Hi all,

I am hoping someone can help me. I started with my company about 6 months ago and had a huge mess to clean up from the last three years. I believe I've helped get things back on track, but I am having trouble explaining a few things to my boss. Here are the basics:

Our bills are being paid at 25 days aging (which they were up to 60+ days)
Our line of credit balance has been reduced by half
Our net profit is lower than last year - approximately +65k
We have negative retained earnings
The owner withdraws approximately 24k in shareholder distributions monthly

So, the question I continue to be asked is, how are we paying our bills (roughly on time in his eyes), reducing our line of credit, yet continuing negative retained earnings. Additionally, he wants to add more expenses with two new hires before the end of the year, which I am hesitant about. I fear it would create a loss this year.

I only have a general knowledge of financial analysis and this is stumping me. Thanks in advance.

Retained earnings go up or down each quarter based on the net earnings for that quarter minus shareholder payments. I assume your net profit figure includes the interest and principal payments that have allowed your loan balance to decrease, but don't include the share owner payments, right? If you have earnings of $65K for the year and pay out $24K per month (that's $288K/year) in shareholder distributions, your retained earnings are going to get even more negative.

I think the question you have been asked is a fair one, where is the cash coming from? Obviously you are paying dividends out of capital, in other words the capital of the organisation is being withdrawn or repaid. You speak of having a line of credit, this means that you are indebted to a bank at some point each month. One reason could be that your sales are expanding rapidly on very favourable margins

Yes, that is my understanding. That the net profit at the end of each year is really what the owner has to draw from. However, he is overdrawing, so there will essentially be a loss at the end of the year, right? We can continue to operate, which we are, but I don't believe this is good for business long-term.

The line of credit is primarily to pay our vendors for inventory. When I first began, the line of credit was almost at $1M AND our AP was upwards of $700K. Through diligent bookkeeping and organization, our line of credit is roughly $450k/month and our AP is around $500k. Our inventory valuation is also lower, at about $450k/mth. We pay most vendors through AMEX each month (to earn the % back) and then pay that off each month with the line of credit. Then, I work each month to pay down the loc through AR. I have a monthly goal of reduction of $30k each month and so far, I have been able to meet that goal, sometimes exceeding it AND am able to keep our bills up to date. Sales are lower, so I can only attribute it to better bookkeeping and organization. The margins are roughly 30%. However, we had some major expenses this year with an office move.



I think the question you have been asked is a fair one, where is the cash coming from? Obviously you are paying dividends out of capital, in other words the capital of the organisation is being withdrawn or repaid. You speak of having a line of credit, this means that you are indebted to a bank at some point each month. One reason could be that your sales are expanding rapidly on very favourable margins

It seems to me you need to explain to the owner that the money withdrawn comes from the line of credit and he needs to reduce this because it isn't coming from profits