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Small Business Finance Recently Uncovered – Determining Your Direct And Indirect Costs

There are two types of costs “direct” and “indirect.” Direct costs are also called “variable costs” and refer to costs that are a direct result of producing, delivering, or returning your product/service. Examples of these are materials and labor needed to produce/deliver the product that only occur once you sell the product, transactions costs like visa commissions, sometimes shipping charges, etc.

Indirect costs are also called “fixed costs” and refer to expenses that your business will have regardless of sales volume. Examples of ithese are rent, utilities, wages that are not based upon commission, interest expense, advertising, automobile, etc. The tricky aspect of these are that a cost may increase with increased sales, e.g. an increase in sales may require overtime or the addition of staff but the relationship is not direct.

A good tool for managing direct and indirect costs is to monitor the costs on your monthly income statement using percent of sales. Divide the cost by total sales.

Direct costs as a percent of sales will remain within a narrow margin, e.g. materials costs if 30% of sales at $1,000 sales then materials should be right around 30% at the $5,000 sales level. The actual dollar amount of materials used to produce more products will go up but as a percent of sales, it will remain close to 30%. What would lower the percent is if you got a better deal from your supplier.

Your indirect costs when monitored as a percent of sales will respond differently. For example, rent equaling $500 per month remains $500 per month even if your sales increase to $5,000. $500 divided by $1,000 in sales equals 50%. $500 divided by $5,000 in sales equals 10%. (It is that old math axiom in action here: A numerator divided into a larger denominator produces a smaller fraction.)

So why is this important? Knowing the difference between direct and indirect costs provides you with a couple of valuable management tools, break-even analysis, and your contribution margin. Break-even analysis is a handy management tool for quickly determining if a solution is feasible. Contribution margin is the remaining profit after direct costs are taken out of a sale. For example, if you sell a bookcase for $250 and it cost you $75 to make your contribution margin is $175 or 70%. The contribution pays for all the Fixed expenses/overhead.

A good way of organizing these costs is to put all the direct costs in the “Cost of Goods” section and the indirect costs in the expense area of your income statement. By doing this Gross Profit equals Contribution Margin and is automatically calculated for you.

Another reason to identify your direct costs is when bidding in a competitive environment. Ever wonder how your competitor beat you on a bid??

Imagine a situation where you know you have covered your overhead expenses for the month with normally bid projects. A quick project comes up for bid around the 15th of the month and you have a crew available to work on it. You figure it will be very competitive and if you use your usual estimating process on it you will not get the project. Since you have already covered all your expenses for the month and any margin above your direct costs is profit. Plus you have a crew that it would be better to have working on a project and being paid by a client versus cleaning the shop being paid by your profits. You decide to aggressively go after the project with a bid slightly above your direct costs.

How to Obtain Small Business Loans When Banks Say No

We provided advice a few years ago about what actions business owners should consider if their bank rejected a small business financing request. The earlier advice is now likely to be especially relevant for many businesses since banks are currently saying “no” more frequently than they have in decades because of a deteriorating commercial lending environment.

A bank saying “no” can actually lead to an overall improvement in commercial financing options under many circumstances, although a business owner is not likely to hope for the business loan rejection in the first place. With requests for needed business financing and working capital, small business owners are increasingly hearing their bank say “no”. Most commercial borrowers are often not sure what to do next since such an awkward situation represents uncharted waters for them.

Even for long-term and profitable customers, banks are routinely saying “no” to small businesses. It is now common to hear phrases such as “thinking outside the bank” and “business loans without banks” when talking about strategies small business owners might need to analyze because this has become such a widespread commercial lending problem.

When contemplating the possibility of banks saying “no”, there are two especially common financing situations likely to materialize for businesses. One of these involves working capital loans (including commercial lines of credit) and the other commercial real estate financing. Recent nationwide commercial lending reports clearly show a drastic reduction in commercial loans for working capital loans and commercial mortgage loans, although it is true that a small number of banks are still proving to be reliable sources for some business financing options.

Small businesses have only rarely pursued the option of replacing their bank. There is little recourse but to pursue such a path when their bank says “no” to routine requests for business financing, and astute business owners need to quickly accept this harsh reality. Improvements to the overall financial health of a business will be achieved in a pleasantly surprising number of cases even though this search for new commercial finance alternatives is undertaken under protest by most commercial borrowers. It should not be overlooked that one or two banks often operate in a near monopoly environment in many communities and cities. When small business owners have literally been forced to find new business finance options, they are often pleased to discover that they can not only replace existing bank financing satisfactorily but also improve their bottom line in the transition.

A prudent starting point for commercial borrowers to adequately evaluate how to get working capital and other business loans when their bank says “no” is likely to be a lengthy conversation with a small business financing expert. Finding and selecting such an expert will not be a quick or easy task for business owners, but this step is likely to be critical to eventual success in formulating a strategy for obtaining new sources of effective commercial finance funding. Ensuring that the commercial financing expert chosen is totally independent and not affiliated in any way with the bank which said “no” is an especially crucial aspect not to be overlooked in locating a reliable expert to help.

Small Business Financing – A Useful Tool in More Ways Than One

Great. I found a business that I am interested in buying. Now where am i supposed to come up with all of the money?

For many people out there who are considering acquiring a pre-existing business, the most obvious obstacle which they must overcome is where to obtain the funds for the purchase. Faced with borrowing anywhere from tens of thousands of dollars to a couple of million dollars, many potential buyers find the task all too daunting. Understandably, these people, who oftentimes are making their first foray into the world of small to mid-sized business ownership, do not believe that they will qualify for a loan.

In fact, nothing could be further from the truth.

Most likely, potential purchasers will be seeking a Small Business Administration (SBA) Loan. And the best part about such a loan is that – unlike when a person applies for a home mortgage – very little of the lender’s qualification criteria have to do with the actual borrower. Instead, the lender is far more concerned with the collateral – in this case, the business – and its ability to generate enough income to enable the borrower to successfully repay the loan.

Thus, as you look around, you will find that many businesses for sale are pre-approved for SBA financing. And this can be a tool utilized by you or your business broker to determine if, in fact, the business that you wish to purchase is a viable one. In short, a business which a bank deems worthy of an SBA loan (considering, of course, that the business fits the primary SBA criteria) is in most cases a safer and better buy than one that cannot qualify for said financing.

One of the strongest products in the market today is the SBA 7(a) Loan Program. This loan can be used for nearly any business purpose, including:

  • Commercial real estate purchase or construction
  • Business acquisition
  • Franchise financing
  • Machinery and equipment purchase
  • Working capital and inventory
  • Or a combination of purposes.

The program offers up to 90 percent financing. So, with as little as 10 percent down, purchasing a building is made easier and buyers can keep cash in the business.

The long repayment terms of up to 25 years provide lower monthly payments, improve cash flow, and make qualifying easier. And there are no prepayment fees on loans with terms less than 15 years.

The program does not carry any balloon payments. The loan is fully amortized so there is no need to worry about refinancing.

The loan amounts offered can be as high as $2 million.

And competitive variable or fixed rates enable clients to choose the rate that works best.

The Firm for which I work, Ridge Partners, has longstanding relationships with leading lenders in the SBA and Commercial Real Estate financing industries. Members of the Firm have some of the strongest financing backgrounds in the industry, and are well-schooled at arranging loans for clients. This works not only to the advantage of our buyers, but also to that of our sellers.