Have you watched the popular television show Mythbusters? The hosts of that show blow stuff up and disprove conspiracy theories. They never cover financial myths, yet these untruths may be just as easy to believe. So we’re going to bust common financial myths that many small business owners fall for.
The Myth: When I’m choosing a bank, the loan rate they offer me is the most important thing to consider.
The Truth: On business loans, or loans against accounts receivable and inventory, the structure of the loan (i.e., the terms of the loan) is actually more important than the interest rate.
A business line of credit or loan is different than a real estate loan. You can shop around for the best mortgage rate because once the mortgage is in place, you no longer need to worry about a change in circumstances. But the rate for a business loan is secondary to having a solid relationship with a bank or banking officer. You never know what lies ahead and you may need to call on that relationship in the future. It’s hard to put a price on a great relationship and reliable service.
Remember that you should only use your credit line for things like working capital, accounts receivable and inventory – not fixed assets. Finance fixed assets with long-term debt instead.
The Myth: I need to load up on inventory in case a big order comes in.
The Truth: Back in the old days, banks would lend money on a handshake and competition was few and far between – so the model of buying a lot of inventory and waiting for it to sell worked quite well. Those days are long gone.
A lot of businesses carry excess inventory because they hope they’ll sell it…eventually. Or they go hog-wild and buy more than they can sell because they get a discount if they buy a large quantity. But their owners don’t realize the dramatic cost of carrying that excess inventory or equipment.
Here’s a better approach: Buy what you need to get you through a designated period of time and keep your cash available for other expenses. Better yet, buy only what you have firm orders for. If you have excess inventory, you’re hurting your cash flow, the lifeblood of your business.
The Myth: I own a business with my husband. We are both young and healthy, so we don’t need a buy/sell agreement.
The Truth: If you have a partner in your business – whether it’s your spouse, your sibling or your fraternity brother from college – you need a buy/sell agreement, and you need to keep it current.
Think of it like a prenuptial agreement for your business. You hope you never need one, but if your partner dies or just simply wants out of the business and you don’t have one, you’re in for a lot of headaches and unnecessary expenses. This agreement would help spell out who gets what and the process you’ll use to determine the value of the departing owner’s share of the business. Without one, an unexpected departure could turn into an earth-shattering event that damages your relationship – it happens all too often.
The Myth: I have loyal employees who would never steal from me. Plus, I get an annual financial statement audit, so if fraud were happening, I’d know about it.
The Truth: Fraud can happen anywhere – even in businesses with seemingly loyal, trustworthy employees. No one thinks that their employees would steal from them, but it happens all the time.
Further, your audit isn’t designed to detect most kinds of fraud. Fraud detection requires specific training that most auditors don’t have. Your auditors will look for financial irregularities, but they don’t specifically look for fraud.
Don’t be foolish; implement strong internal controls to help deter fraud. And if you’re suspicious of fraud, get a fraud review – not an audit.
The Myth: Offering a discount to customers who pay their bills within a certain period can speed up my receivables and therefore increase my cash flow.
The Truth: There’s a reason some customers don’t pay you on time – probably because they have cash flow issues of their own. They still won’t be able pay you on time, even if you offer a discount. The customers who pay you on time anyway will be the ones taking advantage of the discount. Even worse, sometimes customers will pay you late and still take the discount.
Get invoices out quickly and have a process to follow-up with your customers. That will give you better results than any discount ever could.
This article was originally published in The Rea Report, a Rea & Associates print publication, Fall 2012/Winter 2013
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.