Should I Close My Credit Card Once I’ve Paid It Off?

Should I Close My Credit Card Once I’ve Paid It Off?

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Closing a credit card once you’ve paid it off might seem like the right decision, particularly if you’ve carried debt beyond your comfort level. Even if you’ve recently paid off a high-revolving balance, it may not be the best strategy, especially if you are trying to improve your credit score as a business owner.

Instead of making a quick judgement call that could impact your credit, it’s best to figure out if closing a credit card is the right decision or not.

Questions to ask before closing a credit card.

Will you spend beyond your comfort level again?

Make sure to examine the behaviors that got you into debt in the first place to avoid it happening again.

Are you worried about identity/card theft?

While this is a possibility, as of September 21 you will be able to freeze your credit for free, regardless of the state you live in. Since creditors have to access your credit history in order to open accounts in your name, a credit freezes can make it harder for identity thieves to affect you financially. You can then easily remove it if you’re applying for a mortgage, loan, or new credit card.

Is there an annual fee?

If there is, it might make sense to cancel it, especially if you don’t intend to use the credit card again. Keep in mind, even if you close your credit card with a zero balance, it will likely remain on your credit report for seven to 10 years.

As long as there isn’t an annual fee, many experts recommend cutting up the credit card or even freezing a card in a block of ice so it can only be used for emergencies. Then delete the credit card information from any online stores like Amazon.com, Target.com and other retailers so it can’t be easily accessed or used.

How long have you had the credit card?

Credit history matters. The longer you’ve had your credit card, the more reporting credit bureaus tend to like it.

How your credit score may be impacted

Closing a credit card may hurt your credit score since it reduces the amount of your total available credit. Credit bureaus look at the ratio of how much you owe on a credit card compared to your credit limits. Most credit bureaus consider any credit card debt over 30 percent of your limit to be a high balance.

Here’s an example of how credit card utilization works. Let’s say you have $25,000 in credit available on four credit cards. You have cards that have $10,000, $7,500, $5,000 and $2,500 limits. If you have $5,000 in credit card debt among all four cards then you’re using 20 percent of your total credit card utilization.

If you decided to close the credit card with $10,000 credit limit on it, even if you aren’t using the card and are carrying a zero balance, then your total credit card utilization jumps to 33 percent.

Besides looking at your total credit card utilization among all accounts, creditors will also look to see how much credit you are using on each individual credit card compared to the available credit. This is known as your per-credit card utilization.

For example, if you have a credit card limit of $10,000, to stay at or below that 30 percent threshold you shouldn’t charge — or utilize — more than $3,000 a month on that card. Keep in mind, even if you charge more and pay off the balance each month, depending on when the credit bureaus report, it could still impact your credit score. This is one reason why some people pay off their charges before the bill is due, to keep their per-credit card utilization below that 30 percent threshold at any time. Creditors often see you as a more creditworthy borrower if you stay below that amount.

Closing a credit card and credit utilization ratio

When you close a credit card, it increases your total credit utilization ratio — meaning you have to carry lower balances, even if you pay off the bill each month, to stay below the 30 percent limit.

Keeping a credit card account open, even if you don’t intend to use it, may help to improve your credit score by lowering your credit card utilization ratio. If you’re not comfortable keeping a credit card open, you can always close one card and request a credit limit increase for another card to help maintain a lower credit card utilization ratio.

Everything You Always Wanted to Know About Inventory Turnover Ratio but Were Afraid to Ask

Everything You Always Wanted to Know About Inventory Turnover Ratio but Were Afraid to Ask

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Editor’s Note: This is one of an eight-part series about key financial terms all business owners should know.

Any entrepreneur who’s worked in retail knows that a misstep in inventory can cost the company money; and getting caught with obsolete inventory when consumer tastes change can spell major trouble for an otherwise-thriving business. Ask anyone whose company is sitting on inventory of fidget spinners or Snuggies. It’s no wonder, then, that would-be investors often take a close look a business’s inventory turnover ratio (ITR) before making funding decisions. Here’s a quick primer on ITR, why it’s important, and how one expert CFO recommends business owners keep the ratio in check.

What is inventory turnover ratio?

