined and explained

If you’ve ever heard someone use the phrase “net terms,” then you’ve heard of trade credit even if you didn’t know it by its other name.  (Luckily, a rose by any other name smells as sweet, right?)

In simplest terms, trade credit is a short-term financing agreement between a buyer and a supplier. The supplier extends credit to the buyer, allowing them a designated period of time after delivery of the product or service to pay the fee. Those “net terms” you’ve heard of are the period during which the vendor has agreed to extend credit. So, net 30 means 30 business days, net 60 means 60 business days, and so on.

Trade credit is also the easiest type of short-term financing to get as it doesn’t involve a formal application process. And, since 25% of small-to-medium business owners (SMEs) are denied financing from lenders due to poor earnings and cash flow, it’s an essential part of the trade ecosystem.

How accounts receivable affects cash flow

What is trade credit used for?

Trade credit is used to facilitate the purchase of large goods and service contracts. (Even smaller purchases, too, depending on the relationships in place with suppliers.) With trade credit, businesses can purchase what they need at once and stagger repayment across vendors.

Also, implemented intelligently on the part of the buyer, trade credit also gives businesses the flexibility to make sure that they will have enough money to cover all of their trade credit bills on time.

What kind of businesses use trade credit?

Lots, actually. Trade credit is a business-to-business (B2B) service. But it’s very well utilized across industries. Restaurant owners buy from their ingredient suppliers on net terms. Lawn care companies bill their homeowners using trade credit. Strategy consultants extend a line of trade credit to their clients.

With that in mind, though, a buyer doesn’t automatically get trade credit just because they want it. You’ll want to think about trade credit as a tool for building relationships between businesses — and, subsequently, building business credit with continued payment on time and in full. A supplier won’t extend a business a trade credit line unless they have solid trust that they’ll be recouping all of their money at the end of the time frame.

Invoice Payment Terms — 7 Key Concepts and Tips 

trade credit secondary image

Advantages of trade credit

For buyers:

  • More time to pay. It’s hard to come up with the money you need to pay for major purchases all at once. Trade credit extends your window of payment from COD (cash or collect on delivery) to the terms you and your supplier agree on.
  • Build business credit. Trade lines of credit help you establish business credit. Some major credit bureaus take trade credit into account when calculating business credit scores.
  • Potential discounts. Many suppliers will offer small discounts to incentivize buyers to pay before their due date. You might be able to save money if you can pay before your bill comes due.

For suppliers:

  • Open up more relationships. The vast majority of buyers rely on trade credit for large purchases. Offering this financing for buyers can open up new relationships and potentially larger purchases with existing ones.
  • Becoming a preferred supplier. Customers may favor you if they’re able to negotiate favorable trade credit terms with you that aren’t available through competitors.

How to make the most of every invoice you send.

Drawbacks of trade credit

For buyers:

  • Potential discount loss. This is more opportunity cost than anything. Still, if you wait to pay your invoice until its due date, you forego any potential discount the supplier might offer if you pay upfront in cash.
  • Relationship risk. If you aren’t able to pay on your bill for services rendered or goods received, you risk putting your relationship with your vendor in jeopardy.

For suppliers:

  • Risk of delinquency. When you extend trade credit, there’s no guarantee that you’ll get your payment on time — or at all. And although you’ll only extend trade credit to the customers you trust, you’re still taking a gamble on their business.
  • Discounting. In order to incentivize your customers to pay before their terms come due, you might have to offer some form of discounting for early payment. This will cut into your margins.
  • Uneven cash flow. The nature of trade credit means you don’t know when your customers will pay. This creates an inherently uneven, unpredictable cash flow. While you want to be flexible, you also want to set terms that favor your business as well.

Establishing trade credit with suppliers

As we mentioned briefly, you can’t just have trade credit simply because you want it. There’s a deep trust involved in establishing payment terms with a vendor. If they extend you financing, they need to feel secure that you’re going to come through with their cash if they front you what you’re buying.

How to establish a trade credit relationship

The good news is, unlike traditional short-term financing, you don’t have to apply for trade credit. The less-good news is that you’ll generally have to begin at square one with a new supplier. That means starting with COD — or even up-front payment, depending on how your vendor works. Then, you might graduate to deposit, installment, or other net terms. But that’ll depend on how quickly and how well you can provide to your supplier that you’re dependable and creditworthy.

Much like a business lender, the business on the other end of the trade credit line wants to mitigate their risk as much as possible. So, although they’re not formally underwriting you, they’ll be judicious about whether or not to extend you advance payment terms.

If a potential partner doesn’t know much about you, they might opt to pay to check your business credit score to see your history with business debt. (This is a service that many of the major credit bureaus provide.) This is just one reason why it’s important to establish trade credit relationships when you can and keep up on top of them once you have them. Proof of past positive relationships can go a long way in building future relationships.

That first one can be tough to get and take time — but it’s crucial to open doors down the line!

The 5 C’s of Business Credit Explained 

What happens if you don’t honor your trade credit agreement

Your suppliers offered you trade credit because they trusted you, right? Don’t lose that trust! But you will if you can’t come through on your payment.

Not only will you very likely lose your opportunity to work on delayed payment terms with your vendors, but some may never choose to work with you again. They also might influence others not to extend you trade financing — especially if you work in a tight-knit industry.

Worst case scenario: It’s possible that if you owe a large payment, your supplier could hire a lawyer and send a collections agent after you.

Remember that even if you plan to pay, albeit late, suppliers are depending on your money. They factor your on-time payment into their cash flow. Coming up short could affect how — and if — another business is able to pay other suppliers, lenders, or finance their own operating costs. That’s a cascading effect! If you have a down month and need more time to pay, let your supplier know as soon as possible.

Offering trade credit to customers

On the other side as a supplier, you’re taking a risk if you decide to offer financing. And it’s important to understand the risk: SMEs spend nearly 15 days a year chasing payment on outstanding invoices.

But, if you size your risk correctly, you could be opening up your customer base.

Understanding accounts receivable turnover.

Determining whether or not to extend trade credit

The first question to ask yourself: Do you have an existing relationship with this customer? Do you have a way to know if they have a good history with payment? If the answer is yes, you might begin by asking for a deposit or a portion of the invoice COD  and extend net terms for the remainder of the invoice. Then, with time and proven responsibility, you can move toward a full trade credit relationship.

If you don’t have any way to gauge a company’s history, you can also either check their business credit score to get of sense of how they’ve handled past debt. Alternately, you can ask for a trade credit reference from other vendors with whom they’ve worked.

Offering an early payment incentive

To incentivize faster and guaranteed payment, many suppliers choose to offer a cash discount. A common discount is 2/10, or 2% off the price of the invoice if paid in 10 days.

Yes, that technically cuts into your margins on your product or service. But having the cash in hand to be able to put back into operating costs or invest, and knowing you won’t be out that money later, is worth it for many businesses.

What to do if your customers don’t honor your trade credit agreement

This is the chance you take, of course. Before anything, you’ll want to send out a late payment reminder. Don’t assume the worst!

In the interim, you might want to look into a solution like invoice factoring. It’s meant for a situation just like this! With invoice factoring, you sell your unpaid invoice to a factor (lender) who’ll pay you a significant portion of the balance. Then, they’ll pursue the outstanding payment from your client, and pay you the remainder, minus their fee, once they collect. This helps a lot with cash flow!

How trade credit affects cash flow

You’ve likely figured out by now that there’s a very direct tie into trade credit and cash flow. That goes regardless of which side of the terms you’re on.

As a customer…

  • You’ll be able to plan your invoice payment based on your cash flow projections.
  • You don’t have to pay COD or pay for everything at once if you don’t have the cash on hand for it.
  • You can stagger payments across multiple trade credit lines based on available cash flow.
  • You can take advantage of discounts if you have the available liquidity and know that paying in full early won’t affect your working capital.

As a supplier…

  • You might introduce an element of unpredictability into your accruals depending on when your customers actually pay.
  • You introduce the possibility of late or non-payment after services are rendered or goods are delivered.
  • You might want to take advantage of invoice factoring to access cash tied up in trade credit. 

With this in mind, the most important thing you can do on both sides of the equation is have the best handle on your cash flow possible. The more you know about the cash you have on hand, the more you’ll understand whether or not you’re able to either extend trade credit or pay off your invoices. That means you need to be able to forecast and project your cash flow accurately — the more data, the better.

PayPie’s cash flow forecasting tool does just that, nearly down to the minute, by integrating with your accounting software to create an interactive and informative dashboard.

main dashboard and ratios

Signing up for PayPie is easy. Just create your free account, connect your business and run your cash flow forecast.

PayPie currently integrates with QuickBooks Online. Additional integrations are coming soon. 

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels. 

Traditional Term Loans: Understanding The Essentials

term loan main image

Whether or not you realize it, there’s a high likelihood that you know what a term loan is. Or at least understand the concept. (We’ve talked about them before here at PayPie.) Term loans are the most traditional type of business financing available, where you work with a lump sum of capital and repay it in fixed installments along the way.

Term loans are great products — but not for every use case or every business owner. There are, however, ways to know if and when you should apply, or if there’s a better alternative available.

