FINANCIAL LITERACY LEARNING CENTER

Budgets help us keep track of our cash flow to avoid overspending

Budget breakdown

Budgets are prepared by tracking your daily spending and determining your income and expenses. Components of a budget include income (employment, allowances, etc.) and expenses (bills, food, transportation, etc.), which determine your overall cash flow, or movement of cash in and cash out. Expenses can be fixed (stay the same) or flexible (change from month to month).

Ways to spend less and reduce your spending

If your expenses exceed your income, there are some simple tips you can follow to reduce your spending. Avoid impulse buying and use a list when you shop. Determine your needs versus your wants—buy only what you need, not because it’s on sale. Always pay your bills on time to avoid late fees. Carry only small amounts of cash on you and try not to use your credit card; if you must, control your use. Lastly, always keep your goals in mind.

Always pay yourself first

Benefits of savings

The main reason it’s important to save your money is so you can reach your goals, such as buying a house or a new car. Aside from that, having money set aside is important in case of emergencies. You can minimize financial risks (like getting into credit card debt) by ensuring that you have money when unexpected expenses arise. Another benefit to saving money (in a bank) is the interest that you earn or the money the bank pays you for keeping your money with them.

Interest is calculated based on time and the amount of money in your account. The earlier you start saving, the more money you will make off interest because of compounding, or earning money on previously paid interest in your account. The annual percentage yield (APY) reflects the interest you earn on a yearly basis.

The Power of 72

This is a formula that helps you calculate how long it will take for your savings to double in value. Simply divide the interest rate by 72 to determine the number of years it will take: 72 divided by the interest rate equals the number of years.

Saving options

There are several options for saving your money, including under a mattress. However, you won’t earn any interest that way, and you’ve now seen how that interest can add up. One way to save is with a Certificate of Deposit, or CD. These typically offer a higher rate of interest than regular savings accounts in exchange for your keeping the money on deposit for a set term.

You can also choose to save in a Money Market Account, which offers a higher rate of interest and usually requires a higher minimum balance. You can make deposits and withdrawals with these. Another option would be a Statement Savings Account, which typically allows unlimited deposits, but limits the number of fee-free withdrawals you can make during a month. You typically earn interest on the money you have on deposit and will receive a statement at least quarterly listing all transactions in the account.

Not only do you earn interest when keeping your money in a bank, but you can also have peace of mind knowing that it’s safe because member financial institutions (most of them) are protected by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA).

Credit is the ability to borrow money

Ins and outs of credit cards

Using a credit card is similar to taking out a loan: It allows you to buy now and pay later. If you carry a balance on your card, you will be subject to paying interest charges. Some cards do offer “grace periods” or 0% interest for a set amount of time, but it is important to understand what that is. Some credit cards will also offer freebies, such as cash back or bonus points for travel.

As appealing as credit cards can be, you must be careful not to fall into a credit card trap because purchases, interest charges and possible penalties can add up fast, leading to debt and having a negative effect on your credit score and future borrowing.

Tips on correcting credit card problems

If you have found yourself in credit card debt, here are some helpful tips to help you get out. You can start by reducing your expenses by paying off the balance on your highest-rate loans first, which are usually credit cards. Limit your use of credit cards. Instead of using one, pay for future purchases using cash or a check and carry only a small amount of cash. Try meeting with a reliable credit counselor, and after that, consider enrolling in a debt management plan (DMP).

Lastly, beware of debt consolidation traps. Make sure you do your research and know what you are getting into.

The “Four C’s” of credit decision-making

In order to borrow money, you need to show lenders that you are able to pay back the money. Lenders take a risk when loaning money, so it’s important to pay your bills on time and develop good habits. If you aren’t paying back the money you owe, that can influence whether or not you are able to borrow money in the future. Remembering the four C’s of credit will help ensure you are in good standing with lenders:

1. Capacity refers to your present and future ability to make payments. Lenders want to see that you are able to hold a stable job. The longer you’ve been there, the better.
2. Capital refers to your net worth, or the value of your assets compared to how much debt you have. A positive net worth shows that you are able to effectively manage your money.
3. Character refers to how you have paid your bills in the past. Here, lenders are looking at your track record of how you have handled debt in the past to indicate if you will be able to do so in the future.
4. Collateral refers to assets you can offer to secure the loan, such as a house or rental property. This gives the lender peace of mind that if you do default on your loan, they will still get something in return.

