By Mark Borkowski
Access to liquid capital (cash flow) is critical for the growth and survival of business.
By Mark Borkowski
Access to liquid capital (cash flow) is critical for the growth and survival of business. You would think this would be top of mind for entrepreneurs, but in most cases it is not. In my experience, increasing sales and production with an eye to costs dominates the thinking of small business owners. Entrepreneurs are typically very optimistic and charge ahead with only a sketch of a plan to operate the business.
But growth can be as great an enemy as slow sales. I have seen high-growth businesses get into trouble in many ways. One common one is when accounts receivable are not collected in a timely way. Aggressive, growth-oriented owners often consider collection secondary to securing new customers and increasing sales to existing ones. Sometimes inventory levels increase at a level far greater than the sales increase. The prospect of future deals entices unneeded bulk buying, leaving an unproductive liability on the books. When these issues hit, trade payable days increase. Suppliers start to get nervous as their payments are delayed.
The typical fall-back position is to use a line of credit to make up for the liquidity issues. The bank’s LOC is designed to assist with liquidity of the business provided the company is operating under the lending and covenant parameters as set with the offer of finance. It is designed to address liquidity for the current assets section of the balance sheet. Too many entrepreneurs view the LOC as an open vault door where the company, without restriction, can access the funds for whatever reason. I have examples of companies using the LOC for equipment purchases, payment of bonuses and buying of businesses. Believe it or not, LOC utilization is watched closely by lenders. If the LOC remains at or close to the authorization limit for a length of time, then the bank will request the use be scaled back and will want to see more fluctuation in the balance owing.
Finally, what most businesses owners fail to recognize is that the LOC is demand financing. This means that the lending facility is granted at the pleasure of the bank and can be called at any time, for any reason. Again, we have examples where the financing has been called or the company put into special loans with little or no notice. Typically there are warning signs (increasing calls from the bank account manager) or letters requesting either financial improvement or lower use by a certain time. If these are not met to the bank’s satisfaction, then further action from the lender might commence. To stave this off, it is vitally important for the borrower to present a plan to the bank outlining what the plans for the upcoming year will be. It is also important to explain results, either good or bad, and offer definitive courses of action to correct and refocus, especially if there has been a difficult year. As a former lender, I have seen examples of businesses submitting year-end financial statements with not even a covering letter. In one case, the results were dreadful with no explanation and no plan.
It does take some practice, but thinking like a public company and providing updates and reports on the business, good and bad, will enable the company to build trust with your lender. Managers who get into this routine advise that it is a great discipline and forces them to focus on all aspects of the business including cash flow. Entrepreneurs generally are reluctant to impart bad news, but speaking as a former commercial lender, it is easier to deal with bad issues than surprises. Lenders do not like problems (who does?), but will work with companies that are forthright about their results and have realistic plans to correct issues.