From Inside the Vault...

5 Things to Know about Cash Basis vs Accrual Basis Financials

Posted by Bill McDermott on Tue, Aug 25, 2015 @ 10:08 AM

When you first start your business and begin recording business transactions, you must decide whether to use cash basis or accrual basis accounting.  The big difference is in how you record your cash transactions.  Many people use cash basis accounting for taxes and accrual basis for managing the business.  Here are 5 things you must know when considering which to use.


  1. Cash basis accounting means you record all transacations when cash changes hands (revenue and expenses).  Cash basis does a good job of tracking cash flow, but a poor job of matching revenue with expenses.  Accrual basis does the opposite, it does a great job of matching revenue and expenses, but a poor job of tracking cash flow.
  2. It’s difficult to use cash basis accounting if you buy or sell on credit because you may have revenue or expenses with no offset until a later period.
  3. Many business owners use accrual basis accounting to manage their business because it does a good job of matching revenue and expenses even if no cash changes hands.  This becomes even more important as the business grows.
  4. Many companies that use accrual account will use a cash flow report to monitor cash on a weekly basis to be sure they have enough cash on hand to operate the business.
  5. Should your business be on an accrual or cash basis for your tax return? The answer is “it depends.” The quick answer depends on whether your selling terms are to pay immediately. You want to have expenses to offset the revenue, so you might elect the accrual basis.  However, if your business sells on credit, but incurs cost before revenue is received, then cash basis might be better.  Please consult your CPA for specifics before landing on an answer.


To manage your business effectively, you need to be sure that you’re profitable.  So, accrual basis financials that match revenue and expenses are critical. However, you also need to be mindful of what cash you have in the bank and what bills need to paid this week/month. Therefore, a cash flow report is needed to manage that effectively.


Topics: cash flow, finance, profitability coaching, cash flow planning, profitability

3 Ways to Get Your Business Acquisition Financed

Posted by Bill McDermott on Tue, Aug 11, 2015 @ 11:08 AM

There seems to be a lot of business acquisition activity in the marketplace right now. I have several clients that are in various stages of this process. Depending on whether you're on the buy side or the sell side, here are three ways the acquisition can get financed.


1) Bank Financing- This may be a limited option for a couple of reasons. In the typical business acquisition (asset purchase) when the purchase prices is allocated over the assets of the business, there's usually an asset called goodwill that gives banks heartburn. This is due to the fact that there's usually no collateral to cover it. In addition, most banks are only willing to go 3-5 years on the term of a conventional loan for this purpose, so the payments are quite high. However, depending on your circumstances, if you can stand the payments and have additional collateral to support the loan, this could be an option.

2) Seller Financing-This can be a good option for a couple of reasons. If the seller is willing to finance the purchase, then that takes the bank out of the picture entirely. You will probably still have to come up with some cash to put skin in the game to induce the seller to take back the loan. Check with your CPA, but if you're the seller, you should be able to take installment sales method and pay the gain on the sale over the life of the loan vs paying it all in the tax year the business is sold if you take cash.

3) SBA Financing-While this is still bank financing, the SBA has the 7a program which can be used for business acquisition. Typically, a 20% down payment is required but the bank will finance the remainder and obtain a 75% guaranty from the SBA. The guaranty allows them to give the buyer a 10 year term vs 3-5 years for a conventional loan. While there is still a collateral shortfall, the lender will usually put forth " best efforts" to fully secure the loan with personal assets if there is a shortfall of company assets to secure the loan. There is an SBA guaranty fee which is passed on to the borrower, usually 3% of the loan amount, but most lenders will finance the fee in with the loan proceeds. These are the most common options, however some instances will include a combination of seller financing (subordinated to the bank) and either a conventional or SBA loan to make the deal work. It's important to discuss the structure of the sale/purchase and all the terms and conditions with your CPA and attorney to address any legal issues or tax consequences.

Topics: financial statements, debt, SBA loan, small business, SBA loans, small business loans, strategic planning, cash flow, collateral, bank loans, business owners, taxes, cash flow planning, growth

3 Red Flag Phrases You Don't Want to Hear From Your Bank

Posted by Bill McDermott on Mon, Aug 3, 2015 @ 15:08 PM

Bankerese is a language understood by bankers, but is a foreign language to most business owners.  Communication is happening, but the business owner doesn't understand what's being said or the implications it has for his or her business.  Often, we step in and interpret.  Here are three of the most important ones to know:

