The Banks Will Take You Part Way

For many small businesses, especially young ones, bank financing is a key part of the financial structure.  It will pay you to understand how it works, what limits there may be, and what you can do to make it work better for you.

First of all, you need to notice that banks are not risk takers.  Their view of the world is that you, the borrower, should be taking more risk than they are taking.  Many novice business owners think that banks are there to supply their financial needs.  They are not.  They will help to the extent that it does not put them at risk.

Failing to understand this point is harmful for immature businesses.  It is easy to become over-committed and the bank will not pick up 100% of the resulting tab.  Maybe two thirds if you are lucky.

Many years ago, I had a client who was making money hand over fist.  They were expanding their territory, buying machinery, hiring people and best of all selling their product at previously unheard of  levels.  Much of what they sold was leased to their customers.  They had deals with three financial institutions who purchased the leases as they were created.  Usually within 30 days of the delivery.  They also had a line of credit with a Big 5 bank to deal with fluctuations.

What happens when the lease buying institutions slow their purchases while you are ramping up sales and production?  Very bad things happen.  Within a period of about 10 weeks, they went from solvent and growing to insolvent and liquidating.  Price adjusted, in the last 6 months of business they earned in excess of $1,000,000.  They still went broke because they could not handle the cash flow.

Their bank line of credit would have needed to grow to six times what was authorized and they would have needed to cut back their growth.  You cannot do either of those things in a short period.

When you are growing be very cash aware.  It is possible that your worst enemy is an all-star salesperson.  Growth, even profitable growth, is not necessarily a good thing.  It must fit into your cash timetable.  A profitable sale that turns into cash 30 days from now is not going to meet this weeks payroll or pay the suppliers.

Rapid growth hurting new businesses happens more than people realize.  It is not restricted to new businesses, but with older ones the problems are more complex.  The “Where’s the Beef” series of ads were very good for Wendy’s sales, but founder Dave Thomas later noted that they very nearly put them out of business.  Cash was not the problem but logistics was.  To sell more hamburgers, you need to buy the meat, the bun, and the condiments in the right numbers.  You need more fries and more soft drinks and more staff and maybe even more equipment and parking and even restaurants.

None of those things appear without planning and action well in advance of the need.

Like the logistics, banks will participate in growth to a reasonable share of the price, but they will not normally participate after it happens and especially when it does so in a chaotic way.  To expect them to do so is acting contrary to human history

Business is about balance.  Uncontrolled growth, while nice in some ways, is usually harmful.  When you are growing quickly it pays to step back and project where it is leading you.  Talk to accountants and bankers before you need the cash or the logistical changes.  Consider your depth of management.  Be proactive and be very fussy about what sales you accept.

The one true indicator that trouble is just around the corner is this. You are spending more of your time collecting receivables, deferring payables, borrowing from friends and relatives, taking nothing for your own needs and complaining about the banks.  Cash flow failures are first seen as time pressures.  That is time you should have been using to operate the business efficiently.  A double loss.

Don’t be impatient.  Controlled growth wins.  Sometimes turning sales away is a good decision.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.