ITR is a measure of how efficiently a company is managing the goods in has in stock. ITR is calculated by dividing either sales or cost of goods sold (COGS) by average inventory — depending on your industry’s standard practice. The latter method does not take markups into account, so investors may consider it a more accurate representation of true cost. When divided by the number of days in a given period (month, quarter, year, etc.) a company can quickly tell how many days it is taking, on average, for inventory to “turn,” or sell.

Why is inventory turnover ratio important?

Having too much inventory on hand — or having the same inventory on hand for too long — may be detrimental for a business. Not only does it tie up capital, but it also creates a potential liability as inventory is less liquid than other assets.

Depending on the business, inventory may spoil (groceries or imported luxury food products), go out of style (fashion or fad items), become obsolete (tech products), or otherwise lose value based on how long it is stored. Plus, warehousing excessive inventory can be an expensive line-item. A business’s ability to forecast demand correctly and move through its inventory efficiently can be critical to success.

How can inventory turnover ratio impact your ability to raise capital?

The faster a company turns over inventory, the more successful (and often profitable) it is likely to be. Although there are industry exceptions (ultra-luxury purchases like high-end sports cars and real estate properties), investors often look for companies with products that are in-demand. If you’re considering raising capital in the near future, understand your inventory turnover before you enter into serious discussions. It may be prudent to offer a one-time sale or discount on existing inventory to improve your turnover ratio and decrease the amount of assets tied up in inventory.

Ask an Expert

Even if entrepreneurs have never heard of ITR before, they likely have an intuitive sense of how their inventory is turning. Strategic Funding asked Brad Shanahan, COO/CFO of VitaPerk, the world’s first nutrient coffee enhancer, why ITR is so important for business owners to keep an eye on at any stage.

Why is calculating the ITR — and keeping an eye on it — important?

ITR is important because a company often has a significant amount of money tied up in inventory. If the items in inventory do not get sold, the company’s money will not become available to pay its employees, suppliers, lenders, etc. It’s also possible that a company’s inventory will become less in demand, obsolete, or even deteriorate. If that occurs, the company’s money will be lost. Having slow-moving items in inventory also uses valuable space and makes the warehouse less efficient.

How often should businesses be calculating their ITR? Does it vary based on where the business is in its lifecycle?

In my opinion, a company should calculate their ITR on a quarterly basis (for a rolling 12-month time period), whether an early-stage startup or an established business.

What’s next?

A key to success as an entrepreneur is never being afraid to admit what you don’t know. Don’t know as many financial terms as you’d like to? No problem! We’ve got you covered with the next installment of this series, where you will learn everything you wanted to know about payable turnover ratio. And don’t forget to check out our previous installments on debt to income ratio and current ratio.

Talking Shop at Dinner: The Importance of Having Business Conversations at the Dinner Table

Talking Shop at Dinner: The Importance of Having Business Conversations at the Dinner Table

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When it comes to entrepreneurship, inheriting knowledge at the dinner table may play a big role.

In their research paper, “Dinner Table Human Capital and Entrepreneurship,” Hans K. Hvide, professor of economics at the University of Bergen in Norway and Paul Oyer, professor of economics at Stanford’s graduate school of business studied how fathers discuss their work with their sons.

Although the study only looked at male entrepreneurs — approximately 3,800 young and middle-aged Norwegian men (22-45 years old) — it found several key insights that help all small business owners and entrepreneurs.

Inherited industry knowledge can help.

The concept is simple: if parents have in-depth conversations about their work while eating a family meal, they often pass their business knowledge along to their children. Their kids become more likely to understand industry-specific nuances, which may give them a boost if they become an entrepreneur.

Despite the old adage that it is “Not what you know, but whom you know,” the truth may be that what you know is because of whom you know.

Researchers found that if an entrepreneur started a firm in the same industry as his father’s, the person tends to outperform entrepreneurs in the same industry whose fathers did not work in that industry.

Although the researchers concede some of the success could be due to greater awareness of a parent’s specific industry, general parental pressures or expectations to enter that type of business, as well as similar business interests, they also found something else.

