I remember back ten plus years ago having some conversations about the low Canadian Dollar and what was likely in store for Canadians in the near and longer term future.
One American friend held the opinion that Canada should just give up its currency and adopt the U.S. greenback instead.
Another Canadian friend warned about manufacturing complacency setting in with a lower dollar and that Canadian companies needed to become more cost competitive for when the dollar inevitably started moving the other way.
And as a former Winnipeg resident who was on the scene when the Jets left town, unable to complete in the NHL having to pay player salaries in U.S. dollars, its more than interesting to see things come full circle in the hockey world. Go Jets Go!
Ok, so what’s my point?
Simply that with everything going on in the global economy right now, its only a matter of time before interest rates go up.
Business financing rates are about as low as they can get and have been that way for quite some time.
But of course, predicting the magical time when rates will start to climb and stay up IS impossible and who ever gets that one right should be buying lots of lottery tickets as well to cash in on their luck.
Just like the change in the dollar, so will follow interest rates.
When you are at one end of the spectrum, its only a matter of time that you start to move back towards the middle and perhaps beyond.
That’s the way things work… That’s the way they always have worked and will work.
So, as a business owner today, are you getting prepared for a higher cost of capital and potentially higher sustained levels of energy costs?
You do this not knowing when you’re going to be impacted by these inevitable changes, but do it nonetheless because its going to be part of long term survival and prosperity.
Just like people who got accustomed to the easy access to commercial credit from WWII to about 2007 when the recession hit and made the process for securing capital that much more difficult, and just like when much of the Canadian manufacturing sector was set up on the basis of a $0.75 dollar, a certain degree of apathy has set in about interest rates due once again to a lack of meaningful movement over an extended period of time.
Everything right now is pointing to global interest rates going up.
When that’s going to happen could be months or years…your guess is as good as mine.
But this isn’t about if, its about when.
So as a business owner, are you getting your financial house in order and balance sheet in shape to take advantage of the opportunities that always come about due to material shifts and changes in the market, or are you going to be one of the vanquished that did not pay attention to signs?
As a business finance specialist, I am regularly engaged in the conversation of why a business owner should want or need to pay for my services.
Its a good question for sure.
And on the surface at least, it would appear that there are enough business financing options out there that any business owner should be able to walk through the door of their local bank or institutional lender and get all the business financing they require. Right?
Unfortunately, perception and reality are a bit different in the world of business finance.
The process of securing business financing is typically harder and longer than most people think it will be.
There are many reasons for this of which I will only touch on a few.
First of all, most business loans or financing facilities are customized financing in that no two businesses are exactly the same in terms of what they do, the stage of business development they are in, size, scale, etc. So there is work going into assessing each and every business case compared to something like an application for a residential mortgage.
Second, lenders are always trying to balance their portfolios, so effectively what they can lend on at any given time is a moving target making it easy to waste a considerable amount of time focusing on the wrong source of capital at any given time.
The end result is that the overall process for locating and securing proper financing can be very difficult to figure out and when you do get a bearing on the way things work, everything could change before you’re going to need to draw on that information again in the future.
I was reading an article in the Globe And Mail about the small business owner’s reluctance to outsource. You can check it out by following this link … http://www.theglobeandmail.com/report-on-business/small-business/grow/expanding-the-business/small-business-owners-still-reluctant-to-outsource/article2060249/?utm_medium=Feeds%3A%20RSS%2FAtom&utm_source=Report%20On%20Business&utm_content=2060249
The article basically describes how business owners want to outsource, but are unsure of the value of doing so, and end up doing too many things themselves.
This is very true in the world of business financing as well.
With respect to source business capital, there are two basic costs that you have to consider as a business owner.
The first set of costs is your out of pocket costs, opportunity costs for your time, and lost opportunity cost for not getting the right type of financing when its required. In my experience, this can be many times the cost of third party assistance with the financing process.
