Typically, a need for business financing is triggered by some event or string of events. So the timing of when its actually required is not always readily determinable.
Then there’s the classic line you hear from frustrated business owners or managers that the only time they can get a business loan is when they don’t need it.
Combine these first two points with my own observation that 80% of all of business financing requests are unplanned events, and you have a lot of business owners and managers scratching their heads regarding how and when to secure capital.
So here’s a couple of things to keep in mind to increase your odds.
First, because financial statements tend to play a very important role in most types of business financing applications, you need to factor in when and how they are prepared.
In terms of when, financial statements need to filed within 6 months of your year end. If you don’t file until the six month mark, then the results are already 6 months old. And, depending on the lender and how much money you’re after, most lenders will require the last recently completed financial period to be less than 6 months ago. So if your year end is in December and you’re applying for financing in July, many times the lender will require you to get an accountant prepared interim statement for the first 6 months of the current year, or put off further consideration of your financing request until the financial statements are completed for the next year end.
All that being said, one of the takeaways here is to plan as best as you can to apply for business financing in the first 6 months of the year and make sure your accountant is on pace to get them completed well before the 6 month mark. Oh and by the way, the lender will also like an interim financial statement for whatever period is not covered off from the last completed statements to the time of application, but in most cases the interim can be prepared by the business.
In terms of how the statements are prepared, financial statements are done under an accountant statement indicating how much work was preformed to verify the accuracy of the records provided by the business to the accountant. The lowest level of review is a notice to reader, then review engagement, and finally an audit.
If you’re looking for $200,000 or less in business financing, then you may get away with a notice of assessment. Better odds with a review engagement. If you’re looking for financing over $1,000,000, then an audit will eventually come into play.
The higher levels of review cost more money, but without the verification it can be tough to secure business financing, especially lower cost financing.
Bottom line, your completed financial statements are a definite asset that is important to your financing efforts and they have a freshness date that comes into play to some extent.
So when planning out your business over the next year, make sure you take the above into consideration.
To further emphasize this point, say you have a seasonal business that has a year end of December and a peak season of August. If you’re having an off year, which can happen with any business, you may need financing in December or January to carry you though to the next peak. Good luck trying to secure financing with 12 to 13 month old financial statements and an interim statement that may be bleeding red.
Especially for seasonal businesses, you have to apply for business financing after a good year so you can leverage that result. Therefore, if you want some cushion in your available capital going into a season you’re not sure of, you’d better apply for financing before hand.
As 2009 starts to draw to a close, the recession has not yet loosened its grip on small and medium sized businesses. And regardless of what the newspapers say, the recession is still very real and dangerous to your cash flow and will likely be for quite a while.
With that in mind, here are a few things to keep in mind when managing cash flow during a recessionary period.
1. Remember that you’re on your own. Whether your cash flow is in trouble or not, assume that you will get no help from your banker if the need arises. I’m not saying they can’t help you, but don’t assume that they will and make sure you’re prepared for them to potentially say no.
2. All the credit you have accumulated up to now that has proven to be more than enough for your business needs is not enough. I’m not going to say, go crazy and apply for credit all over the place. I’m more referring to 1) applying for credit with suppliers you don’t already deal with and 2) asking your existing suppliers for higher limits with the potential promise that you will do more business with them. In a recession, credit will dry up fast in the most unexpected places, so make sure you have good sources of credit to draw from.
3. You are your own bridge. Sometimes cash flow crunches in recessionary periods end up being short term gaps that result from delayed payments to you from customers, or a credit squeeze by a certain supplier that impacts you short term until you can source else where. In any event, if these clear short term cash flow gaps appear on the horizon, you personally are likely the best source of bridge financing. Why? Because the time period for the bridge is short (less than 6 months I’d say), so its not worth the time and energy to hunt down business financing at a time when its going to be difficult to secure anyway. Second, the less any one else has to know about your cash flow, the better. Having to go to your bank to explain a short term cash flow gap that you need their help with may just be opening up a can of worms. They may decide to help you, or they may decide to take a closer look at your business and perhaps decide that they’re already giving you too much credit and want some back, or who knows what else. Banks can be “fickle partners” in a recessionary time and its usually best to just keep everything low key with them until the economy gets back to normal.