The researchers point to having parents having “dinner table conversations,” which can potentially give children a boost if they go into business in the same or a closely related field. Having that inherent proficiency can also make someone more likely to innovate and become an entrepreneur within that industry.

The funeral business, for example, is an industry that has historically been dominated by family businesses where the next generation of undertakers usually learn the trade from their parents. Typically that means when a new funeral home is opened, an entrepreneur who learned the business as part of growing up will have an advantage over someone who did not acquire the relevant institutional knowledge from family members, the researchers says.

More upfront capital and employees, better long-term results.

The researchers also found these businessmen, who listened to their fathers talk shop, were also more likely to substantially invest a larger amount of initial capital, more likely to have a larger number of employees, and more likely to survive the first four years.

That made these entrepreneurs “positive outliers” the study found because of their large number of employees or high assets.

Use on-the-job conversations.

Surprisingly, many successful entrepreneurs worked in the same industry as their parents, but they used on-the-job observations and conversations, not financial help.

Eighty-four percent of entrepreneurs who started a firm were in the same industry or a closely related one to their fathers’ employment. They reported that they acquired industry knowledge from their parents. The most common method: having conversations at home and observing parents at work to learn the right type of “human capital,” the economic value of a person’s skill sets.

Surprisingly, what wasn’t as common was obtaining help from parents through cheap labor or access to important networks.

Institutional knowledge may counter the Amazon effect.

At a time when more customers are shopping online and retailers and box stores need to counter the Amazon effect, having generational institutional knowledge can make a big difference. It doesn’t matter if you work within professional services, hospitality or medical practice industries.

Track customer behavior and then combine that information with historical knowledge. Offering a more personalized, tailored service can also help, according to a Forbes story “What The Amazon Effect Means for Retailers.”

That’s because price matching online retailers, while offering superior customer service can make a big difference in creating a long-term relationship.

Sue Smith, store manager of Baker Book House in Grand Rapids, Michigan told the CBA, the Association for Christian Retail she will price match Amazon all day long with the philosophy: “Don’t send away empty-handed a customer who is standing right there. ‘I always say to my team that it’s not about the transaction in front of you. It’s about the next one, and the next one, creating an experience where you are inviting them to come back again.'”

Sometimes, going out on your own in a new industry is preferred.

Even if you have insider knowledge, the dinner table capital study also found something else, high-IQ entrepreneurs were more innovative and more likely to strike out on their own in search of greater financial success.

Think of Google and Facebook as well as other technology-based startups that have typically been successful because the founders had an innovative idea for a new product concept, the researchers say.

“The founders of these companies could not have learned the trade from their parents – search engines and social networks did not exist,” the researchers say. “Their natural intelligence and education allowed them to create companies based on innovative ideas.”

Gaining industry knowledge from others.

Unfortunately, not everyone has a relative with the business expertise you need. If you don’t have a parent who has industry knowledge, networking with those who do might be a good way to make up some lost time.

Harvard Business Review offers some great insights in its “When You Agree to a Networking Meeting But Don’t Know What You’re Going to Talk About” article.

First, be clear on your reasons you’re asking for (or accepting) a business meeting. Specifically state if you’re looking to gain information and learn more about the field; or if you would like to discuss long-term business goals in the hopes of potentially collaborating; or if you would like to have a more social discussion to get to know the person.

Next, give a variety of options to set up the length of time and duration to have a conversation This can range from a 30 or 60 minute phone call, grabbing a coffee or a meal, or attending a larger group event like a cocktail reception.

Then, prepare ahead of time to make sure you’re asking the right questions.

If you’re giving advice, ask “How can I be most helpful?” If you’ve asked for the meeting, ask specific questions about the person’s area of expertise ranging from the hiring process to the most exciting projects the person has worked on.

Finally, don’t treat the meeting as a one-off. Follow-up after the initial conversation to establish a connection to help solidify your relationship.

It doesn’t make up for years of dinner table conversation, but it’s a good way to start catching up.

4 must have features for easier payroll processing

4 Must Have Features for Easier Payroll Processing

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Managing payroll can be tedious and time-consuming, but it’s a necessary task if you have employees. Finding ways to streamline the process can make it a less onerous chore, and rethinking your current payroll software provider may be the answer.

