Ratios: Keep Track of Your Business
what I'm gonna finish up today doing. And I'm glad that I was able to get to it. Our ratios, which are just simple tools. They're not in my bonus material, these air. In addition, because I wasn't sure if I was going to get this far ratios now Uh huh. What? These are our tools that you can use to keep on track in your business tools that you can use to keep on track in your business. OK, so that question that you come in and Jesse l said staying on top of cash flow is critical and just er said, agreed with Jesse Elman said, Also, long term profitability. Perfect. That's a perfect set up. Cash flow is segment 10 tomorrow. Long term profitability. Let me let me take off on that point two terms. One of them is liquidity. Now, again, I'm introducing some some kind of, you know, jargon e accounting here. But there's a point I'm gonna get so liquidity is do I have money? Cash flow to pay my bills and cash flow myself over the next year? That's liquidity. Do I am I got enough cash coming in t...
he door to make it. Six months, nine months a year, as opposed to the person on the chat, which is long term is called solvency Solvency. Are you solvent? Okay, let's talk about liquidity first. And this relates to what we're gonna talk about in cash flow tomorrow. All right, Liquidity. One ratio is abbreviate current assets divided by current liabilities. Now, I'm not asking you to be a math major, but there's gonna be this is gonna make sense here in a minute again. Liquidity, which is what I'm talking about now to get rid of solvency is Do you have the ability to collect cash and pay your bills in the next months? Okay. Current assets divided by current liabilities is one way to look at it. What were some of the current assets that we covered today? One is cash. What else? Perfect. You get a smiley face for the day and a gold star way. Have them right outside the door. I gave it away. We were going to tell you, but you're the winner. Cash accounts receivable. You expect to convert to cash within a year Inventory You can expect to convert to cash within a year. Okay, that's the numerator. That's the top those of the current assets. Current liabilities, accounts payable mostly the current portion of your long term debt. That's the denominator. Here's the point. You have to have enough assets coming in the next 12 months that you're gonna convert to cash, toe pale. All of these. Do you agree with that? The numerator has to be Aziz Bigas the denominator. You're in trouble. For example, if you have $100,000 current assets but you have $150,000 current liabilities can we agree that you don't? You're gonna have to go out and get $50,000 somewhere. Thank you. What are the two ways you can use to raise money to run your business as a review? If you get this one, you get a You get a fruit basket today. Part me, you're right. Which would be equity or what was the other one, which is also have debt or equity, right? My point is this You've got a $50,000 difference here. You're going to have to go out and get $50,000 somewhere. That means you borrow it, which is debt or you sell ownership in your business. And this is the crisis that occurs when people have to sell ownership in their business under duress. Big thing for business owners. Why did you go out and get an investor? I did not have enough cash flow to get through the next year. Okay, Which is why. And I think several people have touched on it. And I think Jackie O and Josh in particular, I think everybody has that were cautious with expanding right for cautious. Were cautious. Why? We don't want to get in this mess, okay? We don't want to get in this fix now. I can adjust this problem a little bit. Well, we're still talking about liquidity. So current assets over current liabilities see a over C L. It's called the current ratio. And by the way, QuickBooks can calculate these in their system for you, which is nice. We can amend this a little bit. Here's what you may change. You may leave out inventory in the numerator. Remember, this had inventory in the numerator because inventory as a current asset, you may want to leave that out because between receivables and inventory I don't know about Candace, but maybe you hang on to your inventory for nine months close to a year, depending on your business. Okay, so you may say yourself I don't want to include inventory as as the cash coming in over the next months, cause I think it's a little tight on whether I'm going to sell my inventory or not. So you're not going to include inventory in the numerator That's called the quick ratio again. Why am I telling you this? These are just tools for you to take a look at your business and see where you're headed. Because if you are getting to the point where your liabilities are getting a lot, current liabilities were getting a lot bigger than your current assets. You need to make some changes. You need to get another investor. You need to get more financing. You need to do something. OK, do something ratios that if you're trying to compare and see what you're ratio actually means, that may be industry specific. Yes, thank you. I would highly recommend you go out on the Web and look for these ratios for your industry and a good way to find it is if you if you go out and look at financial company financial websites where you have financial analysis, they can show you these ratios. Or if there is a company that's a public company that's similar to what you do not similar in size but similar in business. If you look at their annual report online, they're gonna have all these statistics and then they're