But in order to be your own bridge, you need to have the cash available to inject into your company. So, either proactively get a personal line of credit against your house, or wait until you see a glimpse of cash flow trouble and then apply. If you already have some personal sources in place, great. Just make sure that the credit is available to you in the event that you need to use it for a bridge.
Personal real estate financing is the simplest, cheapest, fastest form of financing available to you, which by the way will still take at least 2 weeks to fund AFTER you have an approval, so fast is a relative word.
If you have good credit, even in a recessionary period, you should be able to get a prime to prime plus one line of credit up to 75% of the value of your home. And remember, the plan is to never use it, but if you need it, you have it to draw from.
A final point to mention here is make sure this is a short term bridge situation before throwing your own money in. If there’s no clear end to the other side or no bottom to the hole in the cash flow, I would strongly recommend keeping your personal funds out of it.
Remember that a bridge has clear well defined sides to it otherwise its not a bridging situation and needs to be looked at differently.
4. All Cash Is King. If you don’t already, offer your customers cash discounts for early payments if you extend credit to your customers. In a retail setting, offer discounts and sales more often to generate more cash flow and potentially give you an opportunity to reduce inventories. Yes, this will cut into your margins, but consciously taking actions to generate more cash flow may become critical down the road.
5. Match up Inflows with outflows. If you operate a business, like construction, where revenues and expenses are matched to individual projects, try to match your vendor payments related to a project to the inflows you receive. This may delay vendor payments which they won’t like, but if they know their materials were consumed by a particular project and you haven’t got paid yet, then they are typically more inclined to work with you, as long as you regularly communicate to them and as long as progress keeps being made on their account.
By taking this approach you will not be eating up available cash to pay vendors before you get paid (If you can do this at least some of the time, it can be a big help to your cash flow). If a delay takes longer than you had forecasted, then you may now have problems making the weekly or bi-weekly payroll.
Just remember that cash flow problems are out there waiting to happen. You can’t predict when they may impact you, but you can be prepared to deal with them if and when they occur.
Cash flow contingency planning can make the difference as to whether you come through a recessionary period unscathed or not.
The process of buying or acquiring a business can be a grueling and dragged out process with many false starts occurring before a deal is actually consummated. So before you even get to an offer to purchase, or even a letter of intent, go through these five questions to determine quickly if any prospect should be ruled out before too much time and money is spent.
1. Who’s in control of the deal on the vendor’s side? Many times its hard to tell who’s really in charge on the vendor side of the deal. Between brokers, and lawyers, and accountants, and business managers, the process can get very convoluted.
While you would think that the atual owner of the business would control the deal, in many cases this is not the case due to their inexperience in the sales process. If you can’t quickly identify and get comfortable with the decision maker, stop the process and move on. Too many cooks will likely spoil the soup and just have you running in circles.
2. Is the Vendor Willing To Partially Finance The Deal? Especially in business sales were there is goodwill factored into the purchase price, most third party financing will not consider the goodwill portion. Also, vendor financing provides a quazi buyer indemnification fund, helping to assure that the vendor is completely transparent during due diligence and ownership transition. Having a vendor loan in place is going to further motivate the seller to make sure the buyer is going to be successful long after the transaction is completed.
3. Is the historical financial performance of the business supported by 5 years of at least review engagement financial statements? Without review engagement or audited statements, you have very little if any verified financial data to go by. There are ways around this, but its going to take more time and money to verify the accuracy of results.
4. Do your source(s) of capital support the deal being proposed? If you are using your own cash, then you can obviously do what ever you like with it. However, most business acquisition transactions involve third party financing, which can have restrictions on the type and structure of a deal. Too often, purchasers think that if they can get a deal worked out that the financing will be the easy part and too often a good deal falls apart at the very end because the financing process started too late in the game.