Credit reports

A credit report is a record of how you have paid your debts. It tells lenders who you are, how much debt you have, if you’ve made payments on time or not and any negative information about you contained in public records. Having a good credit score is crucial. It plays a role in whether you can get a loan or other form of credit, what your interest rate will be, getting a job, renting an apartment or getting insurance.

Having a bad credit score can either prevent you from getting these things or require you to have a co-signer who does have a good credit score.

How your credit score is determined

A credit score is a number that is developed based on information from your credit report. It is used to determine how likely someone is to repay a loan. Credit scores may vary depending on which scoring services are preparing them. A majority of lenders use the FICO credit score, which ranges from 300 to 850. The FICO score is calculated from several pieces of credit data in a credit report, which are grouped into five categories.

Payment history accounts for 35%, amounts owed accounts for 30%, length of credit history accounts for 15%, and new credit and types of credit used both account for 10%. Credit scores consider both positive and negative information. Making late payments or no payments at all will lower your credit score, while making consistent, timely payments will raise it.

Choosing the right bank for your unique business needs can help your business run more smoothly

Business banking fundamentals

There are several factors to consider when choosing the right bank for your unique business needs. Here are some helpful tips to help you choose a bank, along with things to keep in mind that will help you run a successful business. Be sure to choose a bank that offers the products/services, customer service, account access and additional banking services that will suit your needs.

Ask about payroll services, cash management services, business debit cards, merchant processing services (credit cards, debit cards, gift cards), commercial lending (loan details, features, terms, and loan types), business credit cards, financing, and wealth management. No “commingling”—open up a separate checking and savings account for your business. Know what the account limitations and restrictions are. Take advantage of remote deposit scanners and online access.

This is a good starting point; however, it is important to build a strong relationship with a bank to really take advantage of all they have to offer.

Improve chances of getting a loan

To improve your chances of getting a loan, follow these simple steps. Develop the five C’s of credit: capacity (how you will repay the loan), capital (money you’ve personally invested), character (personal integrity), conditions (external factors that could affect your ability to repay the loan) and collateral (form of security you provide the bank). This will help to strengthen your business credit score. Do your homework and ask questions.

There are countless different types of loans and programs out there for small businesses, so do your research to make sure you are getting what is best for your business. Build a long-term relationship with your banker. They will be a great resource for you and your business. Lastly, improve your personal credit score. Personal credit scores contain much more information than business credit scores and can therefore influence whether you can get a loan or not.

The 4-step planning model for a healthy business

Step 1 – Back-of-the-napkin plan: Go or no go?

In this step, you do preliminary research and planning. The point here is to determine if business ownership is a good fit for you. Most of the time, you don’t have any concrete plans yet, just ideas. It can also help to talk to other business owners in a similar field to get ideas.

Step 2 – Resource plan: What do I need to go?

After deciding that starting a business is the right move for yourself, it’s time to start putting your ideas into action. Start by creating an opening balance sheet. Figure out what you need to get your business going, such as space, equipment, staff and other expenses necessary to open and run a business for about six months. A good rule of thumb is to borrow no more than 200% of the money you invest in your business. A resource plan will help you to identify key numbers and make decisions.

At this stage, it’s a good idea to start looking into banks and developing a long-term relationship with a banker.

Step 3 – Business plan: How will I finance my business?

This stage requires more research, planning and detailed financials. It’s a good idea to see what competitors in the market are doing and even talk to other businesses. All this information will be used to create a business plan, or compelling story as to why your business will be a success. You can then use this to sell your story to banks and other potential investors to obtain financing.

Step 4 – Action plan: How will I manage a healthy business?

In the last step for planning a healthy business, you will create a living document that will continuously need to be updated as times change. Customers will come and go, vendors will go out of business, and prices will change.

Having a flexible plan in place and creating SMART (specific, measurable, attainable, relevant, timely) goals will help you to strategize your time and identify top priorities to focus on.