How term loans work

With a business term loan, you work with a lender to obtain a lump sum of capital that you borrow for a predetermined amount of time. You work out terms with your lender that are contingent on your creditworthiness, business history, and the amount of capital you ask for. And, once approved, you receive all of the cash at once.

Every lender will want to know what you’re doing with the money before you get the green light. But some term loans have restrictions on what you can and can’t do with the money, while others don’t.

But, essentially, term loans are business loans in the most traditional sense that most are used to when they think of financing. You borrow money, and you repay it through fixed payments, with interest, until your set term is up.

Short- and long-term business loans

Term loans come in a few flavors, so to speak. Short- and long-term business loans differ in — you guessed it — their term (how long you have) to pay back the money.

With short-term loans, you’ll generally have faster access to capital with shorter approval processes and less stringent requirements for qualification. The tradeoff is that the terms are less favorable. That means a higher interest rate and a shorter period by which you’ll need to pay back the cash. A short-term loan is generally a loan that lasts less than a year, though they can sometimes extend to around 18 months. Repayment on short-term loans is also usually daily or weekly.

With medium- or long-term loans, the process slows down. As you’d expect, these have longer repayment periods than those of their shorter counterparts, sometimes by several years. They often lower interest rates, too.

As a result, though, these loans only go out to more qualified borrowers, and the underwriting process takes longer. After all, a bank or alternative lender doesn’t want you to have their money for years if you’re not going to be responsible with it. On these term loans, you’ll generally have monthly repayments.

How Cash Flow Forecasting Maximizes Business Funding 

business term loan secondary image

Term loans vs. other types of business loans

Although the most traditional type of business financing, term loans aren’t the only kind, of course. These are a few common alternatives and their most relevant uses:

  • Business line of credit: Instead of a lump sum deposited into your bank account, a business line of credit works as a sort of hybrid between a credit card cash advance and a term loan. You’ll work with a lender to get approved for a sum, but you only use what you need — and only pay interest on what you draw. It’s a great solution for many business owners who want access to fast capital, but don’t necessarily want to have a large interest payment looming over their heads.
  • Invoice factoring: An expensive short-term loan isn’t usually the best solution for an entrepreneur with liquidity issues. Invoice factoring lets you sell unpaid invoices to lenders (factors) who’ll pay you a percentage of the invoice, work with the vendor to collect the balance and return the rest to you, minus interest and fees, when the balance is paid. It’s an excellent alternative for capital tied up in trade credit, and generally more cost effective than other types of shorter-term financing.
  • Equipment financing: If you don’t need working capital, and are rather looking to finance a specific purchase of gear for your business, you should consider equipment financing. As what’s called a “self-collateralizing” loan, equipment financing uses the equipment funded with the money you borrow to secure the loan. For that reason, some borrowers with less-than-perfect credit can obtain this type of business financing.

The 5 C’s of Business Credit Explained 

The best uses for a term loan

You can seek a term loan to finance a lot of different scenarios over the life of your business.

For one, a term loan is a good source of working capital. In other words, you’d borrow from a lender in order to have a source of money to spend freely on general day-to-day operating costs (as opposed to directly investing into an asset). If business owners are in a cash pinch, it’s fairly common to seek out short-term financing in order to supplement their cash flow.

Times when short-term loans make sense include:

  • Making payroll or paying taxes.
  • Funding a marketing campaign.
  • Opening up a new location or expanding into a new market.
  • Financing the creation of a new product or service.
  • Covering a one-time expense, like an emergency repair.

Longer-term loans are also good for specific investments or asset purchases. You can also use a term loan to refinance existing debt — meaning if you have an existing loan and you’re in a better financial position with better credit history, you can work with a lender to refinance into a less expensive product with more favorable terms.

6 Ways Business Funding is Used by SMEs

And when you wouldn’t want to apply for a term loan

Taking on debt is never preferable, of course. But if you’re going to apply for business financing, the benefit of a term loan is its predictability. You apply for a fixed amount of money. And, when you work with a lender, you’ll know up front how much you’ll owe each month, plus how much the loan will cost you by the end in terms of its interest plus principal.

If you’re not entirely certain that your investment will yield results, or you’re in a somewhat precarious financial position, taking on a term loan might not be advantageous. There are other financing instruments, like those we mentioned above, that could be a better fit for you.

Additionally, term loans almost always require collateral. You want to make certain that you don’t put your business in a situation in which you’re taking on debt that you aren’t sure you can afford. That puts your collateralized assets at high risk — and could ultimately jeopardize your entire company, especially if your lender requires a blanket lien on your tangible assets.

How to apply for a business term loan

If a term loan is a fit for your business’s needs, you’ll need to work with a business lender to obtain financing. You have a few options: You can go directly to a bank or credit union, or work with an online lender (alternative lender).

A bit of context is helpful before we go further, though. Small business lending took a big hit during the 2008 financial crisis. And although Main Street lending rehabilitation was meant to be a  mandatory provision within the government’s Troubled Asset Relief Program (TARP) bailout, rehab help never quite made it into practice. Ten years later, the vast majority of American small business owners still find it very difficult to get loans from institutional lenders like banks. They can be picky with their candidates — and they are.

While that little recap covered the United States, SMEs around the world face similar challenges accessing funds through institutional lenders. Worldwide, there’s an unmet funding need of $2.1 – 2.5 trillion.

See our comprehensive list of cash flow statistics.

Where to look for a term loan

Let’s start with those bank loans. If you have several years in business, strong and consistent revenues with a consistent track record, and excellent credit, you could be a good candidate for a bank loan. As a new business, you’ll definitely need to look elsewhere. Because banks don’t lend out much money to small business owners, they can be choosy — and they’ll choose the least risky candidates. To them, that means ones with proven dependability with debt. An existing relationship with a bank is often helpful, too.

Alternatively, online lending has emerged in recent years as a response to the lack of available capital for small business owners. Qualifications won’t be as stringent with most online lenders, but their terms will be slightly less favorable as a result. You can apply for term loans directly at lenders’ websites, or through online loan marketplaces, who can submit your information to multiple lenders at once.

Recurring Revenue — 5 Proven Models

What lenders look for in a qualified term loan applicant

The most important thing to remember when trying to understand business loan application requirements is the lender’s job. It’s all about mitigating their risk.

There’s no way to conjure the future in a crystal ball to know whether or not they’re going to get back their money — that’s impossible. So, when evaluating your application, they have to make the decision based on your odds of paying them back. That’s all derived from your track record. And, since they haven’t known you for years and can’t sample just how good your product is or meet you to understand just how trustworthy you are, all they can judge are things including:

  • Financial statements, including your cash flow statement, balance sheet, and income statement.
  • Recent business bank account statements.
  • Credit rating — both personal and business.
  • Tax returns — both personal and business.

As with all business loans, requirements for term loans will vary from lender to lender.

As we mentioned before, banks and credit unions will require very strong financials. You’ll nee high credit scores (generally very good to excellent) as well as more than a couple of years in business under your belt with good earnings so they’ll have financials to analyze. Online lenders might require slightly less solid credit or revenue numbers and a little less time in business.

That said, term loans aren’t the best options around for new businesses. Most lenders require some established financial track record for your business to qualify. Startups simply don’t have that.

5 Stories Your Financial Statements Tell 

The relationship between term loans and cash flow

There’s a deep connection between term loans and your cash flow. It starts before you even apply for one of these financing instruments, and continues after you’re approved.

Why lenders care about cash flow

Cash flow is an extremely important metric for small business lenders and loan underwriters. It’s a make-or-break factor that’ll determine whether or not you get approved for your loan.

And if you think about it, that makes sense — your cash flow reflects the money you have available to cover your loan payments. Lenders will evaluate your cash flow statement to make sure you consistently have enough cash on hand to cover both your operating expenses and your debt.

Before you apply for a small business loan, you’ll want to have been keeping a detailed cash flow forecast. It’s one of the only dependable ways to know if you’re in a position to take on the financing you think you are. In other words, see what lenders see — don’t be surprised!

Reporting, cash flow and business financial health

Where you’ll see your loan payments reflected

Got approved for a term loan? Great! Make sure you know where it’s showing up so you make sure you do make those loan payments and don’t fall behind. And, as we’re sure you’re unsurprised, your financing will appear on your cash flow statement, too.

What’s called your cash flow from financing activities (CFF) encompasses these outflows. At PayPie, we recommend running a cash flow forecast (like the one below) every month so you can see how your business’s CFF is affecting you.

main dashboard and ratios

How to improve your cash flow position

No matter where you are in the term loan process, make sure you have your cash flow processes zipped up tight. An in-depth cash flow forecasting tool will help you on either end.

  • If you haven’t yet applied for a term loan — understanding the trends in your business and creating a forecast will allow you to get your finances in the best possible position for approval. And to get better terms for a less expensive loan.
  • If you’re ready to apply — have as many insights into your cash flow as possible so you never miss a payment — and you know as fast as possible if you’re going to come upon a cash flow gap.

Spot risk now, thank yourself later. PayPie’s insights and analysis also provide you with a risk score, based on numerous data points, that shows you how creditworthy potential lenders and business partners see you.

Signing up for PayPie is easy. Just create your free account, connect your business and run your forecast.

PayPie is currently compatible with QuickBooks online, and more integrations are in the works.

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels.