5. Are you buying a standalone going concern business, or someone’s self employed status? A business can be very successful, but also near 100% dependent on the owner. If the owner has not developed systems and management and structure that can live without him, then it may be time to find another opportunity.
Don’t feel bad if you don’t have a business exit strategy as you’ll be in good company with the vast majority of small and medium sized business owners out there.
But to be fair, you can define an exit strategy in a lot of different ways.
So lets go over the ways I would describe it and you can send me your comments if you see it differently.
The first type of exit strategy is to sell your interest in the business when its worth the most to others. The focus here is to work on increasing the enterprise value of the business and always have the business in what I call a sellable position, so when opportunity comes calling, whenever that may be, you’re ready to take advantage of a good payday.
The rationale is that you can’t predict when a highly motivated buyer will be looking to invest in what you have been building. So when ever the situation presents itself, you are ready to entertain top level offers.
The second type of exit strategy or approach to business exit is to build up the business to a point where its doing very well in its market and getting close to peak performance where incremental efforts to increase profitability will only generate marginal gains. The rationale is that the best price for selling an interest is when a business is at the top of its game and has a solid near term track record to back it up.
There is never any guarantees that performance at that level can be sustained, so why not try and sell out when you can paint the most glowing picture? If a new competitor enters the market, or an old competitor re-invests, or the economy turns, or whatever … will the spin off effect create a drop off in business, which in turn reduces the business value? Here, we never assume that business will be good and like any other market you want to sell at or near the height of the market.
While similar to the first strategy, this approach is more fixed on the near term where the owner may give himself up to 5 years to build up the business and get out. In the first strategy, while a short term sell out is possible, the main focus is to always be ready to sell if the opportunity arises whether that be in 5 years are 25 years.
Following the first two strategies towards exit, you are always treating your business as an active market position that you are prepared to sell for a good profit at any time.
The third and most common approach is to own and operate a business until you reach retirement age or you just get pain sick of it. The problem with this approach is that its not really a strategy at all in that its far easier to say my exit strategy is to sell when I retire. Therefore, no work is required right now, especially if you’re 10+ years to retirement, right?
Wrong, or at least I say its wrong. Why? Because when that day comes when you decide its time to retire, what are the odds that the business is at or near its peak value, what are the chances its been built up for sale over a series of years to support a solid sale price, what is the probability that there will be a demand for what you’ll be trying to sell?
If you want to take this approach, then in order to get the most out of your business for retirement, you need to be planning the exit strategy years in advance to build a profitable exit versus hoping a profitable exit will happen.
Unfortunately for many, there is no profitable exit and still others that could have been a lot more profitable with some planning and for thought.
If you don’t have an exit plan, its definitely something to start seriously thinking about.
I’ve previously talked about all the ways your cash flow can get side swiped during a recessionary period and how you need to protect yourself from these unplanned events .
Here are some strategies to consider to make sure your cash flow and company aren’t left for dead. Remember that those who can get through a recessionary period relatively unscathed are in a great position to profit out the other side due to the fact that there’s going to be business to be picked up from the fallen.
Strategy #1. Plan for a slow down by making as many of your operating costs variable and consider utilizing more contracting to further reduce your fixed overhead. This may tax your operations a bit, but if cash flow becomes tight, you’ll have your monthly outflows minimized.
Strategy #2. Make sure to spread your supplier business around and potentially take on additional suppliers even if it increases your costs a bit. You never know when a supplier is going to go down due to their own credit problems and if you are relying on their trade credit terms for your cash flow, then you could very well get pulled into the soup as well if you’ve got too much dependence with any one source.
And just because suppliers are big doesn’t make them immune to cash flow problems during a recession. In fact they may be even more vulnerable if their balance sheet is highly leveraged and they have a few large customers that provide for most of their revenues.