If you’re looking for ways to make payroll a less stressful part of your business operations, here are four features to look for.

1. Employee self-service

If you ask your employees whether they’d like to take a DIY approach to managing payroll, the answer might be a resounding yes. According to a Paychex survey, 73 percent of workers would prefer to use self-service tools for things like downloading or viewing payroll information and checking their hours, versus contacting human resources.

Adding a self-service component to your payroll system can also make it easier for employees to handle more mundane tasks, such as changing their address, notifying your business of a life status change (like a marriage or birth of a child), submitting time off requests for holidays or sick leave and filing expense reports – taking those administrative burdens off your shoulders.

2. Mobile functionality

There’s an app for just about everything these days, including payroll processing. Payroll mobile apps are designed to coordinate with your payroll software so you can review hours and approve payroll payments from anywhere, at any time with just a few taps on your phone or tablet.

Some apps do even more than that. You may have the added benefit of being able to set up direct deposit for your employees and/or calculate and schedule your payroll tax payments from your mobile device for even more convenient payroll management.

3. Notifications and alerts

You may already use notifications and alerts to manage your business banking activities and they can be equally helpful for managing payroll. If you struggle to keep up with payroll or tax filing deadlines, for example, you can simply set up an alert to notify you when those due dates are approaching.

Alerts can also be helpful in detecting payroll errors. Your payroll software may automatically send out a notification when the information on an employee’s record doesn’t match up with what’s listed on their pay stub. That can help ensure that employees aren’t being over or underpaid.

4. Diverse payment options

Printing paper checks may not be cost-efficient if you’re shelling out big bucks on ink and paper. Writing out checks by hand can be a huge drain on your time. Adding electronic payment options — such as direct deposit or pay cards — into the mix makes paying employees less of a hassle. Using direct deposit or pay cards can reduce the potential for payroll reporting errors and your employees may appreciate being able to access their money faster.

Switching up your payroll software may require an initial investment but think about the potential return. Upgrading your payroll system could save you time and money, both of which are invaluable for growing your business over the long term.

Nobody's buying? The reasons for poor inventory turnover might surprise you

The Reasons for Poor Inventory Turnover

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Nobody’s buying? The Surprising Reasons for Poor Inventory Turnover

Laurena Reisman, founder of Mishy Moo Pets, periodically takes a close look into items that aren’t selling well on her online pet store. When that happens, she says in an article for iQuoteExpress, she pings previous buyers to get their opinion on the slow-sellers; compares her pricing to competitors; and, most importantly, makes sure that her search engine optimization (or SEO) is still relevant. Prospective customers may be desperately searching for a particular dog collar Reisman carries. But the search engines might not realize she has it in stock.

The reasons inventory isn’t turning over can be complex, critical and illuminating in their metrics. Determining how many times a company has sold and replaced its inventory over a particular period, such as a year can be daunting.

Doing the math

The specific calculation is the cost of goods sold divided by the average inventory. The web site Accounting Explained shows how to calculate inventory turnover ratio using the theoretical example of ABC Company. In this example, ABC has opening inventories of $25,000; closing inventories of $30,000; and a cost of goods manufacturing of $245,000.

The math works like this:

Cost of goods sold = $25,000 + $245,000 – $30,000 = $240,000 Average inventories = ($25,000 + $30,000) ÷ 2 = $27,500 Inventory turnover ratio = $240,000 ÷ $27,500 = 8.73

Check your competitors

You might wonder whether an inventory turnover ratio of 8.73 is a cause for concern or celebration. That depends on the industry. For example, supermarkets, which sell perishable goods, will inherently have a higher turnover ratio than a company with a pricier, slow-moving product, like an automobile dealership.

For that reason, as Accounting Explain points out, WalMart needs to evaluate its inventory by comparing its ratio against direct competitors like Costco.  Knowing the inventory turnover of a manufacturer like John Deere doesn’t tell WalMart if it’s managing inventory efficiently. Nor does it show if sales have slowed and goods are overstocked,

By benchmarking your ratio to competitors, you may discover many insights. For example, you can determine whether your sales and procurement departments are working in sync. The ratio may also alert you that you might be a little too stingy when it comes to inventory. “Sometimes a very high inventory ratio could result in lost sales, as there is not enough inventory to meet demand,” explains Investopedia.

