As usual, Warren Buffet's 2019 shareholder letter has drawn attention for what some may consider to be a surprising risk to his insurance portfolio -- a cyber security disaster comparable to a catastrophic earthquake. He's talking about an event or string of events that disrupts society and shuts down businesses with a significant impact on the economy.
First, the author argues complacency is affecting CEOs. There are so many reported breaches and attacks, that it's beginning to be viewed as just a routine part of running a business. But others – probably small business owners -- negligently ignore the threats, feeling resigned to their inability to effectively deal with events that seems common but unpredictable like a tornado or other extreme weather disaster.
The second piece of advice is to accept the reality that the enemy has any individual company out-matched and that outsourcing to specialists is the only sensible place to begin (once your head is out of the sand). Here's where small businesses with limited resources, again, face special risk because they give up the fight. It’s like saying you aren’t going to sweep the sawdust and crumpled paper off of your shop floor just because you don't have an elaborate sprinkler system.
Finally, the author points out that the government may be warning business owners, but it's not going to help. Don't expect the FBI to roll back a ransomware attack or remediate your data breach. In fact, the regulatory arms of the government will hold you accountable for negligence (which includes inaction) as a lesson to others.
It’s not unusual for a borrower to submit a loan proposal to a bank or a community lender like CEDF for more money than the numbers will support. It’s our obligation to make sure that the ratio called global debt service is in line with reality. This means considering all of the financial obligations of the borrower personally, as well as the capabilities of the business, can the loan be repaid at the contemplated terms? We won’t offer the loan if this condition can’t be met.
That’s also why typical loan covenants forbid a borrower taking on more outside debt without a lender’s approval. It can rock the boat and make the ship roll over.
Sometimes, if only a lesser loan amount can be supported, the loan officer will ask the applicant if the business plan can be realistically changed and still work. This is entirely a business judgement of the applicant. The lender wants to accommodate by approving a modified proposal, but a lender can’t promise that a smaller loan is workable.
Sadly, the enthusiasm and determination of borrowers sometimes outweighs their judgement. It’s frustrating when a CEDF business advisor, trying to help a distressed client some months down the line, hears the peril that the client is facing was caused, “because you didn’t give me enough money.” The unwelcome truth is that had the client been allowed to borrow more, odds are the bottom might have dropped out even sooner.
Another fantasy of inexperienced small business owners is the idea that getting free of debt and raising big money in the equity markets is somehow a dream come true. Appropriate debt financing is cheaper than equity financing. There’s no shame in using it.
It was probably inevitable that the tried and true friends and family approach to small business financing would make its way to the small screen. And while it is hard to imagine making a pitch for an equity investment or a loan to Uncle Charlie or your second cousin’s brother-in-law, it appears some people are doing it this way.
If this sounds slightly ridiculous to you, rest assured that the experts suggest it’s really just the internet age version of something much more conventional -- sending a note to request a conversation.
You must admit that for those who have built a community of dozens or hundreds of contacts, it only makes good sense to announce your fund-raising drive and leverage your network to lead you to what might be a workable source. Perhaps the confusion comes from the crowd-funding phenomenon and the assumption that you can finance your business start-up or expansion in $20 increments. Except for very unusual circumstances, this isn’t the model to rely on.
But in an era when banks pay hardly anything in the way of interest, people do look for more attractive investments that they can understand and perhaps monitor. It might be a good thing that you remembered to send your Aunt Polly a Christmas card every year.
This time of year small business owners who only infrequently take a glance at their financial statements may be getting a full year P&L delivered by their bookkeepers. If you put an ear to the wind, you can almost hear the moaning – “If I have this much profit, how come I don’t have any money in the bank?”
Assuming the profit is calculated properly, there are, of course, only three possible answers to this complaint. Understanding how financial statements work, may not make the answer any more pleasant but it can silence the frustration.
The first possibility is that the business spent money on assets. Capital expenditures don’t hit the P&L so cash is used up but, in return, the company has a shiny new widget machine, or more inventory, or perhaps (depending on the accounting basis) it made a sale on credit (thus generating a paper profit). And now it has recorded some accounts receiveable, A/R being another liquid asset (hopefully), just not as liquid as cash.
The company might have also reduced some liabilities. Again, this is a typical use of cash but it doesn’t show up on the P&L like payment of current expenses. The business owner may not have made a purposeful reduction of debt. It might be just the routine principal portion of a business loan or payment of certain kinds of taxes. For instance, making a sales tax payment shouldn’t normally impact the P&L because the best practice is to record net sales. A business owner with one eye on the checking account might be counting some of the collected sales as his own working capital – a terrible practice. When the payment is made -- whoosh – a bunch of cash is gone.
The third possibility is that cash went out of the company through the equity section as an owner’s draw. One would think the owner would have a fond recollection of withdrawing some of his hard-accumulated capital but sometimes memories are short. Or when personal cash was tight, the owner might have paid some personal expense and the bookkeeper dutifully booked it for what it was – an owner’s draw. Since most small businesses are “pass through” entities for income tax purposes, this contributes to mental confusion at tax return time. The entity might have no responsibility for income taxes but the owner certainly does. Guess which checkbook is used when the IRS payment is made? Again, a reduction of cash and an owner’s draw is taking place, not a reduction of profit by generating an expense.
Understanding the fundamental mechanics of small business bookkeeping is an essential skill for an owner that will lead to better planning, decision-making and less confusion and stress. Using the Statement of Cash Flows which QuickBooks can spit out in seconds is a good way to evaluate what’s happening in your business.
-- Frederick Welk CEDF Business Advisor
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