Strategy #3. Do not enter into longer term projects or entertain deals with new partners. In some industries, like construction, many sub trades just go on vacation and shut down business all together because their experience tells them its only a matter of time before someone chooses not to pay the little guy when money gets tight. More smaller jobs with faster turnover reduce the risk of too much cash being tied up in any one venture.
I’ll be back with a few more suggestions in tomorrows post.
The recession creates the obvious problem of less sales for your business, but even if you’re in a mostly recession proof business, or one experiencing only a modest down turn, beware of what I call the cash flow domino effect.
This is most relevant to businesses that are part of large supply chains, but it can happen to virtually any business, depending on the circumstances, and all these triggers can be like falling dominoes heading straight for your cash flow.
Trigger # 1. Someone in your supply chain or even a related supply chain gets into cash flow trouble. They can’t pay their bills, which impacts the cash flow of their suppliers. Now the suppliers customers will have their cash flow impacted and so on and so on down the line until the problem lands on your doorstep. The more cash flow problems originating in the supply chain, the greater the domino effect and the more likely of anyone being impacted.
Depending on where you sit in the chain relative to where the first domino falls will likely determine how this impacts you. In some industry this can be a complete company killer as business try to find ways to cover their operating costs and protect their credit until such time as the money starts flowing again.
Trigger #2. Your business is doing ok despite the recession and everything seems to be in hand when all of a sudden your bank calls your loans or puts you into what they call special loans. You’ve been a good customer for years and may have never missed a payment, but here they are with a knife to your throat.
Why would the bank do this?
Could be lots of reasons. They may feel that they are over exposed in your industry right now and want to strengthen their portfolio by calling in some loans they know they can get their money out of without losing money. You many be “offside” on one of your debt covenants which might be only marginal, but its an excuse to again reduce their exposure. Or based on the current conditions, they have significantly revalued your security and now believe to be under secured based on the amount you owe them.
Even if they don’t call your loans, they can trim back your limits and still wreck havoc with your cash flow. Remember that most operating credit is on demand and can be called or reduce on demand at any time for any reason.
Its just business, nothing personal.
But you still are in pretty good shape, so you’ll just do to another bank and get business financing some where else, right?
Trigger #3. In the middle of the recession, hardly any main stream lenders are lending any money and few are doing more than selectively helping out their existing clients. So even though you have a viable business, you can’t get a low cost loan. If you have assets to leverage, this could force you into more expensive asset based solutions until the recession blows over and hopefully you have the margins to cover the cost or you could become Trigger #1.
As you can see, the cycle can feed on itself and increase the potential negative impact on your cash flow.
As we get into the last quarter of 2009, the dominos have been starting to fall and are building momentum in some industries and geographies. How do I know? All I hear these days when I answer the phone is a business owner explaining which trigger he’s just been hit by.
More on what to do to protect your business cash flow in future posts.
No matter how good things are going, something can go wrong that sends you side ways and without solid contingency plans in place, your cash flow and business could completely disappear.
Now contingency planning is for stages of stability and growth. If you’re cash flow is already in trouble or going to be in trouble very soon, then its not contingency planning, its crisis management.
By this definition, you may ask why you need to even bother going any contingency planning. If everything is going well and perhaps has been good for a long time, why dedicate time to this activity.
Here’s a real world example.
Customer imports a product and repackages it under different consumer brands, has been profitable for 20+ years, does over $10.0M a year.
Great cash flow model where suppliers provide 90 day terms on product imports and receivables are collected in 60 days. Operating costs covered by a long standing line of credit.
Everything runs like a well oiled machine.
Then the recession hits. And all the suppliers cut back their terms from 90 days to 30 days.
Big problem. Totally unforeseen. Right before prime time of this seasonal business. If it can’t be corrected quickly, the business is all of a sudden in big trouble.
The end of this story was that the business did find a way to stabilize the ship, but there was no contingency plan to draw from and as a result the business was not only in distress, but on the verge of losing customers. The problem was solved through pure crisis management, which can work, but is unpredictable and typically more costly than drawing from a contingency plan designed for a cash flow shortage.