Free Cash Flow: A Deeper Look

Free cash flow change jar

At PayPie, we often talk about how cash flow is the best indicator of your business’s financial health. (And we truly mean often.) But there’s a metric within the bigger umbrella of cash flow that drills down on your survival odds as a company: Free cash flow.

Free cash flow lets your business really see what kind of cash your company has available to work with after it pays for operations and capital expenditures. It’s a bit less straightforward number than just looking at an income statement. But, if you do the legwork, like running regular cash flow forecasts using our insights and analysis, you’ll have an invaluable perspective on whether your business has the runway to invest — and the potential to grow.

Free cash flow defined

Most simply, free cash flow is the remaining portion of your business’s cash flow that you can safely access after the necessary expenses are paid for. Most often, it’s mentioned into context what you can “distribute.” But as a small business owner, you don’t need shareholders for that to be relevant.

Distributions include payouts to equity holders (including yourself as the proprietor of a business), but also those who hold debt (like any business lenders or other debtors), and any investors if that’s relevant for you, too.

Importantly, free cash flow is a short-term metric.

How to calculate free cash flow

Grab your most recent cash flow statement. There are a few different ways to calculate free cash flow, but the most straightforward among them is: 

Net Operating Cash Flow – Capital Expenditure = Free Cash Flow

Wherein operating cash flow (OCF) means:

  • Cash you make from business as usual, minus your long-term investments and taxes.
  • OCF takes into account depreciation expense by adding it back in.
  • You can find your OCF number on your cash flow statement.

Wherein capital expenditures (Capex) means:

  • Cash you’ve spent on capitalized fixed assets, including expanding, upgrading, or maintaining your systems, equipment, space, etc. for business
  • Capex takes into account depreciation expense by adding it back in
  • You can find your Capex number on your cash flow statement in the “investing activities” line

Read More: An Overview of Cash Flow Basics 

analyzing cash flow and free cash flow

How free cash flow differs from net income

If this sounds a bit like your net income, you’re not off base — but free cash flow has an important difference. Your net income takes into account depreciation. (The free cash flow formula adds depreciation back in, as you can see reflected above.)

For instance, say you make a big purchase on a commercial oven for your organic granola company. But you have to pay for it all up front. Although your net income, which you pull from your income statement, will give you one number that factors in depreciation, your free cash flow will indicate a different total. Since your free cash flow gives you a snapshot of the short term, you’ll see a more constrained cash flow number because you paid in a lump sum.

Depreciation is set up within the mechanisms of accounting by design to lessen the blow of a big asset purchase. (The IRS’s term for this deduction is “cost recovery.”) On the other hand, free cash flow’s this-very-second approach to your spending makes sure your costs are recorded as they happen — that’s why depreciation is handled differently. In short, with cash flow, you want to see how that big expenditure affects your bottom line ASAP.

More Tips: The Difference Between Cash Flow and Profit 

What your company’s free cash flow can tell you

Free cash flow is meant to be a short-term metric — and it is. You can learn a lot about your financial solvency as a company, both the now and future, if you contextualize your numbers correctly.

Free cash flow in the short term

Calculated once, your free cash flow gives you a pretty solid sense of your business’s true liquidity or ability to meet its current and near-term financial obligations. And that’s important. If you’re planning to distribute earnings or wages (including to yourself — an entrepreneur can only eat so much ramen). You also need to be able to do so knowing that it won’t happen at the cost of keeping the lights on.

Plus, if you have outstanding business loans — or even business credit card bills — understanding what you’re able to siphon off your cash reserves is essential. Especially if you have something like a business line of credit, wherein you have, say, a six-month window to pay back what you borrowed. Knowing you have the cash to pay back your lender now means you don’t have to worry about extra fees, penalties, or interest.

Free cash flow in the long term

As with most financial metrics — and data in general — the more free cash flow calculations you have, the better. If you see an upward trend in your company’s free cash flow, it’s a strong hint toward growth. It also gives you the opportunity to invest and reinvest in your company.

Since no one number tells a complete story, you’d have to dig into P&Ls and balance sheets to figure out what’s going right. Maybe you’re doing a good job at keeping your costs low as you’re able to increase your prices relative to market competitors. Maybe you’re expanding your customer base and lowering your customer acquisition cost (CAC) in the process. Whatever you’re doing, consistently increasing free cash flow generally indicates positive financial health.

On the other hand, a downward trend in free cash flow over a longer period of time will be able to raise your red flag. Why are you experiencing an earnings decline? Are you managing your assets efficiently and investing the right way? (And do you need help turning things around?)

Read More: The Stories Your Financial Statements Tell 

Why free cash flow matters

If we asked you, How’s your business doing? You’d have one answer to the question. If we asked an outside evaluator to come in, thumb through your exact same financial statements, and respond to the prompt, they’d very likely have something different to say. It has nothing to do with you. Rather, there are lots of ways you can read and interpret the stories your financial statements tell.

Cash flow is already among the least gray financial metrics to interpret. Your cash position paints a straightforward picture — either you’re cash flow positive or cash flow negative. (And the more work you do creating cash flow forecasts with insights from PayPie, the quicker you can make adjustments so the latter never happens.)

But even within cash flow, there’s something called a cash “smoothing” effect which can change the accuracy of your cash reporting. Some businesses use accrual basis accounting (versus cash basis), which reports and records both revenues and expenses as they happen, not when they’re received or incurred. That can sometimes cause a less accurate representation of their short-term cash. This is that smoothing, which essentially spreads (aka smooths) this cash data out over a longer period of time.

The numbers your accounting data provides is still entirely accurate in terms of net income — don’t worry. But free cash flow takes into account that smoothing and attempts to mitigate it. As a result, it’s harder to manipulate.

Hence, free cash flow is an even more precise way to get a sense of a business’s available cash. (It’s even a favorite metric for investors evaluating Wall Street securities, so you’ll be in good company using it.)

Gathering as much cash flow data as possible

If you research more about free cash flow, you’ll find there are quite a few more ways to calculate it and apply it to corporate finance. We’ll advise you not to worry about the others as a small business owner. (They’re a bit more in the weeds, geared toward huge public companies with lots of shareholders.) Just the general overview of free cash flow will be enough for you to understand more about your business’s assets at a deeper level.

That said, we did say more data is better, right? And we stand by it. Because there are many cash flow insights that are immensely helpful for you to make better data-based decisions every day as a business owner.

PayPie’s cash flow forecasting tools provide the deep, nearly up-to-the-minute numbers to help you make the best calls for your company by pulling your latest financial information directly from your accounting software.

main dashboard and ratios

Signing up is easy, and QuickBooks Online users can connect easily connect their businesses. (Not a QBO user? More integrations are on the way, too.)

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels. 

Cash Flow Budget: Why it Matters for Good Business

Cash Flow Budget Main Image

In the words of Ralph Waldo Emerson, “Money often costs too much.” At PayPie, we heartily agree: Cash flow is the best indicator of your business’s financial health and if you don’t watch it carefully, the price can be steep.

Having as many insights as possible about how cash is going into and out of your business is crucial to understanding both the short- and long-term odds of survival. Putting together a cash flow budget it part of that.

A cash flow budget — or cash budget, for short — is different than a cash flow statement. It’s luckily simpler to put together, but just as necessary to understand your runway.

A cash flow budget explained

At its simplest, a cash budget lets a business understand whether or not it has enough net working capital to operate during a fixed window of time. Because you’re assessing liquidity for operational solvency, businesses generally perform cash flow budgeting every month. (Quarterly can work, too, though PayPie recommends sticking with monthly assessments to get the best data you can.)

To calculate your cash flow budget, you’ll look at your estimated cash inflows and outflows over the period of your choosing. That’ll include what you forecast you’ll spend on products or services and operating expenses, plus what you expect to make (and actually get paid out).

If your sources of cash exceed your uses, you’ll have a positive cash position. Vice versa, you’ll be in a negative cash position. You’ll also be able to see your estimated cash position at the beginning of your next cash flow budget period (depending on how often you keep them).

cash flow budget piggy bank

Cash flow budget ≠ cash flow statement

A cash flow budget might sound similar to a cash flow statement, but it’s definitely not. That’s an entirely separate document.

Your cash flow statement is an essential accounting document that you’ll need to keep alongside your cash budget. Part of the trifecta of most important financial statements, your cash flow statement — or statement of cash flows — is a more complex, formal document. It also pulls from your other financial statements, so if there’s a substantial change to your income statement, it’ll affect your cash flow statement as well.

As cash flow is the lifeblood of your business, you need to keep your cash flow statement as current as possible. A best practice is to update it each month before running your cash flow forecast. This way you can ensure that the data in your forecast is up to date.

More Tips: How to Read a Cash Flow Statement

Where your cash flow budget fits into the big picture

Your cash budget gives you a sense of your short-term operations. Your cash flow statement, on the other hand, is taking a look at your cash solvency over a longer duration. You can think of your cash budget as a management tool where you’re watching your costs, supplementing the overarching formal statement of cash flows.

Only together will your company have the insights it needs to make the right decisions about your cash flow and the future of your business.

Read More: A Real-World Cash Flow Story 

Do you need to make adjustments to your overall budgets?

That’s what cash flow budgeting can tell you when used in tandem with your cash flow statement. (Plus, adding cash flow forecasting to the mix gives you just one more piece of the picture, helping you track patterns in your data, like whether your accounts receivable is out of sync with your accounts payable, for instance.)

