What would you do if you lost a customer that represented more than 60 percent of your business? How about if a key employee jumped ship and joined the competition? When customers pay late, equipment is tied up in repair and vendors come knocking, business owners can run out of the “liquid” that fuels business operations: cash.
“Hopefully, a banker is talking regularly with customers and asking relevant questions along the way so there is an indication that a business may be heading toward a performance downturn before it happens,” says John Covington, vice president of business banking at Fifth Third Bank in Cincinnati. “I can’t stress enough the importance of ongoing dialogue with your banker.”
Smart Business asked Covington how business owners can plan for tough times and work through them with successful results and, in effect, a stronger relationship with their bankers.
What obvious signs indicate to a banker that a business is in trouble? What can cause a ‘tough time’?
Usually, bankers suspect when businesses are experiencing a challenging operating cycle. The trick is to pay attention and be prepared before events impair their ability to pay any principal and/or interest due. Businesses may appear on an overdraft report and rely on overdrafts to cover checks written to suppliers or employees, or banks may notice lack of timely correspondence. Owners may delay sending in financial statements or ignore phone calls from the bank. Finally, the financial statement may reveal that an operating covenant has been violated.
The events that can cause owners to pay late or not at all range from a slow economy, lengthening inventory turns, increased competition, changing technology, different payment terms from customers or vendors to losing a key employee or customer. Bankers who do their jobs are asking about these issues before they become concerns for business owners. Similarly, owners must be honest about changing business conditions and how this will affect their ability to perform and, ultimately, pay the bank.
When an owner approaches the bank during a tough time, how will a banker work to develop a solution?
It’s always better to plan for a potential problem so you can work through tough times rather than waiting to react to them. But business owners who are tied up in daily operations often let financials slide too far before realizing they must turn around their situation before a ‘tough time’ sabotages the business’s potential for success. That said, bankers will review company financial statements and compare performance to past years, quarters and months.
Furthermore, how did the company perform relative to the established financial covenants? Just because a company may trip up, a covenant does not necessarily mean a bank will ask for its money back.
Set appropriately, financial covenants serve as an early warning system that, when breached, forces dialogue between the banker and the borrower. Bankers dig for reasons and ask, ‘Why? Why is inventory turning slower? What is putting a crimp in cash flow? Is it different vendor payment terms, slow-paying customers or unexpected operational expenses? Why did a key employee leave? Did the business offer him or her a profit-sharing plan or incentives to stay? What is the company’s customer concentration profile should the business work to diversify?’
After reviewing the ins and outs of the business, bankers will address areas where owners can cut back. For example, if the income statement shows a business is not earning enough money to pay for its operations, then an owner must either generate additional profitable revenue or remove a layer of expenses. The banker then works as an adviser, helping the owner to work through scenarios to improve the financial outlook of the company.
What preventive measures can owners take so they aren’t putting out fires?
Develop contingency plans to address risk factors in the business, and update those plans on a regular basis. For example, one of my clients lost a customer that represented 80 percent of his business. This was a big loss, but the owner knew how to react. He had a plan. First, he recognized that relying on a customer for such a large portion of overall revenues was risky. But the company’s overhead structure was such that the owner could control expenses and make adjustments if necessary. He planned to pay down the building loan so he wouldn’t have this fixed, monthly payment. He had a ‘skeleton staff’ he could rely on if he had to cut labor. So when he lost this customer, he acted on his plan. Today, his business is smaller, but it’s still profitable. Because he could react quickly, his business didn’t miss a beat, and his financials did not suffer.
JOHN COVINGTON is vice president of business banking for Fifth Third Bank. Reach him at firstname.lastname@example.org or (513) 530-0791.