The principles of cash management are largely the same whether for a large corporation or a small business. As any business owner knows, the cash revenue flowing into the business safe must be sufficient to cover the cash expenditures flowing out. For a newly started business, there must be enough cash reserves to cover expenses until sales reach a normal trajectory.
Because dry cleaning businesses are often started with small investments and typically carry low cash reserves, owners must pay particularly close attention to “cash flow” management. The industry also faces the weakness of unpredictable sales and the necessity of using various discounts and coupons for promotions during the opening phase.
Monitor Your Cash Expenditures
When creating a budget, you must be especially mindful of cash outflows, particularly items that the owner can control. Store rent must be set at a manageable level; ideally, it should start low and increase gradually to match the growth of business sales. The acquisition of dry cleaning machines and other equipment is another controllable expenditure. Since plant equipment involves large sums, it is usually acquired through financing or leasing rather than cash purchases.
Equipment Financing
When financing equipment, a business owner must carefully balance monthly payments against expected sales (cash income). From a budgeting perspective, a fixed-rate loan is safer than a floating-rate loan, where payments fluctuate with market interest rates.
Since financing allows for tax deductions, the taxes saved can be viewed as “income” flowing back into the business. If purchasing equipment via a bank loan, the interest portion of the monthly payment is tax-deductible, and depreciation can be claimed based on the equipment’s price. A capital lease offers tax benefits similar to a bank loan.
However, an operating lease allows for 100% of the monthly payment to be tax-deductible, enabling a faster “write-off” of the equipment. For example, if equipment is acquired via a 5-year operating lease, the write-off can be completed in five years instead of the seven years required under standard depreciation. Because these tax savings directly improve business cash flow, it is advisable to evaluate financing options based on their “after-tax” costs.
One must also consider how the type of financing affects the company’s balance sheet. Under a bank loan or capital lease, the equipment is recorded as an asset and the loan amount as a liability. Lenders examine the balance sheet to confirm that current debt can be covered by the company’s income. They also look for a reasonable ratio between total debt and the owner’s net equity, ensuring total assets exceed total liabilities. Lenders calculate how many times the current income can cover all loan payments, known as the “cash coverage ratio.” Consequently, a business owner may need to use operating leases to keep the debt levels on the balance sheet at a reasonable level.
Resist Dangerous Temptations
Small business owners are often tempted to underreport their total cash income. However, underreporting reduces the cash coverage ratio that lenders value so highly, which in turn reduces the amount of financing available to the business. Furthermore, when the time comes to sell the business, the sale price is usually based on cash flow; underreporting income will therefore decrease the potential sale price. Small business operators should resist these dangerous temptations and instead focus on creating tax-free income by utilizing legitimate tax deduction categories.
The success of a business depends entirely on cash flow. Therefore, you must use various budgeting and cash management techniques to keep your cash flow on the positive side. Especially in a small business, no matter what anyone says, cash is king.
