Today, many companies are focusing on cultivating close relationships with their clients to enable them to offer a “total solution” approach.
Some smart banks are following this lead, and this includes the area of credit line management. A bank’s close relationship with a client is key to its ability to respond appropriately, such as increasing a line of credit at an opportune time, says John Sassaris, vice president of MB Financial Bank.
Smart Business spoke with Sassaris about what a working capital line of credit is and what a company should look for in a lender offering such a product.
What is your definition of a working capital line of credit?
It’s a vehicle that allows a company to fund its short-term cash flow needs. Cash flow needs arise during the course of operations, and oftentimes an entity’s receivable collections do not match up well with the demand for cash. That is when a revolving or working capital line of credit is used to help bridge this gap. Over time, as companies achieve profits and retain those profits within their balance sheet, the need to draw on a line of credit for working capital diminishes. The company, in essence, is generating its own working capital based on these long-term actions. However, it is still prudent to maintain a line of credit as it can be used to handle seasonal cash flow issues and take advantage of buying opportunities.
How does credit line management differ today than in the past?
I think, generally speaking, companies use their lines of credit in the same manner they always have. However, today, the global economy dictates a different cash flow cycle. Whereas 25 years ago, manufacturing was generally confined to domestic operations, today, most products are manufactured overseas. This has created a kind of extended cash flow cycle as often-times you are paying for product while it is still in transit. Maintaining an appropriate level of credit is important, as oftentimes you are dealing with the unexpected. Further compounding this issue is that these supplier relationships are often new, and domestic entities are likely not granted much of a credit line from the overseas manufacturers. This eliminates what is essentially the cheapest form of financing for clients, as they do not have the ability to take advantage of terms from their suppliers. That is why communication between the company and the bank is critical, so that you can address these types of issues before they become problems.
What happens if you have too much credit and use too little or vice versa?
From the bank’s perspective, if we commit too high a number and it is not being used, it is actually costing us money. So we attempt to meet the customer’s request, while taking the actual anticipated use into consideration. Ultimately, we review the matter annually, and after the relationship has seasoned, we can determine the appropriate level.
On the flip side, from our clients’ standpoint, I think the line should always have room to accommodate unexpected events within their daily operations. Essentially, it goes back to managing the cash flow cycle and anticipating the unexpected. If a receivable doesn’t get collected or if a machine goes down, you need flexibility on your line to allow you to react quickly to such matters.
How does a bank determine how much credit to give a company?
For new relationships, we rely heavily on the expectations that the prospect has for the future and how those relate to its past performance. Once it is a seasoned relationship, we really look to the historical movement on the line of credit and the corresponding cash flow cycle. If there is a history of payments and draws on the line, it generally means that the company is using the line appropriately. We may increase or decrease the line depending on the client’s future need.
JOHN SASSARIS is vice president of MB Financial Bank. Reach him at (847) 653-1848 or firstname.lastname@example.org.