The big problem with me preaching contingency planning is that I’m preaching prevention, not cure. Its like telling you to back up your computer everyday or buy life insurance or brush your teeth before going to bed.
And as a result, I’d say 90%+ of businesses don’t have any type of meaningful cash flow contingency plan.
Perhaps that would change once business owners and managers understood the risk they aren’t managing. Maybe.
In reality, most business financing is crisis managed or what I like to call unplanned events.
I’m going to talk about cash flow contingency risk assessment and prevention in future posts. For now, I’d just suggest that you take a quick look around your cash flow and see if there is anything that can be flagged as a high risk to your business. This is definitely a worth while exercise and should be done at least a couple times a year.
More and more business acquisition financing is provided by the actual vendor or seller, not just your banker. And in many cases, bankers will not even entertain providing acquisition financing unless the vendor is contributing some amount of financing as well.
This is especially true with purchasing a small business where a good portion of the sale price is tied up in Goodwill. Most lenders will not finance 100% of the goodwill. Actually, most lenders won’t finance any goodwill without some amount of additional security, guarantee, or surety from the buyer.
The lenders logic is that if the vendor is so certain that the value for goodwill in the purchase price is valid, then they should have no problem providing the financing by basically deferring the portion of the proceeds earmarked to goodwill until an agreed upon time in the future.
There are a couple of other reasons why vendor financing is more common for acquisition financing than you may think.
First, any purchase and sale agreement I’ve ever seen always has some form of recourse present to protect the buyer against mispresentations of the seller and vise versa. By having the vendor provide some amount of financing towards the purchase, there is effectively a recourse fund in place which further protects both the buyer and any potential lender that also gets involved.
Second, by having an active stake in the business being sold in the form of a vendor loan , the vendor is highly motivated to provide a seamless transition to the new buyer as well as ongoing support if required.
Many times, the vendor will take the money and run after the completion of sale and payment of all the proceeds, leaving the buyer to deal with any unknowns or transitional problems that might arise. And depending on whose statistics you subscribe to, one of the top reasons for the failure of acquired businesses is due to poor ownership and management transition.
Vendors tend to not want to provide financing if they don’t have to, which only makes sense. However, failure to be open to vendor financing can also leave businesses unsold for several years as potential buyers are not able to secure enough lender financing without the vendor being involved.
Yes, cash flow and income forecasting can be a pretty mechanical process as all the numbers have to be entered and tabulated and assessed. But when you’re looking into the future, the numbers also have to be projected, guessed at, and pulled out of the air to some extent.
That’s where both your experience and intuition comes into play and it will amaze you how both improve your accuracy over time.
When I was managing an annual cash flow that was well in excess of half a billion dollars annually, I got pretty good at estimating where the ship was going to dock and how we were going to hit “the number” decreed from the ivory tower by people so removed from what was going on they may have been on another planet, or at least it seemed like that some times.
I had a large staff, reports, and systems out the wazoo, so you would think this was all highly mechanical, which in many ways it was.
But when it came down to determining which actions to take in the next 30 -60-90 days to make the overall cash flow and income projections work, it always came down to my estimates and guesses of how certain items, both inflows and outflows would play out. Basically my estimates or key assumptions of how things would play out in real time.
And in the real world, you will always have to guess because there’s always unknowns, curveballs, and goof ups to deal with.
So why go to the trouble of creating cash flow and income forecasts if you’re just dreaming it up anyway?
You do it because through the course of continually going through the exercise of reviewing everything that matters to your targeted outcome and summarizing each component down to time and dollars, you develop the ability to accurately estimate how everything will unfold.
Intuition is nothing more than your minds ability to draw on lots of self absorbed data and apply it to a repetitive ritual that generates a realistic result of what is yet to occur.
The more you feed your brain with the key measurements of the business and the more you go through the assessment cycle, the more accurate your guess work will become.