Maintaining your inventory turnover ratio at the right level can keep your business running profitably and well. It lets you know changes you might address that may otherwise escape your attention.

Everything You Always Wanted To Know About Current Ratio But Were Afraid To Ask

Everything You Always Wanted to Know About Current Ratio but Were Afraid to Ask

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Editor’s Note: This is one of an eight-part series about key financial terms all entrepreneurs should know.

Current ratio is an important liquidity ratio that investors and potential investors care about — which means business owners need to care about it, too. Here’s the break down of what you need to know along with expert advice on what your current ratio says about your business.

What is current ratio?

The current ratio, also known as the working capital ratio, measures a company’s ability to pay off its short-term liabilities with its current assets. In other words, it’s a barometer of how much the working capital you have on hand is earmarked for payments. To calculate your current ratio, divide your current assets by your current liabilities.

Why is current ratio important?

Current ratio, taken together with other liquidity ratios, offers investors a snapshot into how your company may perform for the immediate future. Generally speaking, the higher the ratio, the more working capital, the better the company’s health. A ratio below one means a company has more liabilities (debt) than assets. In industries where companies have a lot of assets tied up in inventory, like retail for example, ratios are typically lower.

How can current ratio impact your ability to raise capital?

Current ratio is one of many ratios a potential investor will examine when making a funding determination. Because of the variance of payment terms from industry to industry, current ratio alone is not enough to make a funding decision.

As an entrepreneur, it may help to understand how your current ratio compares to other companies within your industry, and what factors in the near- and medium-term future might impact it significantly. For example, if you’re about to take on a significant amount of debt, or get extended payment terms with a supplier that will shift debt from your short-term to your long-term obligations on your balance sheet, your current ratio might change substantially. Be prepared to answer questions about these or other possibilities when discussing your current ratio with your CPA or CFO.

Strategic Funding asks an expert about current ratios:

In our interview with accounting professional Brad Shanahan, COO/CFO of VitaPerk – the world’s first nutrient coffee enhancer – he breaks down the importance of current ratio and gives startups a bar for which they should aim.

Why is the current ratio an important barometer of a company’s health to potential investors?

Brand Shanahan: The current ratio identifies a company’s ability to pay back its liabilities with its assets, or in other words, its liquidity. The current ratio gives a sense of the efficiency of a company’s operating cycle, its ability to turn its product into cash and its ability to pay its debts.

Is there a current ratio range startups should target to increase long-term viability?

Brad Shanahan: A good range is between 1.2 to 2. A ratio equal to 1 indicates that current assets are equal to current liabilities and that a company is just able to cover all of its short-term obligations, so you want to be above that. A current ratio of 2 is ideal.

What’s next?

How would you rate your financial-terms literacy? There are many more ratios it helps to be “current” on if you plan to raise money in the near future. Don’t forget to check out part 1 of this series, which focuses on Debt-to-Income Ratio.

How to Avoid Growing Too Fast: When Putting on the Brakes is the Key to Success

Is Your Business Growing Too Fast?

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Business Growing Too Fast: When Putting on the Brakes is the Key to Success

Vishal Singh, an entrepreneur in Lincoln, Nebraska, was getting calls from as far away as Brazil and Argentina about his company’s product — technology that could determine if cattle in feedlots were becoming sick.

As the inquiries came from around the globe, Singh gave them an answer you won’t find in many sales books: No, thanks.

He was concerned about expanding too quickly. “We have a product that involves both hardware and software, so we have to make sure there’s no hang-ups on the manufacturing side of it,” he says in an interview with Inc. “We keep in touch with them, but we start with the smaller operations — we need to operate in bite-size chunks.”

Slowing to Succeed

As a business owner, you may want to grow as quickly as possible.  But, growing slowly may be a better path to success. The Kauffman Foundation conducted a follow-up study of businesses that made Inc. magazine’s 5,000 fastest-growing companies list. Five to eight years after landing on the list, two-thirds of the company had, “Gotten smaller, been disadvantageously sold or gone out of business entirely.”