Practical ways to use a cash flow budget

Let’s say you run a company that manufactures and sells contemporary rugs. You’d use your cash flow documents — statement, budget, and forecast — to keep track of your operations.

  • You cash flow statement will serve as your foundation to show how many synthetic rugs you’ve sold, how much it cost you to make them, and during which period of time this cash came in or went out.
  • Your cash flow forecast will be your resource to evaluate and determine your cash trends, like when your margins are synthetic rugs are highest.
  • Your cash flow budget will help you manage short-term costs, especially within operations.

These documents will all inform each other. For instance, if you understand your margins from your cash flow forecast, you’ll get insight into the things that affect your cost of goods within your cash budget. Using them together, you’ll be able to optimize your cash flow.

How to create a cash budget

In order to put together a thorough cash flow budget, you’ll need to gather information on your projected inflows and outflows. Most simply, you’ll need a topline on your receivables and expenditures to calculate your net cash flow.

Here’s a basic cash flow budget template to get you started:

Part I: Cash outflows

  • Operational
    • Supplies
    • Marketing and sales
    • Taxes
    • Payroll
    • Rent or property payments
    • Misc fixed expenses
    • Accounts payable
  • Investment
    • Asset purchases
  • Financing
    • Loan payments
    • Other short-term or installment payments
  • Misc expenditures

Part II: Cash Inflows

  • Beginning cash balance
    • Accounts receivable
  • Business revenues 
    • Asset sales
  • Misc income
    • Claims
    • Rebates
    • Shareholder equity (FYI: this only applies if you’re incorporated with shareholders)

Part I —Part II = Net Cash Flow

Note that this is only an example. Due to the nature of your business, you might be adding many more — or fewer — line items. But the point here is to show the kind of elements that comprise your cash inflows and outflows. This number will also give you a starting point for your next month.

What’s also important to note is how net terms (also known as trade credit) can have a significant impact on your cash flow budgeting. Since your cash budget is measuring the short-term, and you might be either extending or paying on net terms of 30, 60, 90, or even 120 days, your cash flow can be significantly affected when these invoices are either paid or due, respectively. Especially if they’re broken up into deposits and collection on delivery (COD).

That’s one of the reasons keeping a monthly cash flow forecast, along with a longer-view cash flow statement, is necessary.

More Tips: Common Invoice Payment Terms 

How your business can use a cash flow budget

A cash flow budget is yet another financial document. So, if you have your stuff together, you don’t need to do it, right? Well, if you 100% want to stay in business, we’d really, really strongly advise that you do.

More seriously, though, without detailed insights about your cash flow management, you won’t be able to know what changes to make to your cost centers in order to keep the doors open. The more data you have about your financial position, the better. And that’s what a cash flow budget provides you.

Make the right adjustments

For instance, say you go along with PayPie’s advice to do your cash flow forecasting for the month. (Good idea.)

Perhaps, after running the numbers, you end up with a projecting a negative cash position. That’s not great news, no. But it does empower you to do what you need to do to obtain the capital you need. Maybe that’s free up capital tied up in trade credit with invoice factoring or apply for a business line of credit.

Short-term cash flow budgeting also allows you to understand your cost centers more intimately. As a business owners working to better manage your net cash flow, you’ll be able to focus in on where you’re spending monthly and why. Is your cost of goods sold (COGS) rising faster than expected because of market conditions, or something else? Do you maybe have a larger buffer than your expected to be able to bring on extra help?

Read More: How Cash Flow Consulting Helps Businesses 

Short-term cash projections help with a long-term strategy

Smart entrepreneurs will also create cash flow budgets for several months in advance using projections for future cash flow. This’ll let you be prepared for any future issues — and spot cash flow gaps. The sooner you can see where your business might come up short, the faster you can act to mitigate issues so they never arise.

In order to have the most detailed data you can to create highly detailed cash budgets, you’ll need cash flow forecasting tools available. PayPie provides the insights entrepreneurs need to prepare themselves for every cash flow scenario, and take out the guesswork involved in making ends meet.

main dashboard and ratios

Signing up for PayPie is easy. Just create your free account, connect your business and run your forecast. 

Paypie is currently compatible with QuickBooks online, and more integrations are in the works. 

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels. 

Recurring Revenue: 5 Proven Models

Recurring Revenue

Business is inherently unpredictable. You’ll never be able to control whether the market will continue to desire your product or service. But, you can hedge against a few things, like a less lumpy cash flow. As long as you are making money, you can set up recurring revenue models to continue doing so.

Recurring revenue provides stability through dependable income that flows into a business on a consistent basis. Along with regular cash flow forecasting, like the kind offered by PayPie, recurring revenue helps you build long-term financial health and lay the groundwork for future growth.

What is recurring revenue?

Recurring revenue is very much what it sounds like — earned money that flows into your company at predictable intervals. Most businesses are set up to be one-off transactions — purchase the item you need, then go on your merry way.

But, one-off transactions aren’t enough to sustain most businesses, especially when cash flow issues are the number one reason small businesses fail. You can forecast your cash flow to predict inflows — but if that money doesn’t come in, you could experience a cash flow crisis. Recurring revenue streams help prevent this sort of misfortune.

More Tips: How to Read a Cash Flow Statement

Why recurring revenue is important

You’ll always be able to pull the strings on your company’s variable costs, but the same is not always true with your fixed expenses. At the end of the day, as much as you pare back your operating costs, running a business still takes money. Which means you have to make money to stay in business.

A recurring revenue stream lets you better estimate your cash flow on a regular basis. Will you be able to cover those minimum fixed costs? While there’s always the chance the unexpected can happen, the expected, via recurring revenue, is much better. 

Other benefits of establishing and measuring recurring revenue:

Predictable income is perhaps the most obvious benefit to building recurring revenue. But, in generating and monitoring recurring revenue, there are other insights you can build upon including:

  • Average revenue per customer (ARPU): By having a strong sense of what your customers will cost you each month, you’ll find intuitive ways to increase your profit margins. For instance, you may be able to produce consumer goods at a larger scale or lower your cost of goods (COGS). Or, offer upgrades, add-ons, and other modulations to earn more ARPU.
  • Customer knowledge: You learn a lot about your customers’ likes and dislikes from your customer retention rate. The more you know about your customers, the stronger both your brand and business model become.
  • Retention vs. acquisition: Customer acquisition cost (CAC) is a challenge for many businesses. You’ll still have to contend with getting your CAC as low as possible, but when consumers opt into a subscription, you won’t have to worry about getting them back for another purchase. Instead, you’ll focus on retention, which is inherently easier since they’ve already expressed a desire for what you offer.

Read More: 7 Ways to Boost Cash Flow

Every penny counts

5  types of recurring revenue business models 

Different types of businesses require different types of business models. Luckily, no matter whether you’re a manufacturer or retailer, you should be able to find some way to establish recurring revenue streams. Diversifying to bring in a little extra money on a regular basis? Well, that’s just good business. Here are five ways to do just that:

1. Subscriptions or memberships

Subscriptions and membership-based programs, like the ones below, work well to create dependable recurring revenue. Businesses that use subscriptions and memberships rely on income from these fees as recurring revenue. There’s also a good likelihood that you participate in one yourself.

  • Software as a Service (Saas): Companies including Atlassian (Trello, Confluence, JIRA, BitBucket, and more), Slack, ZenDesk, Shopify, DocuSign, and Gusto bill teams monthly.
  • Subscription boxes: Subscription boxes are popular for consumer goods, including Rockets of Awesome for kids’ clothing, BullyMake for dog toys, BirchBox for beauty products, Sun Basket for healthy meal kits, and Dirty Lemon for detox drinks.
  • Content as a Service (CaaS): Many B2C services you’re used to using in your everyday life employ a variant of the SaaS model, including Netflix, Hulu, and ESPN+. This also goes for apps, like Drops for learning language, ClassPass for fitness, or Spotify for music.

Subscription-based businesses are a high-potential area of recurring revenue. Over the last five years, the subscription-based e-commerce businesses have grown more than 100%. And, since 15% of online shoppers have signed up for some kind of recurring revenue-based product — with subscription boxes as the largest category — there’s lots of growth to come.

2. Auto-ship

As a slight variant on subscription services, some e-commerce businesses choose to encourage customers to set up a recurring shipment at checkout. Many even incentivize longer-term purchases with a discount.

The most common auto-ship setup you might be familiar with — and may even use — is Amazon’s “Subscribe and Save” feature. With this feature, Amazon offers a fixed percentage, generally between a 5 to 20% discount, off certain products for setting up auto-ship. It’s a two-way win, both lauded as a consumer hack to save money, and a smart way to generate recurring revenue.

But you don’t have to be as big as Amazon to afford and implement auto-ship.

  • Pet e-tailer Chewy lets its customers set up a custom Autoship package with 5% flat discounted essentials. They also let customers choose their shipping windows or ship on demand if they need the package sooner.
  • Custom hair care company Function of Beauty offers customers the option to subscribe to their formula. It automatically ships every one, two, or three months as desired.

3. Consumable

The famous example for this kind of recurring revenue stream is Gillette razors. (You might know it as razor-and-blade.) The premise is so simple but so effective.