The second set of costs revolves around not continually looking for better fit financing or contingency financing. Most business owners will only look for capital when its absolutely required and don’t take into account how the capital in place may be priced too high compared to available alternatives, or is not allowing for optimal growth. Once again, the true cost of not having a proper balance sheet in place can be incredibly expensive over time.
Utilizing the services of a business financing specialist is another outsourcing choice that needs to be weighed on the basis of the cost and projected benefit. This may or may not be required for every business situation, but it should likely be at least considered more often than not as the do it yourself approach can produce significant visible and hidden costs that can potentially be avoided.
Have you ever heard a business owner say they acquired asset or entered a market for “strategic reasons”?
Or what about businesses that are build on the foundation of subsidies and market protection schemes?
As one of my old mentors used to tell me, if what you want to invest capital in isn’t profitable then its not very strategic.
As I was reading an article on the failings of Ontario’s Green Energy Act ( here’s the article link … http://opinion.financialpost.com/2011/05/16/ontarios-power-trip-the-failure-of-the-green-energy-act/ ), which by the way is not only quite informative but also written to entertain, I couldn’t help thinking about how this type of misguided approach applies to so many small business failures.
Any time there are any artificial supports present in the market that hold your position or even allow you to compete in the market or cause the market to even exist in the first place, over time the outcome is not likely to be very good.
Even if you’re not dependent on subsidies or some form of industry price protection, market access, etc., there are other things to consider.
For instance look at the Canadian manufacturing sector where may of its members built a business on a $0.75 Canadian/U.S dollar ratio.
But what happens if the dollar moves to parity as it has done before in the past? Not likely going to happen. Right? Wrong.
Instead of getting costs inline to be able to protect against such a movement in a highly dependent variable that makes or breaks the business, many companies choose not to and as a result are out of business today.
And the great thing about the last example is that while the dollar is at $0.75 and you reduce your costs to be able to compete at par, the short term upside is that all the cost savings are profits. Not a bad incentive to making sure you’re competitive.
When I was in the corporate world, the business movers and shakers would always be selling us finance guys a load of crap in terms of their market assumptions for key investments they wanted to make.
As the finance guy, my job was to be the counter balance to the hype and try to ascertain if we were trying to build a foundation on sand or stone.
When the numbers didn’t materialize, costs are now higher, and profits are lower and if that ends up killing you or your project, the next guy comes along and buys the assets at their true market value where money can be made.
Creating any type of business or growing an existing business that is not designed to be competitive on some scale does not make any sense, period.
Sure, you may be able to get away with taking such an approach for a period of time, but in the end things are going to come apart.
The problem for many small businesses is that if it doesn’t come apart in the first generation of owners, its only a matter of time until the next generation or two takes the hit.
I guess one can rationalize that you don’t care if everything falls apart when they are retired or no longer dependent on the business for financial returns. But I say that’s pretty short sighted and a very opportunistic way of thinking, and then when things do blow up, the same business owner starts yelling fowl and want a new form of support to replace their lack of business finance fundamentals.
Getting it right can take some work.
But the alternative is too much like gambling which, in my opinion is why there is such a high level of SME business failure.
If you’re a small business or medium sized business owner then you are both business person and investor.
The process of starting a business and growing it must have a considerable and continual focus on risk management for a number of reasons.
First, without eliminating, identifying, and mitigating risk, you always put yourself in a position to be shut down by events you no longer can control or influence.
Second, you’re ability to attract capital and lower cost forms of capital is highly dependent on your ability to show that you have historically been able to manage risk and that you have accurately identified and mitigated existing risks to a satisfactory level.
Third, you put your own hard earned equity in jeopardy which can set you back years and create a level of stress and disruption that most people would want to avoid at all costs.
I came across this article for managing risk in the Financial Post. http://business.financialpost.com/2011/05/11/no-need-to-dread-investment-risk-just-manage-it/
And while its geared more to a pure investor, the points made apply to SME’s as well.
Its interesting that when I talk to entrepreneurs trying to raise capital, the attitude many times is that you have to take risks and that just comes with the territory.