Fast growth, while alluring, may create issues hindering companies from developing the processes they need to succeed, including:

  • The quality of the product suffers as the quantity ratchets up too quickly.
  • Communication breaks down and employees leave.
  • The company cannot collect the money it’s owed fast enough.
  • Leadership takes on too many roles, with too many day-to-day tasks depending on their participation.
  • In the rush to fill jobs, the company hires the wrong people, and the culture declines.

Maintaining Your Vision

The signs of your business growing too fast may include customer complaints, cash flow problems, and mission creep. “When a business grows too quickly, many founders lose sight of their original vision,” writes CEO Brandon Vallorani. “They broaden out so far that their team members forget what the product or service was that built the company in the first place.”

The question to ask is whether your growth is a result of realistic planning, anticipation, and orderly preparation. If your growth is getting ahead of you, your business might be getting away from you. Keep an eye out for the warnings signs of excessive growth, and when the temptation comes to press on the gas when you should be working the brake, remember who won the race between the tortoise and the hare.

5 Ways to free up capital with smarter purchasing

5 Ways to Free Up Capital with Smarter Purchasing

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Part of running a business means spending on inventory, goods, supplies, capital equipment, IT systems, communications, and services. Each month, these necessary expenses means money out the door, and the more you spend, the less cash you’ll have to put towards other strategic initiatives.

By spending less in your regular purchasing, you may end up with more money to invest elsewhere in your business. One way to cut fat — not muscle — by getting smarter about your procurement operations.

Revisit vendor relations and strategies

Habit can be a great tool for efficiency, but may also contribute to sloppy operations. Reevaluation of suppliers is standard procedure in quality control purchasing. Consider the same approach in reevaluating your vendor relations, including:

  • Key suppliers may have increased pricing over time, considering your account a “safe” one.
  • New alternatives, either from existing vendors or competitors, might satisfy your needs at a better cost, or you might find advantageous quantity discounts.
  • Some suppliers may offer vendor-managed inventory to hold products in a separate part of their warehouse. You don’t pay until you take an item to fill a sales order. You get the advantage of lowering inventory investment while maintaining fast availability.
  • On-time delivery, financial stability, quality of goods, and service levels also may affect the total cost of purchasing. Vendors that ship defective items cause you to lose time in returns and miss sales opportunities.
  • A company with warehouses closer to you may be able to provide rapid response to your inventory needs.
  • Between two vendors with similar pricing, the one that it is easier to do business with is the one that is more likely to save you money.

Split core and convenience ordering

Vendors have two rough categories of goods and services: core and convenience. Core offerings are items fundamental to a vendor’s business. Convenience items aren’t a mainstay but might command higher prices and margins because customers don’t want to go to other sources.

For example, an auto parts business with spark plugs, alternators, and mufflers as core items might have for convenience bolts and non-specialized tools. When you buy brake pads, you might remember you needed a 10-millimeter wrench and pick it up there rather than travel to another store.

Convenience buys may make sense if they are a one-time expense, or the time to research a lower price might be better used differently; however, if you need something regularly, buy it from a vendor for whom it’s a core item that must be competitively priced. Better pricing will pay off in the long run.

Cut waste

Take a step back and examine your purchasing strategies. Anything you buy should directly support corporate strategy. If someone in your organization can’t adequately justify a purchase, it shouldn’t be made.

To help cut waste, rationalize inventory levels; only have enough on hand, or quickly available, to cover seasonal, cyclical, or peak demands. At the same time, levels should be as low as possible to achieve these goals. The less money tied up in inventory, the more is available for other uses.

Waste happens in other spending areas, too. Considering having a service perform a full utility audit to see where there may be incorrect billing or waste in electric, water, or sewer. Many consultancies perform the analysis for free and make their money through a percentage of the savings they help you gain (which suggests how often businesses pay more than they should).

Benchmark spending

Benchmarking is the practice of comparing performance to a reference to see how your organization does by comparison.

What seems like a normal level of spending in any area, whether it’s inventory, computer technology, or legal services, may be significantly off from what your peers do. There may be good reasons your expenses in a given area are higher than competitors, but it may also be a signal of spending too much.