And in many ways, this is the secret of some of the world’s most successful people who always seem to make the right decision most of the time or when it matters most. They have spent, in many cases decades, feeding their own super computer all sorts of relevant data about their business, competitors, the market, the economy, and anything else that could have an impact on what they do.
When you’re field of vision is wider than your competitors, when you can instantly see and assimilate relevant information into the right decision most of the time, then you have developed superior intuition. And by acknowledging this to yourself and utilizing it to your benefit, you are practicing both art and science to achieve a greater outcome.
Back in the corporate world, there were only four days in the year that meant anything… the end of each fiscal quarter. And everything that took place between those dates was to achieve the quarterly target that lay just ahead.
People used to ask me what it was like to come up with the plan to get to the number and then manage to it. Because everything was such a moving target, moving at real world speed, I would say it was like trying to throw a brick through the open window of a speeding car and having it go right through the car without hitting the driver as it went out the other side.
But every quarter, I hit the number. I can’t say it got a whole lot easier, but as time when on, I made better plans to get to the results, as more and more things came into my field of view.
As a business owner or manager, you may view forecasting as a waste of time or a use of time you don’t have. But you need to find the time to work it into the mix for by so doing, you will greatly expand your intuition and become much more accurate in your decision making without even realizing why.
You don’t necessarily have to do it all yourself, but being involved in the process can create a powerful benefit to you that will leave your competition scratching their heads when you always seem to be one step ahead of them.
If you’re like most business owners, you or may not have thought about your eventual business exit strategy. Lets look at why this is a very common issue with business owners and why it should be given more time and attention. The underlying goals of any for profit business is to generate cash flow, build assets, and create a profitable exit plan from the business some time into the future. While the these goals are clear, the exit related goals do not get a great of attention until the owner is getting near retirement age or after some event causes the owner to need to exit. The result tends to be a suboptimal ending in terms of money actually realized from selling their business interests. Here are the main reasons (from my observations and discussions with business owners) for a lack of business exit planning and the resulting disappointing financial returns. 1. Business owners do not see a connection between what they’re concentrating on in the business today and their eventual exit. This is a highly flawed way of thinking as the present and future are closely linked in a number of ways. The actions of today, will impact the potential of any future exit. If the goal is to build optimal wealth, then all activities need to be ultimately geared towards increasing the value of the business enterprise, which effectively is to increase the value of the business exit. If the present actions are eroding the potential future exit value, then they should be corrected in order to maximize overall wealth of the owners. 2. Business owners assume that the process of exiting from their business will be quite straight forward and easy to navigate when the time comes. Again, in most cases this can be a radically incorrect assumption that can have a disastrous impact on the business owner’s retirement fund. The reality is that business exits can be hard to manage and in many cased they take way longer than expected to complete and the profit realized is far less than expected. 3. Business owners don’t want to deal with the end of their business ownership, so its easier to just ignore the whole ‘process and wait until they’re forced to deal with it. This holds true for many individuals that started a business from scratch and operated it for a considerable length of time. 4. Another misguided point of view many owners have regarding their eventual business exit is that there will actually be a buyer ready to buy at the exact time the owner wants to sell for the price the owner wants to sell for. This type of thinking can lead to very disappointing results. In reality, a business owner should always be ready to exit and always be directing their business to achieve an optimal future exit, regardless of when it actually takes place. If a buyer is looking for your type of business right now and is prepared to pay a premium for a business in an optimized and sale-able position, then a business that is always ready to exit stands to profit handsomely. While this particular circumstance may never occur, it also prepares the business for immediate exit if other circumstances present themselves, either personally or professionally. The most common unplanned circumstance I can think of here is the sudden passing of the owner or a death in the owner’s family where the owner does not want to continue with his or her business commitments on a day to day basis. If the owner is always ready to exit, then this or any other unforeseen circumstance will reduce the potential of a massive discount in sales proceeds caused by a sudden unplanned business exit. If you want to get the most cash out of your business exit, then start building one into your planning, because you never know what the future holds.