gonna have all the statistics for the industry. That is a liquidity ratio. Liquidity. Can you pay your bills over the next months? Let me do a solvency ratio. I mentioned for the fruit basket that there's two ways to raise money to run your business. There's debt and there's equity, right? Very simple ratio is looking at your debt in comparison with your equity. So if you have raised, if you have taken out $100,000 bank loan and you have sold $300,000 worth of stock, that's a 1/3 ratio. Now, is that good or bad? Well, it depends on your industry, really. But I will tell you this. Another red flag is when the debt number on the top starts creeping up on becoming much bigger in comparison with the equity number on the bottom. Okay, when the debt number on the top starts getting bigger than the equity number. Now, let me talk about industries. Some industries can carry a lot of debt. How many of you pay your utility bill? Yeah, they got pretty good cast. Float on an earnings. A utility company can carry a lot of debt. Why? They've got reliable earnings. They've got reliable cash flow to pay off debt. Utility company can carry a lot of debt. Most of the people in this audience are in businesses where your profit is less certain. And also in businesses where there is the possibility for hot, huge success down the road. So many of you are in businesses where the upside is monstrous because of technology innovation. Microsoft into the example until recent years, never had any debt. They didn't need to Why people were buying the equity in the stock price was going up. They could issue Maura Maura Equity because they were performing and the company performed. Earnings went up. Salesman up. Stock price went up. They never had to take on any debt. Also Microsoft for years never paid any dividends to reward shareholders. Why the stock price get going? They didn't have to pay a dividend. People didn't demand a dividend. Finally, they got so much cash. Like apple the syrup independence because they're gross slow down. So they wanted to reward shareholders. The growth of the stock price goes down, you know, we're sitting on a gazillion dollars. Akash will pay people a dividend. So depending on your industry, you may have a lot of debt or a lot of equity or some mix. All right, But even in your own little world as you move along, if this debt numbers started to creep up and not the equity, that might be a warning signal to you in terms of selling equity in your business, a friend of mine says, You know, I'd rather own 1% of $ million company than 100% of a $1,000,000 company. So when you're selling off ownership in your business, consider that being a really small owner of a gigantic company, that might be a pretty good thing. If that's what you want to do. Now that everybody wants to grow like that. Any questions on liquidity? Insolvency. Okay, Candace carries inventory your business. Let's talk about ratios related to inventory. Yeah, ratio related to the solvency. That is solvency. Because that has to do with long term success of your business. Specifically, If he just can't get taking on more and more and more debt, you're gonna have a problem. Inventory. We have a cycle, don't we? An operating cycle for every business. As a friend of mine says, Get the cash and don't get sued. What a great you know, we could monogram that on a pillow and put in our office, Get the cash and don't get suit. That's pretty good advice. So we spend money two on a product or service. We deliver a product or service, which might be inventory. We collect cash. We use the cash to spending, and it keeps going right. People like Candace are you spending money to buy inventory and their out of pocket that money until they deliver the product or service and they get paid. So there's a time gap here. Wal Mart. I know several people kind of on the periphery of servicing Walmart and one person who was a friend of a friend, is a Proctor and Gamble rep that is responsible for getting tied soap and ivory soap to Procter and Gamble products into Wal Mart stores. She lives in Bentonville, Arkansas, where Wal Mart's headquarters North West Arkansas. Wal Mart has such clout that they insist that vendors like Procter and Gamble deliver product and stock the shelves every day. In other words, the Onley inventory that WalMart carries is what you see on the shells. There's no back room with extra inventory. It's along this. It's all in the store, Okay? They have virtually no cycle, their cycles so short because they're not keeping much inventory at all. So if there's 50 bars of Tide soap, they sell 40 of them the same day. And then Procter and Gamble comes back in and stocks the shells, and it doesn't cost Wal Mart anything. Now. We're not in that instance, but it's a good example of this cycle. So the the ratio I'm going to show you is a way of tracking this cycle, Okay, looking at your inventory over your cost of sales inventory divided by cost of sales. Okay, so let's say that in a year, Candice has cost the sales of a $1,000, and, on average, that should say average inventory, the average during the year. On average, she's got $100,000 sitting on the shelves. Okay, What that means is she is selling Oliver Inventory out and re buying it again 10 times in the year, right? She's she's buying all the inventory. I mean, she's selling all the inventory and buying it all again 10 times in a year. Now you could look it as cost of sales over inventory cost goods sold over inventory. You could flip the ratio to make it 10/1. I'm just You can do that. It's not real important. The point is, you're comparing these