There are two aspects to benchmarking. The first is to know and calculate standard metrics widely used in procurement. They include the average cost to process a purchase order, percentage of suppliers that provide 80 percent of spending, the percentage of purchasing budget that is department operating expenses, and cost reduction savings as a percentage of total purchasing spending.

The second is getting access to data from a wide array of organizations in your industry to see how you stand. Get access to the information through benchmarking tools from third-parties, whether analyst firms or professional organizations. The tools are software you use to compare your metrics to the subset of your industry that comprises your peers.

Improve your negotiation skills

Most people in business, including those who work in purchasing, think they are good at negotiating. While they may have natural talent, there are common misconceptions that may work against you. For example, letting the other side go first means you may give up control of the process and be unlikely to get something positive in return. Or you may assume that the other side saying no means the end of a negotiation, when it may be a chance to continue the process and change someone’s decision.

Even people with strong natural aptitude need training to become truly effective in negotiation. If your purchasing people haven’t had training, get it for them. The return on that investment may be immense.

Everything You Always Wanted to Know About Debt-to-Income Ratio but Were Afraid to Ask

Everything You Always Wanted to Know About Debt-to-Income Ratio but Were Afraid to Ask

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Editor’s Note: This is one of an eight-part series about key financial terms all entrepreneurs should know.

Your company’s debt-to-income ratio (DTI) is quick and easy to calculate, and it can tell you a lot about your financial situation. Many entrepreneurs look at this key performance indicator (KPI) for their businesses and their personal finances each time new recurring debt is added or subtracted. Be warned: calculating it may even become somewhat addictive!

What is debt-to-income ratio?

Debt-to-income ratio is exactly what its name implies: A measure comparing the percentage of a company’s debt to its overall income. It is calculated by dividing total recurring debt by gross income. It’s most commonly calculated and shown on a monthly basis, but DTI can be expressed over any period of time.

Why is debt-to-income ratio important?

Debt-to-income ratio is important because it is an indication of how much money is left over after your obligations are paid. This money may be used to promote or grow your business, allocated toward purchases or improvements, or taken as earnings.

The lower your debt-to-income ratio, the smaller your debts are compared to your overall income. That’s why higher DTIs are less attractive to entrepreneurs and their potential investors. The best way to lower your DTI may be to pay off recurring debt or costs, although doing so isn’t always advantageous. Talk to your accountant or CFO if you have questions about your DTI.

How can debt-to-income ratio impact your ability to raise capital?

All lenders will consider your DTI before making a funding decision, because DTI allows them to determine your ability to pay back additional debt. Traditional lenders want to ensure you’ll be able to meet the repayment obligations of your agreement. Equity investors, who may not be recouping money in the immediate future, want to ensure you’re not seeking a capital infusion just to repay existing debt. DTI is an important metric for determining your company’s runway, or the amount of time your business can continue to survive if your income and debts stay the same.

Ask an Expert

Alissa Bryden, author of 100 Entrepreneurs and a CPA at Virtual Heights Accounting explains why debt-to-income ratio is so important as entrepreneurs seek funding for their businesses:

How often should entrepreneurs be analyzing their debt-to-income ratio?

The debt-to-income ratio should only increase when you add additional monthly payments (debt) to the company. Thus, it is an indicator that can be analyzed when new debt is being considered or as a baseline each month, quarter, and year. In this way you can baseline your revenue growth over your monthly debt payments. It is a KPI that is of value to have included with your period reporting (month, quarter or year) but likely does not need to be considered more than that.

Does the percentage of acceptable debt-to-income ratio vary by industry?

Absolutely. Industries which require higher fixed asset purchases, such as manufacturing or construction, would generally have a higher debt-to-income ratio. However, they have hard assets that support the debt. A service-based company would be expected to have lower debt levels in relation to its income. Each case is different and there is no generic template that can be provided. Everything from newness of the market, industry benchmarks, internal finances and growth projections should be considered when determining where a company’s acceptable target is.

What’s next?

