When financing a business, owners commonly mistake the difference between the amount of credit they think they need versus the amount they actually need.
The error comes from a lack of proper forecasting and budgeting of cash flows, says Mark Bober, partner at Akron-based Bober, Markey, Fedorovich & Co. He says the investment in working capital in a typical business varies between 15 percent to 60 percent of sales.
“If you have an investment of 30 percent in working capital, then, if you grow your sales by 15 percent, not all of that increase in sales over a gross profit margin is going to fall to the bottom line,” Bober says. “It’s going to fall to the bottom line in terms of profit but not in terms of cash flow because that portion of it is going to be tied up in working capital.”
As the borrower, the business owner is responsible for presenting the lender with financial information that reflects the true and correct results of operation and the financial position of the business; and in some credit agreements, the business owner must report receivables and inventory numbers on a daily, weekly or monthly basis.
“Then that would be the basis for how much they advance on the loan,” Bober says.
Banks often give a line of credit based upon a company’s accounts receivable and inventory on the working capital line of credit. Bober says the lender is typically going to advance at between 80 percent and 85 percent of a business’s eligible accounts receivable and between 50 percent and 60 percent of a business’s eligible inventory.
Bober suggests business owner ask themselves the following questions to determine whether they have opportunities to accelerate cash flows and manage their working capital more properly.
* What type of efforts are being made to speed up the collection of receivables?
* Does the business send out monthly statements to customers, showing what they owe?
* Does it make collection calls to customers?
* If there are discrepancies between what is billed and what the customer thinks should have been billed, are those calls investigated and resolved on a timely basis?
And for those who want to expand their credit line, Bober suggests the following steps.
* Budget and forecast. Bober says having a business plan in place that includes budgeting and forecasting gives the lender a good picture of how the business is going to be operated into the future.
* Consider management. “(Banks) are lending to a business but they’re also lending to an individual,” he says. “The credibility of the individual becomes a very important factor in the eyes of the lender.”
* Review the payables. If vendors are expecting payment within 30 days and the average aging on payables is out 90 days, it’s going to be a problem for business owners trying to expand their line of credit or renew the line of credit. “That is going to be an indication to the lender that the business may be undercapitalized, and it may be a situation that’s just going to continue to get worse,” Bober says. ” … (Lenders) don’t want to be funding losses unless there’s a path to profitability and to repaying their debt.”
* Have reliable and timely financial reporting. “Depending on the way your loan agreement is structured, you may have to get an accounting firm involved (because) it may require compiled, reviewed or audited financial statements,” Bober says.
* Make sure there are no surprises. The lender wants to know what’s going on in the business as soon as the business owner knows. “(The lender is a) business partner … in the sense that they’re not an equity partner, but they’re helping you fund your business growth,” Bober says.
HOW TO REACH:
Bober, Markey, Fedorovich & Co., (330) 762-9785 or www.bobermarkey.com