Their focus is to aggressively market their opportunity, taking the position that the strong upside potential will more than make up for any and all risks they face as a new business or an existing business taking a leap into a new area of business opportunity.
Which is also why start ups and acquisitions have such a high failure rate and why they have such a hard time attracting capital.
Sources of business financing capital, either in the form of debt, equity, or a combination of the two, are certainly looking for opportunities to extend loans or make investments as that is how they make money.
But what they are also looking for is a business model and opportunity that has done a good job of identifying the risks that further capital investment will bring along with a plan to address and mitigate these risks in an acceptable fashion.
There is always going to be risk of loss for everyone involved. But having an approach that demonstrates risk management has a much better chance of raising capital than one that does not.
Let me further add to this last point…
The less focused you are on risk and risk management, the harder it will be to locate and secure capital, the more likely the cost of financing will be higher, the more likely that the terms and conditions of business financing will be more difficult to meet and manage, and the collective result of the above is that the risk of failure has also increased.
During economic times when there is abundance of money that needs to be placed by money managers, the prospects for getting money for the aggressive business owner or entrepreneur could still be very strong.
But right now, we are not in such times, and the more sure path to money is by demonstrating your ability to manage capital and keep it.
And as the article linked to above states, “if it keep awake at night, it’s too risky” should always be factored in before you accept any type of business financing commitment.
Ok, last week, everyone, including myself, was saying that without a conservative majority or a workable form of government coming out of the election, that the economic sky in Canada was going to fall.
So the conservatives won a majority, and the sky is still above us … now what?
That’s the great and frustrating thing about the world of business financing. Once you have quantified or removed the potential adverse effects of one variable, another dozen or more are ready to take their place.
Just look at this week.
Everyone is speaking positive of the outcome of the election from an economic stability point of view.
But, we still have an economy that is over heating and heavily driven by commodities that are currently on the down stroke.
The Canadian dollar is being pushed down by the commodity markets, but for those needing to hold AAA bonds, Canada and Australia are the best bets which should be positive for the dollar.
The bond market is currently dipping down, but its not expected to last too long either.
In many ways, we are back to the pre election status quo where the Bank of Canada is still going to react to inflation in the near term and will likely keep increasing rates until they see a balancing out of inflation and a stabilizing of the level the dollar is trading at.
Banks and institutional lenders are more likely to continue loosening their purse strings with a conservative majority compared to a less appealing alternative.
So capital should continue to be available at very good rates, but be prepared for it to be some work to secure and also factor in that the cost of money is likely going to be higher as the year goes along.
For project financing with a payback of less than 10 years, fixed interest rates may provide a greater appeal and hedge against interest rate increases as well.
Being that most working capital is priced with variable rates, expect the cost of operating funds to be going up.
At the present time, these trends appear to be fairly clear (at least for the moment). If we had not elected a Conservative majority, the near term projections would likely be very similar, but all bets would be off for the mid and long term period.
All in all, we came out of the election process about as good as anyone could expect or rely on.
This certainly doesn’t solve all problems or remove all risks related to business financing, but it does take some of the noise out the market and allows us to get back to focusing on market driven variables versus politician driven ones.
Despite the high dollar, earthquakes in Japan, and general instability in the global financial markets, the Canadian economy is chugging right along and even slightly exceeding its growth targets so far in 2011.
This RTT News wire provides more of the statistical facts for those that are interested… http://www.rttnews.com/Content/AllEconomicNews.aspx?Id=1588120&SM=1
The challenge with growth is are you growing at the right speed to keep inflation in check and interest rates from rising.
And while the Bank Of Canada governor Mark Carney has mentioned that there is still considerable lack in the economy, capacity is being used up slightly faster than projected.
So for now, its likely that business financing interest rates aren’t going anywhere in Canada.
But that could change in the second half of 2011, especially if the economy stays on its current growth pace.
This is in keeping with what we have been hearing now for the last several months.
