This story appears in the
December 2000 issue of
Startups.
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Q: How
do we figure the line-of-credit needs for our growing board games
distributorship?
A:
Figuring how to finance your trade cycle is not a trivial pursuit.
As sales grow, so will inventory and accounts receivable. You
finance this growth with increased accounts payable, after-tax
profits, and a business line of credit.
Here's a cash-cycle equation to help you figure out what you
need in terms of a line of credit: According to your financial
statements, your customers pay you in 60 days. You carry 25 days of
cost-of-goods in inventory. You pay your suppliers in 45 days.
Profits, after taxes, are 6 percent of sales.
Sixty accounts receivable days1 plus 25 inventory days 2 less 45 accounts payable
days3 equals a
40-day cash cycle. Each $1 million in annual sales is $2,740 in
daily sales. Multiply daily sales times the 40-day cash cycle for
line-of-credit financing needs of $109,600 for each $1 million in
sales. But wait a minute: That $1 million in sales produces $60,000
in profits, so the actual line-of-credit need is only $49,600.
If your business is seasonal, refigure this equation using
receivables, inventory and payables from your peak season. Plan
ahead. Get your credit line set up well before you really need
it.
Remember that banks aren't your only option. Factoring
companies provide lines of credit, too.
Using the cash-cycle equation isn't as accurate as a
computer-based, 12-month cash-flow projection program, which can
help you fine-tune assumptions and test various combinations of
days payable, receivables, inventory and profits.
1 Divide
receivables by annual sales; multiply by 365.
2 Divide inventory
by annual cost of goods sold; multiply by 365.
3 Divide payables
by annual cost of goods sold; multiply by 365.
George M. Dawson is author of Borrowing to Build Your Business: Getting Your
Banker to Say "Yes" (Upstart Publishing). Send
your financing questions to bsumag@entrepreneur.com.