two. Here's the goal. The goal is to sell as much as you can cost of sales and minimize the inventory you have to keep. This is the magic of Wal Mart. Their cost of sales is a gazillion dollars, and their inventory cost is nil. Why do we care? Because the lower you keep your inventory, the less money you have tied up in inventory, and the faster you sell, the faster the circle goes and you collect cash, See what I mean? We want to minimize our inventory, and we want to maximize our costs of sales. So I mentioned I got my wife's boss is gonna help us by a car about a car lately. So if you look at a car lot and I didn't know this until I worked with a car dealer, I always used to think, man, can you imagine the hundreds of thousands of dollars Million's? They have tied up in a car lot? Those guys were turning those cars really fast, if you visualize it. Big car dealerships were selling 2 to 300 cars off month. All the cars you see on the inventory when you drive by there, not there next month. They're they're turning those cars over, turning them turning in, turn him so they've got a big investment in inventory. But if they sell all the inventory every month and they do that 12 months out of the year, their cost of sales is pretty big. Compare with their inventory. So what? We just did its explain how if you can maximize your sales and minimize your inventory, you can get that cash collected faster. And you don't have to buy as much inventory. Which ties up your cash. Okay. Two assets. Tie up most of your cash. That's inventory. What was the other one for the fruit basket today? Well, the asset ties up the most cash besides inventory for me, it could be, but one I was getting at was receivables. Let's talk about receivable. Big risk. I'll discuss it tomorrow again in cash if you increase sales, but your average collection slows down. Okay, this is why And this this whole issue This is why, with inventory and receivables paying online, it's just speed this up. Okay? Everybody can pay faster. You don't have as much inventory of people pay on average within two days rather than a week. May want to check it speeds everything up. It's fantastic. Uh, here, an example. Let's say it's June and you have $100,000 in sales, and on average it takes you 30 days to collect the money. That would indicate that after 30 days, you've got $100,000 back in your pocket. You've turned the cycle when it's back in your pocket. Okay? You increased sales July 130,000. That's good, but on average, because you added new clients who pay slower a tissue 45 days on average to collect the money after 30 days. Do you have this whole 130,000 back? No, because it takes 45 days on average. Some of this has not been collected. If you increase sales again 250, where you gonna get the money to pay for these sales and spend the money and do the prep? And by the inventory? If you haven't collected all this yet, how can you increase your sales if you haven't collected all this yet? Because again, it's gonna take 45 days, which means it's bleeding into this next month by 15 days. So here is the problem. If you're going to increase sales, you've got to consider who your increasing sales to. And are they going to pay you at the same rate? Because if they don't, you're going to get into a cash by, particularly if you're growing. You need even more money to develop these sales than you do here. And even more money here than you do here is what I'm saying the trend. If sales are going up, your costs are going up. And if you're slowing down the dollar collections, you can't pay the costs and you're stuck having to go out and get more financing again. Okay, that Okay, that's a big one for this audience where you guys can go out and Bill and do stuff on a on a low cost basis, right away. Collection, collecting. Is everything okay? Going back to a point that I made earlier, I would be judicious and careful about discounting couple reasons. First of all, you guys deserve to get paid for what you do. You know what? And I have in restaurants. I married a waitress, my wife, waitress for years. I'm a big tipper way. I know that's hard work. I'm willing to pay people for their expertise, and I feel because I'm in that same boat. But more importantly, when it relates to this, if you discount, you're cutting the cash flow. And if you're cutting the cash coming in, you're cutting your ability to grow your business the next month. So I would be careful about discount. I mean, I'm 51. I just tell people. No. No, I'm sorry. Do you discount now about those cardinals? You know, I don't have any hesitation. I just told people. No, because I value what I do. And I'm willing to let that business walk away because I don't want Jack around with trying to collect money that's going to screw up my cash a little later. Now, you may have a different view, and that's cool. Okay, so this is receivables speeding up collection of receivables, speeding up collection of inventory to see the pattern, inventory and receivables. Get it out the door and get the money in. Get the inventory out the door. Get the money in. Get the money in from the sale. Get the money from the sale going back. A couple more. I'm glad I got to Ratios. You may be bored out of your tree, but I'm glad I got solvency. Don't let that debt number creep way up compared to the equity, particularly if you're in a company that where your profit is uncertain and you know you're not. It's hard to make the debt payment. Don't take on more debt. This one makes sure that this ratio is at least to 1. That you've got a dollar of current assets to pay that current liability