First, spend a couple of sentences summarizing the Concepts in Action video you watched this week. Then, answer the following. In the Concepts in Action video you watched this week, the speaker mentioned that for a small business, having payment terms is like using "free money" for a while. What do you think this means? And in your personal financial life, can you think of a situation where you also have access to using free money for a little while every month?

Working Capital Management

Alan Litchman: My wife and I, in 1998, we bought Finagle-a-Bagel. So it was in October of 1998. The company was about four or five years old at the time, and it was about four stores, and me and my wife were working in corporate industry, in corporate America, and we decided we wanted to do something on our own. So we bought a little company here in Boston, and so far its been great. Litchman:

Hi, I am Alan Litchman, and I am co-president and owner of Finagle-a-Bagel.

Laura Trust: Hi, my name is Laura Trust, and I am owner and co-president of Finagle-aBagel. Why did we think it was a sound investment? You never know if its a sound investment. I mean were going into a business we know basically nothing about. We had never been in the food business before. Entrepreneurship, to some degree, is a little bit of, you know, faith, and luck, and hope that its going to turn into what we think it could be.

Litchman: You know if we want to revamp a store and we want to, you know, spend a hundred grand to bring some equipment that maybe will make different products, things of that nature, we try and look down and see how many people are going to buy the new stuff and then what type of profit would you make from it. And does it justify the cost? So what we try and tell our team members and our managers is that, if someone walks in from the street and buys something and gives you a dollar, you really got a dime. Okay? Because 90 cents, in essence, has gone to pay the lights, pay the employees, things of that nature, in terms that are really simple. So if you want to spend a thousand dollars on something, you need to get $10,000 in to justify it.

Trust: You need to do pro-formas and things like that to understand where the opportunities lie, and what kind of capital you would be required to continue to grow it. So theres some financial aspects to mapping out the future, but at the end of the day you just have to have a sense that theres something there thats going to continue to grow for you.

Litchman: Well, umcash flow questions are great. Cash flow is a very difficult thing in a small business. The first thing that, you know Im 44, so I came of age with computers, and so its wonderful that a color screen came into play a few years back, and you could see red and you could see black. And red is when you dont have cash flow and black is when you do have cash flow. So the first thing that you need to really understand are banking relationships. So youve got to start with a good bank, and then you can try and really understand how to model your business.

Trust: The reason why we were comfortable taking on debt versus going with a venture capital partnerI want to qualify thatwe werent comfortable taking on debt. Its a necessary evil when youre going into business. The reason we left corporate America is we didnt want to work for somebody else. So when you, in essence, take on a venture capital partner, youre putting yourself right back into a situation where youre working for somebody else. And that wasnt our goal. So we understood we had to take on debt. We also understood that, if the company continued on the path that it was on, and we opened the right stores in the right locations, the cash flow would allow us to service any debt. And we understood what the time frame was for the amount of debt that we took on. We understood the payback schedule, and we had a plan.

Litchman: And so you have to try and decide, whats it going to cost you to borrow the money. Whats the opportunity cost of using your own money that might be in the stock market or something of that nature, when youre putting it into a business. And youve just got to make those decisions all the time. Since weve been doing this, people value companies in multiples, and multiples on product have gone from 10 times earnings, to basically negative earnings, now theyre probably about four or five times earnings. Okay? So thats a big change over 13 years.

In interest rates, weve seen borrowing rates go from almost in the double digits down tonow I think we pay .25 or .45 in our line of credit. I mean, those are big differences. And all that plays into when youre making decisions.

Theum, the question about buying things and owning things, or renting and leasing is a great question, and its something that you really have to think hard about short-term and long-term. In a small business you never have any monies, but you know in the long term its better to own things in this case. And one of the things that we found is that we knew by owning real estateand you see, were in New England, and real estate in New England is scarce.

And the things we were able to get our hands on are wonderful sites, and weve always felt that, if we ever had a problem, we have equity, and wed figure out some other way to deal with these things. Not knowing what the problems would be, but 10 years later with the recessionthe irony in the recession is a lot of our sites are great banking sites. And banks were, they were, they were ringing our bell left and right to try and get their hands on some of these properties, which they thought we leased. And it turns out we owned them, and it was great. We were able to reposition properties, get our cash flows better, and in some cases these banks were our lenders to our company and it gives us a little bit of leverage to renegotiate things.

On the retail side, its the exact opposite of selling bagels to grocery stores. The retail side youre receiving your money immediately, but you dont have to pay your bills for 30 days. So, while 50% of our money is cash and 50% is credit cards, thatcredit cards come within 24 hours, so, in essence, all of our revenues come in immediately, which is great, on the retail side. You know, you dont have to pay those bills for 30 days, so obviously youre cash flow positive, and you have a little bit extra, and you can earn a little interest and things of that nature.

The selling bagels to the grocery stores is the exact opposite. You have to pay for everything with your suppliers, probably within 21 days, or maybe 30 days because youre buying in larger quantities. And you dont get paid right away. And one thing weve learned is you dont always get paid what you agreed that sale price was, because theres so many programs. Grocery stores, you agree with the price, and theyll say, Well, wed like to put your program on sale, can you give us a discount price? Wed like to advertise it. Lots of different things are helping your top line, but they hurt your bottom line, and theyre unexpected.

We try and establish terms to get paid, and we try and have rules, and we try and have people sign off on things, which obviously include interest if you dont pay it, it covers some administration costs and things of that nature. Its actually quite the opposite. In very large companies, if they, lets say they owe you $50,000, and they send you an email and they say they were about to pay you the $50,000, but you need to pay an administration fee of $45 for something. You need to respond to this e-mail. And if you dont respond to it, they charge you $300 for not responding to the e-mail. And one of our large customers charged us $6,000 in 30 days on a $20,000 bill because we didnt respond to e-mails. So its quite the opposite.

So you definitely need a line of credit, and you definitely need some surplus, and you definitely need a good accounting department to go get the money.

Trust: There are various ways that the company uses credit in its ongoing operations. One of the ways is through trade credit, which is the amount of time you are given to pay back your vendors for the products that you buy. And the longer the terms are for your trade credit, the better off you are, because it allows you the time to get paid for the products that you used the ingredients or the paper or whatever it is to sell to your guests and have the money in your pocket. So weve been very fortunate to work with some very flexible vendors, who have allowed us decent terms to get them paid back for the product that we buy. And that trade credits been very important to us over time.

Some vendors arent as flexible with it as others, but many of the larger ones understand small businesses and the needs that they have. So thats been a great thing for us. The use of that, sort of, free money, if you will, is vital to businesses our size, particularly ones where the product doesnt necessarily get sold right away. So you bring in a truckload of flour, before that flour becomes a bagel and gets sold and you get the money in your pocket, its a fair amount of time. So the longer you have to get that money back before you have to pay your vendors isis good.