Bookkeeping is the organized process of tracking all income and expenses and is the basis for all financial management, business decisions, financing, taxes, owner’s draw and retirement

Bookkeeping steps

• Obtain business accounting software. Effective software is critical for success.
• Open a separate business checking account. Do not mix personal and business accounts.
• Reconcile your checking account. Do this each month using business accounting software.
• Track sales. Create a foolproof system for tracking sales and use it consistently. Use tools such as register tape, invoices and a sales book.
• Deposit all sales. You can do this using your business checking account, or if available at your bank, remote deposit capture. Total sales should equal total deposits.
• Write business checks for business expenses. Do not use petty cash until you are experienced at bookkeeping and have an effective system down.
• Obtain a separate business credit card. This will also help you with tracking expenses.
• Pay business expenses first. After all expenses are accounted for and paid, then you can take an owner’s draw.
• Generate and use a profit and loss (P&L) statement. This statement will provide you with the most accurate depiction of the organization’s financial health.
• Pay yourself with the owner’s draw. Transfer money directly from your business account into your personal account. It helps to assign the payments to an equity account called “Draws.”

Financial statements

There are three basic financial statements that your business should have: balance sheet, cash flow projection (or statement), and profit and loss statement. These statements will not only help you in making key decisions, but they also show investors and other stakeholders what the overall financial health of your business is. These statements tell a story using numbers and they can easily be generated using accounting and bookkeeping software.

Balance sheet

A balance sheet is a snapshot of the business at a specific point in time. It lists the company’s assets (cash, accounts receivable, inventory, investments, land, equipment and other tangible items), liabilities (debts, including accounts payable and loans payable) and the owner’s equity (amount of assets that came from the owner). The assets (on the left) should equal the same as liabilities and owner’s equity (on the right). Balance sheets are used in the application process for a loan.

Lenders use these to compare how much of your own money you plan to invest against the amount you need to borrow. The higher the proportion of owner’s equity to debt, the better. You can use opening and closing balance sheets to compare and identify sales trends from year to year.

Cash flow projection

A cash flow projection shows how cash is expected to flow in and out of the business over a period of time. A cash flow statement shows how cash has historically flowed in and out of the business. A projection will help you manage your cash by showing if the cash coming in is enough to cover the cash moving out. This is a useful tool for setting goals and planning for expenses. It also helps to determine your break-even point during the startup or expansion stage.

Cash flow projections are also usually required in the loan application process. They show lenders your ability to manage cash in the future so that you’re able to pay back the loan.

Income statement

A profit and loss statement (or income statement) measures the business revenue and expenses over a month, quarter or year. This shows if the company is making a profit or incurring a loss. The P&L statement measures the ability of your business to grow and repay debt. The basic formula is sales (cost of goods sold/gross profit) minus overhead equals net profit.

Business financing do’s and don’ts

• Invest your own money. This shows investors and lenders your commitment to running a successful business.
• Earn the right to borrow. Borrowing is a privilege; in order to obtain financing from others, you need to show your ability to manage debt.
• Show profitability. Lenders want to see that you are able to run a profitable business.
• Understand and keep working capital. It’s a critical component to supporting operations and should grow as your business grows.
• Match sources and uses of funds. Current assets should be financed with current liabilities, and fixed assets should be financed with long-term loans that match the use life of the asset. Not doing so can result in having to pay for an asset faster than the asset can generate profits.
• Understand collateral options. Most loans need to be secured with an asset, which is then sold off if you default on the loan.
• Understand risks and costs for loan types. All loans carry risks and costs. Decide what makes the most sense for your business.
• Shop around. Start with your current bank and go from there to get the best loan with the least amount of risk associated.
• Get expert advice. There are several resources for small businesses, including the Small Business Administration, FDIC or your own banker.

Criteria for qualifying a loan

There are important factors that lenders will look at when deciding whether or not to qualify a loan for your business. This is where having a good credit score is crucial. Having a good credit score will show lenders that you have the ability to repay a loan. Having a bad credit score can prevent you from obtaining the financing you need, or require you to have a co-signer. Another factor to consider is equity contribution, or the amount of money you personally have contributed.

This shows your commitment to the business. Lenders will also look at your ability to repay a loan by analyzing provided financial statements. The criteria vary from lender to lender, however you can be certain they all want to see strong profits and good cash management skills. The last thing looked at to qualify a loan is the loan-to-value ratio. Lenders will typically loan between 70 and 90 percent of the market value of an asset.

Ensuring you have these criteria met will greatly increase your chances of getting the financing you need.

