By: Mike Kavanagh and Mark Borkowski
Access to capital/ liquidity (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 our experience, increasing sales and production with an eye to costs is paramount. Entrepreneurs are typically very optimistic and charge ahead with only a sketch of a plan to operate the business.
Ultimately, we have seen high growth businesses get in trouble for some of the following reasons:
1. Accounts receivables are not collected in a timely way. Collection is secondary to securing new customers and increasing sales to existing ones.
2. Inventory levels increase at a level far greater than the sales increase. The prospect of deals entices unneeded bulk buying.
3. Because of these issues, Trade Payable days increase. Suppliers start to get nervous as their payments are delayed.
The typical fall back position to this is use the Operating Line of Credit (LOC) to make up for the liquidity issues the company is faced with. The Bank’s Line of Credit is designed to assist with liquidity of the business provided the company is operating under the lending and covenant parameters as set with the bank’s/lenders 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. We have examples of companies using the LOC for equipment purchases, payment of bonuses, buying of businesses, etc.
In addition to the covenants which are monitored by the bank, the LOC utilization is also closely looked at. If the LOC remains at close to the authorized level for a length of time, then the bank will request that the utilization be lowered and will want to see more fluctuating activity with the balances.
Finally, what most businesses and the entrepreneurs 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 in 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 utilization by a certain time. If these are not satisfactorily met, then further action from the bank/lender will undoubtedly commence.
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 /refocus especially if there has been a difficult year. As a former lender, I have en 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 a trust between you and your bank/lender. Managers who get in this routine advise that is a great discipline and forces them to focus on all aspects of the business including cash flow/liquidity.
Entrepreneurs are generally reluctant to impart bad news but speaking as a former commercial lender, it is easier to deal with bad issues rather than having surprises thrust upon them. Lenders do not like problems, (who does!!), but will work with companies who are forthright with results and have realistic plans to correct issues.
Don’t be afraid to ask for concessions, higher limits or better rates especially if there are well founded reasons for doing so. But communication is the key. You need money and they have it.
Failure to provide meaningful reports to your stakeholders, investors, lenders could jeopardize your sources of liquidity and choke off needed funds and hamper growth. Be proactive!
Don’t wait for the Lenders to give you their plan, you probably won’t like it!!!
Michael Kavanagh | Managing Director
Argent Capital Advisors, Capital advisory services for the SMB sector
40 Village Centre Place | Suite 200
Mississauga, Ontario | L4Z 1V9
T. 905 766-3354
And Mark Borkowski is president of Mercantile Mergers & Acquisitions Corp. Mercantile is a mid market M&A brokerage specializing in the sale of privately owned companies. He can be contacted at firstname.lastname@example.org or www.mercantilemergersacquisitions.com