A company sells a core, durable good once, then creates a recurring revenue stream with proprietary consumables that must be continually purchased to use them. The economics here are favorable for businesses, because the “blade,” so to speak, is often sold at a much higher margin.

In fact, many companies often sell away the “razor” at little-to-no markup. Many major companies — Procter & Gamble, owner of Gillette, included — often give “the razor” away to bring customers into the recurring revenue ecosystem immediately.

There are several other upsides to this model:

  • Keurig Green Mountain, which makes the Keurig coffee brewers, earns the majority of their revenue on the recurring purchases of its single-serve K-Cups. Its market share has exploded: 29% as of January 2017. Such dominance has allowed the company to create an additional revenue stream. Keurig licenses its proprietary technology so other consumer packaged goods (CPG) companies can sell their beverages in K-Cups, too. (If only they’d offer their “razor” for free.)
  • Startup toothbrush company Goby combines the consumable and auto-ship models. Goby sells an electric toothbrush kit once, then makes its recurring revenue on its brush heads — the only other product it sells. Customers receive $15 off the product itself when they opt into an auto-ship option at checkout. (Hello, hybrid solution.) 

4.   Contracts and retainers

Even if you create an infrastructure for recurring revenue, there’s still a fair bit of crossing your fingers and hoping your customers will continue to spend. Although consumers favor these less, contracts are a way to build in a little peace of mind and a lot of value.

There are many ways to build a contract or retainer into your business model. And many businesses do. They’re used at well-known tech and telecom companies and negotiated privately between restaurants and their suppliers, for instance. Even a rental agreement for a property is a form of contract wherein a landlord receives recurring revenue from a tenant monthly.

Retainer models are another common form for many professional service companies. With retainers, the professional and client agree on a set number of hours and scope of work for a project each week or month. Then, the agency, consultancy, or group of specialists bills a flat-fee. There’s a lot of flexibility in this approach, which can be tailored to work for something as creative as a copywriting agency or as traditional as a law office.

You can choose to structure a contract or retainer with a monthly fee, of course. Or, alternately, you might want to consider a yearly bill to create a larger lump sum of recurring revenue. Many subscription-based companies offer an alternative to monthly subscriptions with a small discount if companies pay a year up front. It’s a good deal for everyone, especially if your customer knows they rely on your service; and you, of course, get your cash.

If contracts and retainers sound like viable options for your business, there are benefits from the behavioral economics standpoint, too. Because humans are inherently loss-averse and hate to see our money go away, we experience the “pain of paying.” If you can get your customers to agree to pay you once when it works for them and be done, they’re more likely to view the investment as a good, and painless, one.

5. Loyalty and habit

The most desirable kind of recurring revenue is the one you don’t have to chase down at all. It just happens because your customers are that loyal. As you’d expect, it takes a while to get here — and many businesses never do.

Some of these might sound familiar:

  • There are those who don’t start the day without a light-and-sweet iced coffee from Dunkin’ Donuts.
  • Others who pack their workout clothes to go to SoulCycle, no matter the city.
  • Brand evangelists who religiously buy Apple MacBooks and Apple-branded peripherals.

This phenomenon isn’t just for consumer brands. Think, for instance, of Atlassian, whom we mentioned in the first example. Many companies whose engineering teams loyally use JIRA decide to put the rest of their teams on Trello, since they’re fond of Atlassian’s products (and already in their ecosystem, anyway).

Recurring revenue from habitual behavior is tenuous — your customer could, say, move or encounter a product sample that changes her mind. Regardless, branding and brand loyalty is immensely powerful and could generate consistent returns if executed well.

How recurring revenue affects cash flow

If you’re able to establish a recurring revenue stream for your company, that’s a big win. Recurring income is a huge step in creating stable cash flow.

Because, yes — this all comes back to cash flow.

Use cash flow forecasting to build stronger recurring income

Recurring revenue makes sure your business can keep its lights on. As your customers pay a consistent fee every month (or year, or whatever you’ve established), you introduce a level of predictability into your company financials. You’re able to build out more accurate cash flow forecasts and drill down into whether or not you make certain choices with your business.

For instance, will you have enough money each month to apply for business funding to speed along your growth? Or, at the complete opposite end of the spectrum, are you at risk for still not making ends meet? If the latter is the case, you’ll be able to quickly make changes to your business model, whether that’s bringing down your COGS, or maybe attempting to lower your CAC.

More Tips: The 10 Best Businesses for Cash Flow

4 ways to ensure  your recurring revenue recurs 

As much as a recurring income sets you up for success, you have to nurture it like any other kind of financial variable to keep it sustainable.

1. Keep customer payment information up to date. Credit cards expire or get replaced. PayPal and Venmo accounts get unlinked. In order for you to keep receiving recurring revenue, make sure your customer payments are valid and consistently coming through.

2. Stay in front of renewals. Don’t let subscriptions, auto-renewals, memberships, or contracts lapse. If a customer figures out they can live without your product or service for any amount of time, you’re far more likely to lose a customer. (Remember, the pain of payment is strong!) If your customers aren’t interested in renewing or don’t have the means to, work with them to provide incentives or custom payment packages. A little less revenue is better than none at all.

3. Watch your churn rate. Keep an eye on your subscription attrition, otherwise called your “churn rate.” If it’s high and climbing higher, and you’re not at minimum recouping your CAC, the alarm bells should be ringing. It’s time to change something. (Remember that your best sounding boards are your subscribers, both current and past.)

4. Monitor your cash flow diligently. Your cash flow is a window into the health of your business. Cash flow forecasting helps you monitor your recurring revenue. You’ll be able to predict whether you’re going to need to make changes and how you can improve your margins.

Having the best tools to understand your financials is paramount to getting the best information. Signing up for PayPie is easy. Just create your account then connect it to your QuickBooks Online account. Your near-real-time cash flow forecast will pull from your current financial data.

PayPie currently integrates into QuickBooks Online, more integrations are on the way.

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels

5 Stories Your Financial Statements Tell

The stories your financial statements tell main image

For some entrepreneurs, putting together your financial statements can seem like busywork. You have a business to run, so can’t your accountant just whip up what you need and send it off wherever it needs to go? Theoretically, sure. But the most forward-looking business owners understand that doing the numbers isn’t just perfunctory.

That’s because your financial statements tell very specific stories about your business. What they say could have a big impact have on your company’s cash flow and future. But, it all depends on who’s looking, and, of course, the numbers themselves. (See what kind of stories unfold with PayPie’s cash flow forecasting.)

The first 3 chapters in your financial story

We’re not talking about just any financial information. We’re talking about three business financial statements very specifically — what we at PayPie (and most everyone else) look at as the accounting trifecta. Together, the income statement, balance sheet, and cash flow statement give the full picture of how your company is performing financially.

Income statement

If you’ve never heard the term “income statement” or “statement of income,” then you’ve probably heard “Profit & Loss” (or just “P&L”). Whichever term you know, they all mean the same thing.

Your income statement is the first massively important document in the trifecta. Briefly, it shows you whether or not your business is making a profit. It also reveals where you’re earning and where you’re spending — and, naturally, whether you’re spending more than you’re earning.

That alone can tell a story, but what’s especially notable about your P&L is that it tracks data over a specific period of time. Many business owners do them quarterly, and, at a minimum, yearly. Some even choose to draw up an income statement every month to be able to get a more consistent pulse on trends.

Learn more about income statements.

Balance sheet

Next up is your balance sheet. Like your income statement, this also has another name — the “statement of financial positioning.” It centers on a simple but telling equation to allow you to see your business’s net worth:

Assets = Liabilities + Equity.

In contrast to the P&L, your balance sheet looks at a specific moment in time. This is an important difference when you’re thinking about the stories that your accounting documentation tells, especially because circumstances change so rapidly in business. Due to accounts receivable and payable, among other factors, how your finances look on one given day can — and likely will — be very different compared to another. Even if it’s just a week later.

Learn more about balance sheets.

Cash flow statement

Rounding out the three, your cash flow statement. (And, our personal favorite at PayPie. Because, absolutely, we have a favorite financial statement.) Your cash flow statement — or “statement of cash flows” — shows the movement of cash into and out of your business. That includes your investments, operations, and any financing you have, too.

We mention cash flow last certainly not because it’s least. Far from it — in fact, most small businesses fizzle due to poor cash flow management and the subsequent lack of capital. Rather, it’s important to understand your P&L and balance sheet first because your cash flow statement ties directly into numbers that appear on both. It pulls from amounts on each. It also supplements them with additional insights.

Learn more about cash flow statements.

income statement and balance sheet in a financial report

What your financial statements reveal

Alone, your three financial statements certainly help you get a picture of how your business is doing. But it’s sort of like reading through a book without vowels. You can get through the story, but the words are incomplete. Plus, you won’t understand how the writer intended you to get through the book. You miss the insight into the language that having every last letter provides.

And there are a lot of stories hidden in your accounting documentation! You’ll want to make sure you understand what some of the most important big ones are saying about your company.

1. How well you budget your cash flow

Since cash flow is a big component of all three of your statements, you’d likely expect that you can gather a lot about your business’s cash flow when you look at all of them. What you can especially see? If you’re good with that cash. Which, as we mentioned before, is a major part of your company’s likelihood of survival.