With commercial lenders loosening up the purse strings to some degree these days, now is a good time to be locking in the current rates if you have any fixed interest term lending facilities.
In the process of trying to secure business financing for a small or medium sized business, the business owner or manager is typically focused on presenting their business plan, historical financial statements from the accountant, and some projections for the future profitability of the business.
What is overlooked in many cases is the state of the accounting and/or bookkeeping system that counts the beans.
In this day and age of closer scrutiny by lenders and debt providers, its not uncommon for lender due diligence to reach into the bookkeeping and accounting system and practices to see if the proper rigor and discipline is being applied to the financial side of the business.
And what’s even more common is that most businesses score keeping systems are not up to par and can’t meet the standards of the person doing the reviewing.
When this happens, all the hard work it took to find a lender that was willing to provide business financing in the first place can quickly go up in smoke as the business owner’s credibility goes out the window along with all the ledgers and sub ledgers that don’t balance.
Its not at all uncommon for businesses to take a close enough is good enough attitude to record keeping, then through everything at the accountant at the year end to see if they can make sense of it in order to produce some sort of reliable and valid financial statements. Unfortunately, because year end filings aren’t required for months after the year end, nothing in the behavior tends to get corrected due to the fact that as soon as the books are finally closed for a given year, the business is half way through the next with another set of incomplete records already in the making.
The message here is basically that good accurate bookkeeping and accounting practices provide credibility and support for any lending decision a bank or institutional debt financier is prepared to make to a company.
Counting the beans properly should also lend to better decision making, better cash flow management, and greater lead time to deal with issues that are known sooner.
Good financial management is just as much a decision making factor to a lender as is the business strategy, owner experience, and historical financial performance.
And its likely that higher scrutiny is going to continue, especially after the high levels of loan failures of recent years.
When I was working in a large U.S. multinational, anytime I was drawn on the carpet to report on the business for whatever reason (the good, the bad, and the ugly), the boys and girls in charge of the ivory tower always wanted to know three things:
Where is the business at right now?
How did we get here?
What are you going to do next to either take things to the next level or fix the existing problem?
If there was any fancy graphs or charts that drew their attention away from the above, I was always quickly pulled back into the world of what was important to them, and needed to focus in on answering these questions before any other form of communication was going to take place.
While perhaps not exactly the same with business lenders, you should be taking a similar approach with your business financing application.
The first question, where is the business right now, is answered by an up to date balance sheet and interim income statement. The balance sheet will be supported by an aged accounts payable and accounts receivable, and a fixed asset ledger.
The second question, how did you get here, is answered by three to five years of historical financial statements prepared by an outside accounting firm.
The third question, where are we going, is answered by detailed financial projections including at least 12 months of monthly cash flow projections, two years of overall cash flow projections, two years projection income statements and balance sheets that reconcile to the cash flow projection and the current financial position. The projections will need to include detailed assumptions that explain how every (every) number is created and what its based on.
While this would appear intuitive on the surface to most, there are two key areas where the information is lacking.
First, business finance applications do not connect the different areas together. There can be significant in-congruence between past and present, and between present and future. Its extremely important that the story being told by the financial statements (and the narrative report that should be included to minimize assumptions and off base interpretations) is congruent, well balanced, and flows from one period to the other without being disjointed or inconsistent.
Too often, business owners provide all the information, but don’t reconcile the collective package to make sure the story being told is tight and accurate and seamless from beginning to end.
Second, most business finance applications do a very poor job documenting the assumptions in the projections and providing good logic and support for all the numbers being projected. Past, present, and future are all important elements to every applications … equally important. Unfortunately for many business owners, the glossing over of the projections can result in declines or less than optimal terms.
If you need help answering these questions when seeking business financing, give me a call and we’ll go through your business profile from beginning to end together.
While it is absolutely true that any type of long term, scalable business venture will utilize financial leverage to provide the necessary capital to operate as well as reduce the weight average cost of capital of the owners, leverage comes with costs and challenges that cannot always be directly quantified.
