One of the best things a company can do to bolster its case for a line of credit is to invite bank representatives to take a tour of its operations, says John Holland, Vice President and Business Development Officer at Consumers National Bank.
“When you meet at the bank and you’re sitting at the table looking at numbers, it can be difficult to convey what you want to do with your business,” Holland says. “If you’re able to bring people from the bank to your business and show them what you’re doing and offer a sense of what you could do with additional funding, that will be to your advantage.”
When you can share your goals and a clear sense of purpose with your bank, it puts you in a much better position to secure additional funding support.
“You need to look at your bank as a financial partner in your business,” Holland says. “In the same way that your accountant or your lawyer wants to help you, your bank has the same goals.”
Smart Business spoke with Holland about how to best position your company to secure a line of credit from your bank.
What are some key things to think about when pursuing a line of credit?
The most important thing for the banker is to understand what is causing or driving your motivation to get a line of credit. Is it to increase your productivity? Is there a gap in your current operation in which a customer is stretching out your receivables? Do you have too much inventory?
If you want to expand your market and go into a different market, you’re going to need working capital in order to help you get through that cycle. You need to determine the time frame and work with your bank to determine the line of credit that would best meet your needs.
How do banks determine an amount for the line of credit?
Banks generally use a formula to determine what an appropriate line of credit amount would be. First the bank will want to know your cash conversion cycle, which is basically the time between spending money to make your product and the collection of money from the sale of the product.
In order to determine the conversion cycle length, you will need to answer questions such as, ‘How many days does it take to make your product? How long does the product sit in inventory before it’s sold? How many days do you have to pay your vendors? How many days does it take for your customers to pay you?’
For example, let’s say you determine that your cash conversion cycle is 30 days and you expect your total sales to be $1 million this year. Divide the sales by 365 to get the daily sales average, in this case $2,740. Multiply the daily sales average by the cash conversion number (30 x $2,740 = $82,200). In this example, a line of credit amount of approximately $85,000 would be appropriate for your company. Of course, if your company’s sales are seasonal, you may need more financing during your busy season and less when business slows down.
Each time you prepare a set of financial statements, it is a good practice to recalculate your cash conversion cycle. If that cycle begins to lengthen, it may be time to reevaluate your line of credit needs with your banker.
How can the bank help after you get the line of credit?
One thing banks have done to facilitate lending is to use a borrowing base line of credit. Every time you want to draw on your line of credit, you send the bank a certificate that shows the status of your inventory, your receivables and your payables.
The idea is to make sure you are within the scope or parameters of the line of credit. This protects both you and the bank.
The borrowing base line of credit is a positive approach intended to help your company grow conservatively. Your bank is right there with you on a monthly basis to help you stay ahead of your finances. It’s all about enabling the bank to be a financial partner in your growth plans.
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