Among the things those evaluating your cash position will be able to see are:

  • If you keep consistent — and right-sized — reserves.
  • If you have a tendency to hedge for emergencies or if you lean on financing often.
  • If you experience — and anticipate seasonal — fluctuation in revenues.
  • If and when you invest your cash, and how it affects your ability to pay your outstanding bills.
  • If you correctly manage your trade credit relationships.

2. How you manage your working capital

You have money to put into your business? That’s great news. Working capital is a huge sticking point for lots of small-to-medium enterprises (SMEs) who need access to more funds to initiate growth phases. Many businesses seek financing specifically for working capital, so it’s important to know if you’re using your own productively.

Your financial statements will reveal a lot, including:

  • If you’re keeping too much working capital on hand instead of investing it.
  • If, on the other hand, you’re investing too much and not keeping enough in reserves.
  • If your investments are incorrectly distributed to accelerate growth.
  • If you’ve put too many resources into one asset class versus another preventing maximum return on investment (ROI).

3. If you’re making the money you could — or should — be

Whether or not your business is maximizing its revenues can end up being a subjective conversation. There are a few things about the conversation, though, that aren’t a matter of opinion. Or, at a minimum, are less debatable than others.

Your statements will shed light on:

  • If your profit margins are too slim, and, relatedly if your cost of goods (COGS) is too high.
  • If your raw materials are increasing faster than you’re raising your prices or getting better terms with suppliers to sustain your margins.
  • If you’ve created a sustainable monthly recurring revenue (MRR) model.
  • If you’re pricing similarly to others in your sector — and making the same margins.
  • If your fixed and variable costs are on target or should be adjusted so you can net more profit.

4. Where you fall relative to industry peers

Benchmarking is an important concept in business. It’s helpful for you to know where you stand relative to others in your sector, and for outsiders evaluating your company to get an objective sense on how you’re doing. It also allows industry experts to be able to map you in your competitive landscape.

Your financial statements will help with benchmarking by:

  • If you’re growing are the same rate as comparable companies.
  • If current economic conditions are impacting you differently than peers.
  • If you’re allocating your capital in substantially different ways, or your operating costs are relatively significantly higher or lower.
  • If you’ll hit profitability before other major competitors.

5. If your capital asks are realistic

There comes a point in the life cycle of many SMEs when you’ll want to borrow money. It’s not a badge of shame — far from it, actually. Many entrepreneurs look for business financing when they want to accelerate their growth or seize an opportunity. And no amount of savvy cash flow management or diligent recordkeeping can see the future.

If you’re asking for a loan or an investment, your statements will be able to expand on:

  • If you have the cash flow to be able to pay back a lender in the case of a loan.
  • If you have consistent revenue history that makes you a good candidate for a term loan.
  • If you’re in a hyper-growth stage, or your business is on the decline.
  • If you already have a lot of outstanding debt.
  • If you don’t have enough equity left to offer.

Who interprets these stories (and why it matters)

You can learn a lot about your business from gigantic stacks of paperwork — but, other than the taxman, who cares? Many people, actually. (FYI, your income statement is of primary concern to the tax folks.) 

Lenders

When the time comes that you do want to borrow money, your financial statements matter. A lot. They’re the bulk of your loan application, and your underwriter will scrutinize them with a fine-toothed comb. (Don’t worry. They’re just doing their very reasonable but equally thorough jobs.)

That’s all to say that if your financial statements give off the wrong impression to a small business lender, you won’t get the money you might very much need. Or, with the terms you desire.

With business lending, your approval and subsequent terms are all about mitigating risk. A lender won’t allow you to borrow money if they don’t think you’ll pay it back. And, if you do get the green light, they still won’t give you favorable terms if your financials tell the story that you’re a high-risk borrower.

As they examine your accounting documents, especially your balance sheet and cash flow documentation, you want to make sure you present a super-responsible business owner. Liquidity is important here: Above all, they want to see they the story that you’re a safe bet to be able to pay back their money on time and in full.

The 5 C’s of Credit Explained 

Investors

The process of due diligence with an investor interested in your company is a short way to say “a deep dive into every financial document you’ve ever touched.” (They’ll talk to your friends and enemies, too.) As well they should! If someone is going to put their own cash into your business without any guaranteed return, you better have something better than solvent.

Of course, the quickest way for them to be able to tell if that’s the case is looking at your accounting trifecta. Investors are going to care quite a bit how you’re spending money, why you’re spending it, and your performance relative to your major competitors. If you have a good history with how your financial management, when you hire, etc, it’s a good chance that you’ll make their money work hard, too.

Investors want to see the story of your growth and your path to profitability. There are a lot of ways to illustrate that with meetings and pitch decks. You’ll have the chance to do that, but make sure you seize the opportunity to do so with your finances, too.

Potential business partners

There are lots of different types of business relationships: You could bring on a partner, acquire another company or sell your own, or simply establish a trade credit agreement with a major new supplier. Whatever you’re pursuing, all of these different arrangements are big deals. Don’t be surprised if the party you’re transacting with asks to open your books.

As good as your word is, it’s only as good as your last paid invoice or your last sale. And as much as you can find out from a business’s credit score — which is public information, by the way! Potential partners can only feel great about a major transaction, or even offering net terms when they feel satisfied that they know the story of your business.

Remember that the decisions you make with your company have implications for your partners. Poor cash flow management leads to a delinquent payment leads to turtles all the way down.

How to understand exactly what your financials say

You never want to be in a position where someone understands something about your business that you don’t. Especially anyone who’s in a position to change the trajectory of your future. So, you have to know all of the storylines that your financials contain — and know them first, and better, than anyone else.

The only way to see the whole picture is to collect all of the puzzle pieces. So, yes, that means all three statements. But it’s even more granular than that — you need all of the data and insights that power the numbers on each of those documents. Like we said before, more information empowers you, not less.

A cash flow forecast from PayPie adds a ton of depth into knowing how your business is doing. You’ll be able to understand the financial statement trifecta and make adjustments to get your company on the path it should be.  Signing up is easy — just connect your free PayPie account to your QuickBooks Online account. Your forecast is also free. Get started today! (If you don’t have QBO, hang tight. We’re working on other integrations as we speak).

main dashboard and ratios

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels and Shutterstock. 

Balance Sheet Basics for Business Owners

Camera representing a balance sheet as a financial snapshot

By definition, your balance sheet measures your business’s net worth by taking into account assets, liabilities, and equity positions. It literally gives you a snapshot of your financial strength 

Your balance sheet is part of a trifecta of accounting statements, which also includes your cash flow statement and income statement (P&L).

You have a business to run — helping empower you to do that is our job at PayPie. Part of managing cash flow with professional acumen is to know what’s going on inside your books. Here’s what you need to know about your basic balance sheet for a small to medium-sized business:

What is a balance sheet?

A balance sheet is an accounting document (financial statement) that lets you get important information about your business’s financial position at any given time. (Usually, businesses produce one quarterly or yearly — but that time period is up to you.) Sometimes also called the statement of financial position, the balance sheet is based on a straightforward equation:

Assets = Liabilities + Equity

On any balance sheet example, you’ll usually see assets on the left with liabilities and equity on the right. Sometimes, in a vertical format, assets will be on the top of the balance sheet, with liabilities and equity on the bottom. Either way, it’s a pretty readable, accessible document.

As you’ve likely come to understand around anything related to accounting, there’s more to your balance sheet than a list of numbers.

More Tips: Income Statement Basics 

Your assets

This is the good stuff. Your assets include your tangible holdings, both liquid and illiquid. For example, think cash and equipment, respectively. Your inventory would be included here, too.

When listed on your balance sheet, you might subdivide these into things like fixed assets (real estate, machinery) and current assets (accounts receivable, petty cash). That’ll help you get a better picture of what you can access and quickly convert to funds should you need to.

You might also be wondering about things like patents, trademarks, or intellectual property (IP). Technically, IP and similar holdings are also considered assets — although these are classified as “intangible” assets, which are different. And, unsurprisingly, much harder to value. (Relatedly, many investors dispute the exact worth of intangible assets — and value them differently on an individual basis.) (Unless you hold the patent for a best-selling soft drink, velcro or breakthrough in quantum computing.) 

Your liabilities

Any debt lives here. If you’ve taken on business financing, for instance, that loan principal and its interest will live within your liabilities column. Business credit card balances, too, as well as outstanding invoices.

This also includes your operating expenses. Your overhead needs to be counted here: Think salaries and benefits, rent, and any taxes you’ll owe, too.

Like your assets, an organized business owner will find it advantageous to organize liabilities by type, too. A good way to consider them is as current (utilities, taxes) or long-term (mortgage, loan interest). This’ll also come in handy when you’re trying to see if your cash flow projections will cover you for both now and down the line. Plus, you’ll be able to figure out if you’ll have the liquidity to reinvest retained earnings (onto that next).

Your equity

Equity (also known as shareholders’ equity) is the last piece. You’ll figure out whether you have any equity in your business when you subtract your liabilities from your assets. You can also think of this as net assets. As such, you’re going in the right direction if the number is positive — that means you have more assets than debts. 

There’s one more step to get the full picture of your retained earnings. In other words, the money that’s actually left to reinvest into your company. If you have investors, you’ll have to distribute any remaining dividends. However, account for shareholder payments before you get your final equity number.