To depart into finance 101 for a second, when the after tax cost of debt is lower than the opportunity cost of equity, it only makes sense to utilize debt to bring down the overall or weighted cost of capital necessary to run a business.
Even if the business is debt free, operating strictly on its own cash reserves, the argument can be made that debt financing would allow the owner or owners to withdraw capital in order to investment in additional profit centers which in turn will make more money.
In theory it all sounds good and in practice, debt financing, especially at today’s rates, make a great deal of sense to take advantage of.
In practice, while leverage is almost always going to be necessary for some point in time, the ongoing management of third party debt or investment should not be underestimated either.
Put another way, any time someone else gives you money for a fee or return, they are someday going to want the money back. And while financing commitments and agreements may seem to place a certain amount of stability as to when money has to be repaid or refinanced, things can also change in a hurry, leaving the business scrambling for alternative sources of capital.
In the current recession, this sort of stuff happens everyday and its one of the more common calls I get from potential clients.
While each story is unique, the basic gist is that everything was rolling merrily along with the business when all of a sudden, for no reason, out of the blue, a source of third party business financing called their loans, cut back on credit lines, increased their rates, etc.
Most people believe this type of problem only happens to businesses that are scrambling for survival and/or are offside with their loan covenants.
When the economy is on a nice growth trend, the unexpected is less likely to happen, but still can happen with no advanced warning. In more turbulent times, all bets are off with respect to financing stability for anyone leveraging their balance sheet.
So if leverage is going to be necessary, then management of same is also going to be required.
And prudent management would include things like 1) always keeping your commercial financing profile up to date and in order, 2) periodically assessing your alternatives in the market, 3) developing an emergency refinancing strategy that can be implemented quickly.
An alternative approach most commonly utilized is to do nothing and deal with things as they happen. And during the past few decades, this approach has worked pretty well for most businesses. When things do go a rye there can be some short term scrambling to develop an alternative course of action, but the outcome is rarely ever fatal.
It will be interesting to see how the passive approach works going forward. Capital markets are upside down globally. Each major financial incident sends shock waves through the market, potentially delivering financial leverage disarray to your door.
Ongoing management of leverage does take effort and consumes resources. In today’s capital markets its also becoming more of a necessary risk management activity that every business needs to consider.
We are now in a time when there are no real predictable rules with respect to business financing and capital procurement, creating a greater need for business finance contingency planning.
There are two basic types of contingency planning business owners and managers need to be consider these days.
The first has to do with existing loans and debts on the balance sheet. Its not uncommon these days for lenders to cut back the limits on lines of credit and trade suppliers to reduce credit lines. So even if the economy in general is not providing a negative impact on the profitability of your business, the business cash flow management process can be turned upside down by things completely out of control of the business manager or owner.
Demand loans for equipment can also be called at any time without a formal reason or negative repayment action on the part of the business. This provides a stronger case for term loan products that do not provide the lender with such broad and subjective repayment options.
And in cases where a business has become late on payments or offside with debt facility covenants, it can’t be assumed that the lender is going to work with the owner or manager even if the cash flows are minor and expected to be rectified in the short term.
For existing debt or credit reliance, the business needs to develop contingency plans that will identify alternative sources of credit that can be secured and the related cost. This has to be continually explored on a regular basis as alternative financing options will change as time goes by as well. And the process can’t start when you have a financing problem as it can take more time than you may have before the business is negatively impacted.
For new business financing, the contingency plan that I would recommend is to start the process sooner even to the point when any new strategic direction is being contemplated. The typical planning approach is to do what’s best for the business and then look for the money that’s required to administer the plan when required. But the probability of finding and locating the desired capital has gone down on average, so it makes a great deal more sense to scope out the capital markets first and then adjust the strategic plan accordingly if required. This is far more strategic than just assuming funding will appear when required.
Business finance contingency planning needs to take on a greater importance with all businesses that are serious about their ability to survive the current recession and profit into the future.