Hans Kasper, MS-CPA, PS

How To Internally Finance Your Business
 

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The ability of a company to function without debt is closely related to the owner's understanding of the internal financing ratio (IFR) and its interrelationship with the daily operations of the business.

This ratio not only can measure the stability of the company's current financial position, but can also, with projected financial statements, model that stability into the future; thereby allowing, companies of different sizes and industries to be compared with each other.

While the IFR is closely related to cash flows, it also takes into consideration the company's ability to generate a net income of sufficient size and what that size is relative to operating costs.  Let's face it, your company either is out of gas, is pumping unleaded, or is running on jet fuel--the choice is yours by design as the owner.

While the IFR has various levels of calculation (primary, secondary, and ultimate), if your company is not making the grade at the primary level, you are not going to survive your competition who are at the secondary and ultimate levels.  At that point, the only reason you are working for is a paycheck and not the enhance value of your business in a private sale or an IPO.

I have heard it said that there are two times in an economic cycle when companies go bankrupt.  The first is two-thirds of the way down into the downward portion of the cycle and the second is one-third of the way up into the upward portion.

The first type of company runs out of cash because they were not managed properly during a good economy and did not trim expenses quickly enough during the downturn.  The second type of company survives the downturn, but runs out of cash on the way up as they do not have enough surplus to fund the growth in the upward cycle.

The internal financing ratio blends together all three financial statements--the balance sheet, the income statement, and the statement of cash flows--into one single ratio.  In addition, there is:

  • the minimum cash ratio,

  • the one turn period ratio,

  • the one turn breakeven ratio, t

  • he turnaround ratio, and

  • the years debt ratio.

Once the main causal elements of the IFR are determined, the critical success factors and the important success factors of the individual company that are inherently linked to the main causal elements must be determined and acted upon.  The critical and important success factors are those items which will cause your company to succeed at the ultimate IFR level is acted upon or will cause you company to go out of business at the primary IFR level is not acted upon.  All other factors or elements within a business are of little importance at the Board level as they will not cause your business to succeed or fail.  Unfortunately, these are the factors to which the owner generally pays most attention--it is called putting out the fires.

Therefore, the IFR is most intimately involved in the planning process and can be most easily translated into the implementation process through lower level definition and re-definition of the critical and important success factors.

As a matter of fact, each person within a company should know what their critical and important success factors are and how they relate to the IFR and the ultimate success of the company at the ultimate IFR level.

In addition, while the main causal elements of the IFR are fixed and never change, the critical and important success factors will be ever changing--some over years and some quarterly.

To be able to learn more about the IFR, critical success factors, and important success factors, click here to order How To Internally Finance Your Business.

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This page was last updated on 05/13/2010

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