More Insights: How to Read a Cash Flow Statement

income statement and balance sheet in a financial report

What your balance sheet tells you

Your company is like a living, breathing organism. Or, it certainly feels like that because everything is constantly changing. When things are moving so quickly, it sometimes seems impossible to freeze time on any given day and ask, “How are things really going?”

Your balance sheet is the closest tool to being able to do just that. A balance sheet is a financial snapshot of your business at a specific time. It’s like a photograph in the sense that it captures a moment. But, that also means that it’s not like a time-lapse video, which is why you’re not going to want to rely on it for any kind of historical or trend info.

Why you need a balance sheet

First of all, if you’re an S-corp or a C-corp, you need to provide one to the Internal Revenue Service (IRS). That’s just the law. But, think of this less as of why you’d need a balance sheet and more of why you’d be at a disadvantage without one.

  1.  To know how you’re doing relative to industry benchmarks.

How’s your financial position relative to others in your sector? Where’s your money going relative to others? Are you holding onto way more working capital, or do you not have enough cash? The answers to these questions will all be different depending on a company’s needs. But you should know where you fall relative to others. Especially if the info is out there.

  1. If investors come knocking, they want to understand your distributions.

If you’re in the lucky position in which investors want to put money into your company, a balance sheet will be one of the absolute most important documents they’ll evaluate. Foremost, they’ll look where you’re allocating your capital, how much cash you have on hand, and even if you’re holding onto unnecessary working capital or other assets. Equally, they’ll be able to tell how you’ve managed your business based on the liabilities you’ve racked up.

  1. To get the whole sense of your company’s finances.

Remember how we mentioned a balance sheet was like a photo, not a time-lapse? Well, in order to get to that long time-lapse, you need that singular photo.

Read More: Reporting, Cash Flow and Financial Health

Balance Sheet

Where your balance sheet fits into the big picture

Filling out an accounting balance sheet alone isn’t enough to manage your business to its fullest potential. Those assets and liabilities you documented on your balance sheet? Your Profit & Loss (income statement) shows where that money went, when you spent it, or the avenues through which it came in.

Your cash flow statement and balance sheet start work in lockstep. Your balance sheet shows your net cash, and your cash flow statement uses that number as the basis of its documentation for your cash position. Any time anything related to cash on your balance sheet changes, your cash flow statement changes too.

Cash flow statements and forecasts both pull information from your balance sheets and income statements. Establishing a regular practice of creating cash flow forecasts helps you create a historical record of your cash flow that can be used to track trends and make informed predictions. (Think snapshots turned into a time-lapse sequence.) 

cash flow management main dashboard

Getting a sense of your liquidity

If you feel like this all keeps coming back to cash, you’re not going crazy. Your balance sheet, working in conjunction with the income statement and cash flow statement, let you as a business owner ensure that you’re in the financial driver’s seat.

And a lot of that has to do with cash: Making sure you’re not spending too much cash in the present, that you have enough of it for later, and that it’s allocated in the right places for the future.

Part one of optimizing your business’s cash flow is having all three of these statements organized and up to date. The other is having insightful cash flow forecasting and risk assessment (included in your forecast) at your disposal in order to start seeing the patterns in your inflows and outflows.

PayPie integrates directly into QuickBooks Onlineand signing up is quick and easy. (No photography lessons required.) (Other integrations are on the way.)

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels and Shutterstock. 

Income Statement: An Overview

Income Statement

A business owner’s income statement is a key part of their financial story. You might be tempted to leave as much of your accounting work up to your bookkeeper, sure. But your income statement — which you also might know as your Profit & Loss, P&L, or earnings statement — is something you should know how to read (and produce) own your own.

A P&L gives small-to-medium enterprises (SMEs) the crucial understanding of the actual net profit of their business. In other words, it’s the only way you can actually figure out if your company is making money — and whether you might want to adjust your cash flow management processes to get yourself to profitability.

The basics of an income statement

With accounting, it’s tempting to stuff your fingers in your ears and leave everything to your certified professional accountant (CPA). At PayPie, we’re fundamental believers that it’s really important to know what’s going on in your books so you don’t have to smile and nod as if you understood your own business’s financials.

In the simplest sense, an income statement measures your income and expenses over a period of time. (Hence why it’s also called a Profit & Loss — these terms are interchangeable with “income statement” from here on out.) You’ll quite obviously want to keep P&Ls for your fiscal year, but most SMEs also keep these for quarters to spot helpful cash flow patterns (we’ll talk about this more in a bit, hang tight). Sometimes, producing them monthly can even help more.

Whether or not you’re tracking these numbers formally, you’re likely keeping tabs on this info in some sense or another. Otherwise, you’d have no idea what’s exactly going on in your business. But the point of an income statement is to get stuff organized in one place for you to be able to make informed decisions and help anyone else who’s evaluating your financials (like a business lender or the IRS, for instance) get a quick sense of the financial health of your company.

If you’re using small business accounting software, like QuickBooks Online, you can create an income statement within the application. At PayPie, our cash flow forecasting and risk assessment tool uses your income statement as a primary source for analysis and insights.

Profit & Loss

What an income statement shows

When someone’s on a diet, they’re supposed to log calories in and calories out. It makes sense why a dietitian would recommend a food and exercise journal — if you’re trying to get a sense of whether or not you’re on the right path to losing weight, you have to understand whether you’re eating more or burning more. Your net calories will tell you.

In a way, your statement of income is like your business’s diet plan. You have to figure out if you’re spending or earning more, and your net profit will reveal that. Spend more than you earn and you’re in the red; flip that, and you’re in the black.

The numbers on your P&L will allow you to get a sense of the answers to these questions:

  1. Is my business generating a profit?
  2. Am I spending more than I’m earning?
  3. When am I spending the most, and when are my costs lowest?
  4. Am I paying too much to produce my product?
  5. Do I have money to invest back into my business?

And, the more granular your records, the better able you’ll be to identify trends.

Your income statement, cash flow statement and balance sheet are three of your main financial reports. Read how they all come together. 

What you’ll need to read an income statement

There are a few essential elements of a Profit & Loss. You’ll need to understand the fundamental differences among them all to not only put one together but to also read one, too.

The first two are the most important of all:

  • Revenue: What your business takes in. This combines any revenue stream, whether it’s from a retail storefront, e-commerce, wholesale business, passive investments — you name it. Put that here.
  • Expenses: What your business spends. This includes both the fixed and variable costs for making your company run on a daily basis. Think salary, overhead, redesigning your company website, software.

Then, you’ll also want to know:

  • COGS: Cost of goods sold. This means taking into account the component parts of what it takes to make whatever it is you sell. So, even if the candles in your shop sell for $18, you need to think about the expenses to get the goods ready for sale, like the jars, wicks, wax, and labels. This is most important for product businesses, less so for service businesses who may not have a COGS.
  • Profit: Your total expenses minus your total revenue. Although this seems straightforward, this doesn’t tell the whole story.
  • Gross Profit: Your total profit minus COGS. You end up paying your business’s operating expenses from your gross profit, so this number is arguably the most important of all to understand from your income statement.

You might also hear the abbreviation EBIDTA, which means earnings before interest, depreciation, taxes, and amortization.” Don’t worry about that too much unless you’re dealing with investors or you’re a very high-grossing business (in which case, your accountant will help you out). But, basically, this number provides a very clear picture of how your business is doing without these other factors. A look at the cold, hard financials of your business beyond cash flow, since it looks at non-cash items, too.

Your income statement will include some other terms, too, but these are the ones you’ll need to grasp in order to use a P&L effectively to make decisions for your business.

Who looks at your income statement

Some or all of the following parties will or should review your P&L statement:

  • The Internal Revenue Service (IRS). You might need to prepare your Profit & Loss for any number of reasons. In the most basic sense, the IRS will generally need to take a peek at your income statement — along with your balance sheet and cash flow statement — in order to verify your business’s financials. If for no other reason, that should give you a big incentive to keep this important document clean and up to date. Also, your business income taxes are based on your profit each year.
  • Small business lenders. In many scenarios, lenders require you to submit your income statement with your application for business financing. That especially goes with term loans where lenders will be taking a hard look at whether or not you can handle your repayment.
  • Investors. Unsurprisingly, if you’re courting investors — or vice versa — submitting a Profit & Loss in due diligence will be a must. In order for lenders to get a true understanding of your financial picture, they’ll take a hard look at your books. This is where EBITDA on your statement of income will be important, as well as your cash flow forecasts. Detailed records are essential here.
  • Buyers or clients. If you’re planning on selling your business — or even doing business with new clients — you should prepare to have your P&L ready to show. The income statement gives partners a sense that you’re solvent.
  • You. (No exceptions on this one.)As a savvy business owner, the more time you spend in the weeds understanding where you’re spending and where you’re earning, the more intelligently you can make decisions. The more helpful you find your P&Ls, the more you might find you want to keep more frequent records.

Your income statement should inform financial decisions

Your Profit & Loss is meant to give you a great sense of the current sense of your business financials. Beyond seeing the now, though, smart business owners will make decisions based on the numbers.

