Monday, September 1, 2008

Five Actions to Take in Times of Tightening Credit Markets

Whether we agree with it or not, small and medium-sized business owners are entering into unprecedented turmoil in the financial markets (USA Today Article). No matter how good your product or service is, the survival of your business depends on your careful and thoughtful navigation through these potentially dangerous times. We've organized a list of five important ways to make sure your company is on the best possible course.

These are and will continue to be tough times for most banking and financial institutions. They have federal and other regulators and auditors that they must regularly appease. It is imperative that you do everything in your power to help them continue to feel comfortable loaning you money. Keep them updated with your income statement and balance sheet projections for a minimum of the next twelve months. Diligently fulfill all of your monthly, quarterly, and annual loan covenants to which you have committed. Make sure they have your most recent tax return(s) and interim financial statements. Keep your deposit relationship with them and show your commitment to them. You may even want to call your banker and ask them what you can do for them.

You may have already had customers ask for extended payment terms while they work through difficult financial times. Certainly this deserves your empathetic attention, but you must be very careful with this request. The cash flow of your business is often a complex organism that, with a slight tweak, could significantly impede your cash flow. Perhaps an example will help illustrate this point.

Imagine you manufacture widgets for many companies. All of your customers pay you 50% of their orders up-front and the rest upon delivery. One customer approaches you with a very large and profitable order, but asks for net 30 terms. You hesitantly agree, grateful that the order will keep your equipment and labor operating at capacity for the next couple of months. About one month into the production process, after you have purchased the materials, your customer calls and asks to put the order on hold indefinitely due to slowing demand for their products. You now have labor to pay, material suppliers to pay, and no cash coming anytime soon.

While this example may not perfectly apply to your situation, the underlying principles do. Avoid the temptation to extend your customers' payment terms.

One of the most common sources of capital for small to medium-sized businesses is the owner's home equity line of credit (HELOC). The business owner draws against their HELOC and then loans the money to their company. With the rapid decrease in real estate values across the nation, mortgage lenders are uncomfortable with their equity position, or lack thereof, in a secondary or tertiary position against an asset that is losing value. As such, many are sending letters notifying their customers that as their line is paid down their limit will decrease proportionally. If you are looking to pay-down outstanding debt, you may want to consider keeping this line of credit maximally extended (and continue to gain from the tax benefit that most HELOC-users reap) and pay-down other obligations.

We know that in this real estate market many are walking away from mortgage obligations and either short-selling or allowing the banks to foreclose on their homes and properties. Credit card, car loan, student loan, and other payments are being missed for a number of reasons. All of these things will hurt your personal credit. What does this have to do with your business finances? The answer is almost everything. Most banks and lending institutions will run a credit check on each owner of 20% or more of a business. We have seen many circumstances where a bank refuses to lend money in an otherwise "bankable" deal because the credit score of one or more of the owners is too low. If at all possible, seek remedies to any personal credit problems that will protect or improve your credit score.

The day you started your business is the day you signed up to be an expert on cash flow. When you are running low on cash, do you know why? When you have a surplus of cash, do you know why? Forecasting will help you better you understand the answers to these questions, which will empower you to improve your strategic decisions as well as the tactical implementation of your strategies. We work with a company that during the last two years has completely changed its cash flow dynamic for the better with the help of forecasting, good advice, and diligent execution.

We are not suggesting that banks and traditional lending institutions are the only medium to finance your business. Historically, these sources have been the most affordable and sometimes the most accessible. For the foreseeable future, these resources are going to become less accessible and more expensive. By following these five steps and continuing to profitably operate your business, you will improve your chances to obtain and/or maintain your sources of credit.