Provides information from banks, lenders, investors, landlords, businesses and government agencies

Business credit reports – getting started

It’s okay to use your personal credit while your business is getting started; however, it’s very important to eventually establish business credit for a number of reasons. Not only will the stability of your business be compared to competitors in the market, but customers will also have an easier time finding your business when they do searches.

To start the credit-building process, you first need to obtain a tax ID number from the IRS and a DUNS (Data Universal Numbering System) number from Dun & Bradstreet. Once you have those, you need to subscribe to a reporting service by submitting financial statements, accounts to be included and registration information. The three reporting services you can choose from are Dun & Bradstreet (D&B), Experian Business, or Equifax Business.

They will contact the creditors you list for the most updated information. There are different subscription packages you can purchase, so be sure to do your research and choose one that meets your needs and budget.

A business credit report includes:

• Commercial credit risk score
• Indicators to predict the potential for business failure
• Credit filings in existence for secured property
• Business ownership information
• Other businesses owned by the same organization
• Public records of security interest filings

Personal credit impact on business

Your personal credit is your foundation for building a business. Before applying for business credit or loans, it’s a good idea to review your personal credit report to ensure the accuracy as it could have an impact on your business. Lenders will more than likely review your personal credit reports and contact your bank to check how you handle your accounts and existing loans. Your personal liability can also help with building business credit and establishing credit with vendors and suppliers.

Once you’ve checked the accuracy of your personal credit score, you can work on improving it by paying your bills on time and minimizing how much you owe in comparison to your credit limit.

Personal guarantor advantages and disadvantages

You may be required to personally guarantee a loan to your business, which has both advantages and disadvantages. Doing so will indicate your support of and investment in the business to the lender. It could help you to establish credit, obtain better loan terms and may even ease startup expenses or cash flow. On the flip side, you are fully responsible for paying back the loan even if the business is not performing well. You risk losing personal assets, such as your house.

You also might be required to have a co-signer, like your spouse, which could cause implications between the two of you or other partners and owners.

Core competency of small business ownership

Cash conversion cycle

The cash conversion cycle is one way of looking at cash flow and consists of three components;

• A business pays for raw materials.
• The business makes a product or service using those materials.
• The business sells those products or services to make money to buy more materials.

It’s important to know how long it will take to get through the cycle because this impacts cash flow. The faster the cycle goes, the faster you can buy new materials to make more products and, in turn, make more money. If you have inventory sitting on a shelf, you’re not able to use that money to make more and sell more. In conclusion, the quicker the better.

Tips to increase cash flow

If you find your business isn’t generating cash quickly enough, here are some simple steps you can follow to help increase cash flow:

• Incentivize people to pay with cash
• Negotiate with vendors and suppliers for better terms or payment plans
• Reduce costs when able (staff, reduced options)
• Do not postpone paying estimated taxes
• Do not hide from loan officers—they can provide invaluable advice
• Do not pay vendors late (they can cut off supply)
• Do not overestimate revenue
• Do not underestimate costs

Importance of recordkeeping

The success of your business depends on creating and maintaining an effective record system. One reason it’s so important is for tracking details, such as customers, sales and inventory. It will help you keep track of important details such as who your customers are, what their needs are and what they’re like. In order to run a business, you need customers, and in order to keep customers, you need to keep them happy and give them what they want. Tracking details will also help you with future planning.

Without doing so, how will a business know what they need to order or what has been selling well? Recordkeeping is also important for staying in legal compliance. There are certain documents you are required to keep, such as contracts or employee payroll for tax purposes. Be sure to keep original copies of everything and understand what you need to keep and for how long.

Recordkeeping tools

There are several tools you can use for recordkeeping, but it’s a good idea to start off simple, and as your business grows, you can adapt a more complex recordkeeping system to meet your changing business needs. The most basic system is simple “paper tools,” such as file folders and cabinet storage. This is a good method for all paper documents. Another you could use is a “tickler” system, which is helpful for remembering certain dates or deadlines.

This could be used for license renewals, upcoming bills or call-backs.

A more modern way of keeping records is with computer systems. This is more convenient as it’s quicker and takes less space. You must remember to back up your computer regularly though or you could lose data. Cloud computing is another option that is becoming popular. It allows you to access information from anywhere, and you are less likely to lose data due to crashing.

If you choose this method, it’s important to have appropriate security put in place to prevent others from accessing confidential information.