Read More: How to Read a Cash Flow Statement & The Difference Between Profit and Cash Flow 

The relationship between cash flow and your P&L

First, your income statement will part the clouds about your net profit. Should you be looking into different manufacturers or suppliers to lower your cost of goods and spending less? Should you be shifting a portion of your production to a different season to even out your cash flow?

Toward that end, you’ll also be able to spot important seasonal fluctuations in your finances. Even if you’re not making tweaks to your cash flow management processes based on this info, it’s essential that you know the trends.

Tools, like cash flow forecasting (see image below), also help you better understand how your business both earns and spends throughout the course of a month, quarter, and year. These kinds of insights and analysis are powerful. You’ll really know when your business will be flush with liquidity, and when you need to save up.

full risk profile

Signing up is easy, and PayPie integrates directly with QuickBooks Online.

(More integrations are on their way.)

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels and Shutterstock. 

How Business Financing Options Affect Credit (And Vice Versa)

business financing options

Applying for business financing can sometimes seem like an opaque process. Yes, there’s some subjectivity involved in business financing approval — a human underwrites your loan, after all. But, for the most part, lenders use a fairly consistent set of qualifications across the board. No matter which small business financing options you’re seeking, lenders often look at one element before anything else: Your business and personal credit histories.

This means you’ll need to understand your credit history and how it affects your creditworthiness before applying. Once you’re approved, you’ll also need to know how getting that loan will affect your credit afterward.

Proactively, you can take charge of your business’ cash flow by using forecasting tools. PayPie’s forecasting tool can help you see the strengths, weaknesses, and opportunities in your cash flow. As business funding plays a role in your cash flow management, here’s what you should know about the relationship between business financing options and your credit.

Business funding begins with your credit history

Some types of business financing products are harder to qualify for than others — that’s a given. For instance, only the most qualified candidates with solid credit histories and consistently great revenue can score Small Business Administration (SBA) loans. (Despite your buzz, your kombucha startup will need to build up some real time in business before you can even consider a government-backed loan.)

Before you can even understand if you’re in the running for certain business financing products, you’ll want to review the basic requirements for business financing options you’re interested in. These requirements will vary from lender to lender. They’ll sometimes include revenue and time in business — but they’ll almost always include your credit rating.

Before you apply for business financing, lenders look at your credit history because it’s considered an objective representation of your history with debt. A credit report indicates risk: the better your report, the more likely they are to get their money back. And lenders are in the business of mitigating their risk. They tend not to lend to the riskiest borrowers with weaker credit histories.

Your Business Credit Report and Why It Matters 

Both your personal and business credit histories matter

As a business owner, your personal credit history will be the first place a lender looks to size up whether or not they believe you’re a good candidate for any sort of business financing options. But they’ll also be looking at your business’s credit history.

A personal credit score is that number you’re used to seeing usually measured out of 850 (though some other bureaus use different standards) — it’s important for applying for personal credit cards, mortgages, car loans, even when you open up an account with a new telecom provider. Factors that affect your personal credit include your credit utilization ratio, length of credit history, outstanding debt, and more. Your personal credit score will vary slightly among the three main bureaus — Equifax, Experian, and TransUnion — depending on how they weight different factors. Lenders will look at this because you own the business — so, if you’ve been historically responsible with personal debt, it’s likely you’ll do the same with your business’s money.

Then, there’s your business credit score. It’s exactly the same in that it represents how you’ve handled debt in the past for your business. The factors that go into it are similar, too, but it also includes things like the risk inherent in your industry (like tobacco manufacturing or apparel manufacturing) and your company size. This score, which is often between 0 to 100, begins building as soon as your business starts.

Why a strong credit rating is important

A strong credit history obviously hugely important for qualifying for business financing options. But, often, the stronger your credit rating, the less expensive your loan. Candidates with good credit history — and, subsequently, higher credit scores — will generally receive better repayment terms.

For example, if you apply for a $35,000 medium-term loan with a credit score of 810. You might receive a four-year monthly repayment at 8.5%. That’s $6,409.15 in interest. But maybe that same loan to a candidate with a score of 690 would have monthly repayment terms of three years at 15%. Try paying $8,678.31 instead. There are, of course, a lot of other factors that go into determining your loan terms. But credit history is a big piece.

business financing options credit report

How business financing options affect your credit rating

You got the business financing you needed — that’s huge. Take a breath, feel good. Okay, now get serious about paying it back so you don’t put your credit history in jeopardy.

We’re not out to be killjoys, certainly. You wouldn’t be flippant about letting your business credit card bills collect dust, right? You’ll need to be serious about paying back your business loan with the same steadfast approach, too. Although a business loan is a very different financing instrument than a business credit card, they’re both funding options. No matter what you’re approved for, you have to pay back your debt. That means delinquency on your business loan will negatively impact your credit history.

The Best Business Credit Cards in the United States 

How business financing options can improve your credit

Before we get into doom and gloom, let’s look on the bright side. If you’re diligent about paying your loan bills on time and in full, according to the terms your lender sets, you’ll be able to raise your score. It makes sense: You’re proving to your lender that you are, in fact, responsible with debt.

If you pay off your loan like you should, you’ll put yourself in a great position to qualify for better financing products down the line — whether that’s a better business credit card or a higher-quality loan (like that SBA loan). You could even refinance your existing loan to lower the cost of your payments now that you’ve proven you can pay back your loan bills.

How business financing options can hurt your credit

On the other side of the coin, your credit rating could be at risk if you miss those payment due dates, or you’re not able to pay at all. This is what’s being called “delinquent” or “in default” respectively. Both are very, very bad news for your creditworthiness.

How to use cash flow to choose the right business financing option

It’s absolutely crucial that you only take out a business loan that you can afford. That means one that you can pay back in terms of its total capital amount, but also one with repayments you can afford based on your business’s cash flow.

When you use your cash flow forecasting tool to understand what kind of money is going on and what’s going out, you should be able to make an informed decision as to what you’ll be able to handle on a daily, weekly, or monthly basis — whatever your terms are. That’s why it’s so important to know your cash flow.

As you can imagine, that’s also why lenders scrutinize your bank balances, balance sheets, and cash flow statements so closely. They want to make back their money.

Cash flow vs Profit — The Difference 

How three types of business financing options could affect your credit

1. Short-term loans

Term loans are what you’re thinking about when you hear “business financing” — that lump sum that gets deposited in your business bank account after approval. They come in lots of different forms. Short-term loans good solutions for working capital, specifically with bigger purchases.

The most important thing to understand about term loans is that you begin paying interest on the full amount of your term loan as soon as you receive it. Short-term loans specifically often require daily or weekly payments — which might be difficult for some entrepreneurs to keep up with.

Term loans will absolutely build your credit with consistent payment. But, daily or monthly payments can quickly become overwhelming for business with a high risk of cash flow problems. You’ll need to be sure you can afford these payments before signing on to a short-term loan.

2. Business line of credit

As an alternative to a term loan, a business line of credit is a better option for businesses with cash flow concerns. It’s set up as a kind of hybrid between a credit card cash advance and a traditional business term loan. You’ll get approved — based on your personal credit history, generally — for a certain amount of business financing. Then, you’re able to take out — or “draw” — as much or as little as you want to use at a time.

What’s different here is that interest only begins to accrue when you draw funds, and you’ll only owe interest on the portion of your total credit line that you use. Think of it like a clock starting. If you were approved for a business line of credit in January with a six-month repayment term, but you didn’t make your first draw until March, your repayment isn’t due until September.

Maybe you need a short-term business financing option, but you’re concerned about a business term loan tanking your credit history because you might not be able to afford daily or weekly payments. That’s a real concern — especially since many people use short-term financing to supplement cash flow concerns. In that case, a business line of credit could be a much better fit. Not only will you not have to worry about destroying your credit rating in the same way, but a business line of credit is actually a great credit-builder to prove your responsibility with repayment.

What to Know About Cash Flow Forecasting 

3. Invoice factoring

Invoice factoring is another essential option for cash flow crunches. With this type of business financing, you actually sell your invoices to a lender (factor) who’ll pay you a portion of your invoice, and then work directly with the vendors whose payment is outstanding to seek the remainder. You’ll get the rest, minus a fee when the balance is paid out.

This is one of the best options available for cash tied up in trade credit or overdue invoices. Because you’re selling your invoice and not taking on any debt, factoring doesn’t actually affect your credit history at all. Your activity with short-term loans, business lines of credit, and credit cards, too, all get reported to the credit bureaus. That’s not the case with invoice factoring, though. Since you provide collateral (the invoice), there’s no debt to report to the credit bureau. You actually might end up benefiting on the credit side, especially if you’re able to pay other bills on time as a result of freed up cash.

Every business financing option  affects your credit rating

If you take away nothing else it should be that your credit history is really, really important. It’s important before you apply for business financing. It’s important after you apply for business financing. But it’s also something you can control.

The bottom line is that every business financing product affects your creditworthiness and overall financial health — but it’s up to you to decide whether it’s a negative or positive effect. The simplest way is to make certain that you’re only taking on the business financing options you can afford. And that’s done by having an airtight sense of your cash flow and sense of how business lenders view your risk.

Start the process now by creating a PayPie account, and then connecting your business accounting software.

PayPie currently integrates with QuickBooks Online. Additional integrations are coming soon.

The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional. 

Images via Pexels