You can walk the walk, but do you talk the talk? If you’re trying to secure funding for your startup, it’s important to be well-versed in financial lingo. Check out part 2 of this series where we discuss current ratio.

Inventory Turnover Ratio: Why keeping track is very important for small business owners

Inventory Turnover Ratio: Why keeping track is very important for small business owners

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No matter what type of small business you run, managing your inventory correctly can be extremely difficult.

If you run a restaurant that serves perishable foods, if you order too little inventory your customers will be dissatisfied and you won’t fulfil your potential in terms of how many sales you generate. But if you order too much food, you will find yourself with space wasted, money wasted and food wasted.

Understanding your business’s inventory turnover ratio can help you more accurately manage your inventory. To understand what the inventory turnover ratio is, it is necessary to break down this term to its components:

  1. Inventory: The goods available for sale and raw materials used to produce goods available for sale. Inventory represents one of the most important assets of a business because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company’s shareholders.” (Investopedia)
  2. Turnover: “An accounting term that calculates how quickly a business collects cash from accounts receivable or how fast the company sells its inventory.” (Investopedia)
  3. Ratio: “The comparison of [two] or more quantities which indicates their relative sizes.” (ThoughtCo)

Thus, your inventory turnover ratio is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. It measures how many times a company sold its total average inventory dollar amount during the year. Therefore, a company with $20,000 of average inventory and sales of $100,000 effectively sold its inventory five times over giving it an inventory turnover ratio of 5.

Take a 360 degree view of your business when making inventory decisions. Let’s say you own an auto repair shop that focuses on giving your customers new tires. There are many factors you might consider when making new tire orders:

  1. Suppliers: You must consider if there will be deals or specials from your suppliers given at different times of the year as well as the delivery speeds.
  2. Storage: You must know how much space you have to store your inventory.
  3. Waste: You must consider what percent of tires you receive will be duds that you will have to ship back to the supplier.
  4. Sales estimates: You must look at past sales data to determine which months of the year are most popular for people to purchase new tires.
  5. Discounts: You must factor in if you will offer sales or discounts to your customers.
  6. Timelines: You must evaluate which types of tires are more popular at different points of the year (e.g. snow tires vs. all-season tires.)
  7. Numbers: You must also consider what percent of your customers need one tire replaced (e.g. for a flat tire) rather than changing all four tires on their vehicle.
  8. Growth: You must calculate how fast (or slow) your business is growing.
  9. Trends: You must calculate market trends (e.g. if big winter tire companies are advertising their services, more of your customers may ask for these.)
  10. Competition: You must figure out what your competitors’ strategy is (e.g. if a shop down the road offers to change one tire for $30, you may want to focus your business on selling four-tire packs.)

There are many methods to making sure that you’re inventory is working for you. Perhaps the most important method is called First In First Out, or FIFO, if it is abbreviated. As Casandra Campbell writes about it for Shopify, “It means that your oldest stock (first-in) gets sold first (first-out), not your newest stock. This is particularly important for perishable products so you don’t end up with unsellable spoilage. It’s also a good idea to practice FIFO for non-perishable products. If the same boxes are always sitting at the back, they’re more likely to get worn out. Plus, packaging design and features often change over time. You don’t want to end up with something obsolete that you can’t sell.”

Another important principle to remember is to set “par levels.” Campbell writes:

“Make inventory management easier by setting ‘par levels’ for each of your products. Par levels are the minimum amount of product that must be on hand at all times. When your inventory stock dips below the predetermined levels, you know it’s time to order more. Ideally, you’ll typically order the minimum quantity that will get you back above par. Par levels will vary by product based on how quickly the item sells, and how long it takes to get back in stock.”

Furthermore, remember the 80/20 rule often still holds true: 80% of your business comes from only 20% of your inventory, 20% of your customers, and 20% of your suppliers; however, knowing this, remember to have alternate suppliers ready in the event one of your key suppliers messes up an order or is out of stock.

Keeping an accurate count of your inventory, and correctly predicting your future needs are excellent ways to save your business money. Wasting money on unused inventory is costly and can easily be prevented. Knowing your inventory turnover ratios for each specific item that you require to operate your business are excellent ways to make sure you properly account for your inventory, saving your business both time and money.

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