red flag phrases of bankers


  1. "Your loan is being transferred to Special Assets."  If your banker tells you this, it's bad news.  Your loan is an asset to the bank and it's special (in a bad way) because it has more than average risk due to changes in your cash flow, your balance sheet or collateral most likely.  Banks put all their special loans (assets) in one department of the bank.  The sole purpose of this department is to collect the loans as fast as they can or get you out of their bank as fast as they can.  Rarely, if ever, do you go back to the former banker that was handling your relationship.
  2. "Your loan is in default."  A loan default is the failure to repay a loan in accordance to its term and the lender has or is about to take legal action to get the money back.  Defaults can occur through a variety of ways. 1) Failure to remit payment, or 2) you violated a provision in the loan agreement like a loan covenant.  Your bank should be willing to discuss with you options of what they can or can't do, prior to declaring a default.  To avoid legal action, make every effort to come up with a mutually agreeable solution with the bank.  Many banks will accept a reduction of the loan balance, a higher interest rate or more collateral as possible alternatives to avoid default.
  3. "Your loans are cross collateralized and/or cross defaulted."  If you have two loans with the same bank, this means the collateral for Loan A (accounts receivable for example) is also collateral for Loan B (the company building) and vice versa.  It also means a default on Loan A is also a default on Loan B even if payments are current.  Before you sign the second loan, check your commitment letter or loan agreement to be sure this provision is not in the documents.  If your company is in good financial shape and there's not a collateral shortfall on the second note, the lender should be willing to let both loans stand on their own.  If they refuse and want to "cross" both loans, you may want to consider taking the second loan to another bank.
If you hear these terms and aren't sure how to handle the situation, consider getting advice from a banking expert on how best to proceed. 

Topics: problem loan negotiations, understanding loan covenants, business loan, loan negotiation, small business loans, bank loans, loan covenants, loan covenant default, loan covenant, cross collateralize, business owners, loan modifications, loan renewal, loan covenant waiver lettter

How Much Debt is Too Much?

Posted by Bill McDermott on Fri, Jul 31, 2015 @ 16:07 PM

Some people are risk takers and don’t mind going in to debt and some are totally debt averse.  They don’t borrow at all. 

But how much debt is too much?

The easy answer is don’t borrow more than you can afford to pay back or don’t borrow more than a lender is willing to loan you. They may not be the same amount.  Do you want to use up all your borrowing power on this transaction or do you want to keep some in reserve? Here are some things to consider:

how much debt is too much?


  • Assume for the moment that you will use terms loans with monthly principal and interest payments for any borrowing need: working capital, equipment real estate or business acquisition.
  • Each loan will probably have a different term. Working capital is 2-3 years, equipment is 3-5 years, real estate is 15-25 years and business acquisition up to 10 years.
  • Calculate the total amount of your loan payments and make sure you have cash flow to cover those payments with a 25-30% cushion.  100,000 in payments requires $125,000-130,000 in cash flow.
  • Cash flow is typically defined as EBITDA: earnings before interest, taxes, depreciation and amortization.


Remember the higher the cushion (50-100% vs 25-30%) the more wiggle room you have for owner’s distributions for taxes and or other personal expenses. 


Here’s the tough part.  Let’s pretend you’ve maxed out your borrowing capacity.  All of a sudden there’s a great opportunity to buy out a competitor.  You’re forced to either fund it yourself (if you even have the resources) or take on an investor.  More often than not, the investor will seize the opportunity to take a bigger piece of your company than you want to give up.  It may be a good idea to save some of your borrowing capacity for the future. 


Another way to look at how much debt is too much is look at the leverage ratio or debt to equity ratio. 


  • Most lenders like to see the ratio of $3-4 of debt to every $1 of equity on the balance sheet. 
  • This is a 3 or 4 to 1 debt to equity ratio. 
  • Think of it this way. Your creditors have put up credit for 75-80% of your assets and you’ve put up 20-25% in equity. 
  • Beyond this level, most lenders feel they’re taking more than their share of the risk.  
I hope these tips will be helpful the next time you think about borrowing. Now you'll know whether it's the right time to borrow.

Topics: debt, strategic planning, cash flow, credit, business owners, cash flow planning, line of credit

3 Things to Know Before you Refinance your Business Loan

Posted by Bill McDermott on Wed, Jul 22, 2015 @ 15:07 PM

Businesses that took out debt a year ago or even 3 years ago may find themselves in a situation where the cash flow used for the loan or the purpose of the loan has changed.  Many businesses find themselves in a situation where a refinance makes sense because they either want to reduce their loan payments to use cash flow for growth or they may want to increase the loan amount because their business is expanding.  Businesses are dynamic, but a loan repayment is usually static due to the fixed term of the loan. A floating rate loan is the exception.

loan refinance

Before you refinance your business loan, there are three things you must consider:

  1. Is there a prepayment penalty on your current loan and have you factored in the cost to your refinance?  This is especially important if you have a fixed rate conventional loan or an SBA loan.  Many SBA loans will have prepayment penalties for payment in full on a refinance.  Depending on the type of loan and the length of the amortization, they can range from 3-10% in the first year and will burn off to 0 over a time period ranging from 3-10 years.  If it's a large loan, like a commercial mortgage or business acquisition loan, then the prepayment penalty can be high. While it's not technically a prepayment penalty, there are many fixed rate loans offerred through a derivatives product called an interest rate swap (you and the bank swap rates, you want fixed and the bank wants floating).  If you cancel the swap early, the intermediary is entitled to a make whole payment either to you or the bank depending on where interest rates are relative to the swap rate when the deal was consummated.  
  2. Are your loans cross collateralized?  If you only have 1 loan with your bank then disregard this point.  But if you have a line of credit and a second loan (building mortgage or equipment loan) then check the fine print of your loan agreement.  If your loans are cross collateralized then it's possible the bank will ask you to refinance both loans rather than just one.  Sometimes there's a collateral shortfall that the bank handles by doing this.  Other times this is just put in the small print of your loan agreement to make it hard for you to change banks.  Before you look at refinancing your loan make sure this language is not in your loan agreement or note.
  3. You can't payoff an SBA loan with another SBA loan.  Many business owners don't know the SBA guidelines when it comes to loan amortizations.  SBA loans are made on the most favorable terms for bank financing in the marketplace (10 years for working capital and business acquisition or 25 years for real estate).  Therefore, the SBA won't extend the term of a loan beyond it's original amortization.  While there may be 1-2 exceptions, you would be paying off your SBA loan with a conventional bank loan and the payments and interest rate could be higher.  As an alternative, you could take out a second SBA loan (limit is around $5 million aggregate).  However, you would be making 2 payments where you would prefer to make one and it be a lower amount.
Before you jump in with both feet on a refinance, check out these three things to be sure you don't find a "gotcha" down the road that makes your refinance a no go.

Topics: small business, small business loans, cash flow, collateral, credit, bank loans, bank loan covenants, loan covenant, cross collateralize, banking, business owners, cash flow planning

4 Must Haves to Get a Loan From Your Bank

Posted by Bill McDermott on Tue, Jul 14, 2015 @ 09:07 AM

Securing financing for your business can be challenging.  Whether you're borrowing money for the first time to start your business or you're looking for a loan to grow, the lending criteria banks use can be rigorous.  It's important to know what are the must haves that a bank is looking for to approve your loan.  Here are the top 4:

3 must haves for loan approval


  1. Financial statements that are timely and accurate.  Some clients have one or the other, but you need both.  Financial statements are the language that bankers speak to obtain credit.  If you can't provide them within 30 days of month end or you can't produce them accurately then take a hard look at your people or process that is required to get you there.  
  2. Cash flow sufficient to repay the loan with a cushion, usually 25-30% cushion. If you've heard bankers talk about debt coverage of 1.25 or 1.3-1, this is what they're talking about.  Make sure you understand how they calculate it. Does it include or exclude owner distributions or taxes. On a line of credit, is it interest only or does the bank term out a principal portion of the line in their calculation?  Since this is a ratio, make sure you understand both the numerator-cash flow and the denominator-loan payments.
  3. Collateral sufficent to cover the loan amount that is margined.  What is an appropriate margin?  For most real estate, equipment and accounts receivable, the margin is 20-25% meaning the lender can loan up to 75-80% of the value.  However, if you want to borrow $500,000 and your only have $300,000 of margined collateral, then the lender will be looking for you to secure the difference.
  4. Good credit is a personal credit score above approximately 680.  Since your credit score is based on a variety of factors, good credit excludes bankruptcy, liens, judgments, garnishments, and foreclosures.
When you go to the bank, these items will be what they're looking for to approve your loan. You can also read about 3 deal breakers for financing

Topics: business loans, interim financials, debt, SBA loan, strategic planning, cash flow, collateral, credit, bank loans, income statement, finding financing, banking, business owners, cash flow planning, line of credit

3 Deal Breakers for Start up Financing

Posted by Bill McDermott on Fri, Jul 10, 2015 @ 09:07 AM

If you're thinking about starting a business, you know you're going to need financing. Some banks like lending to start ups, some don't. You've heard of the 5 C's of credit:

  • Character
  • Cash flow
  • Collateral
  • Credit
  • Conditions 

But most banks like to see a balance sheet that is:

  • Liquid (plenty of cash)
  • Not leveraged (less than $3 of debt to every $1 of equity)
  • And three years of profitable operations historically 
But you may want to know what are the absolute deal breakers where the banks won't lend under any circumstances.

startup financing

As an aside, most start ups are financed through an SBA program (most often the 7a program). So, the SBA has specific guidelines which the bank combines with their own to make the loan.

1) Poor credit- About two thirds of your credit score is based on payment history of your credit obligations. So, if you've had a history of slow payments that could be a deal breaker. Also, if you've had a prior bankruptcy, liens, garnishments or judgments that will also affect your ability to borrow. Generally, banks are willing to loan to individuals with a credit score of 680 or above. Below that, it becomes increasingly unclear whether a bank will loan or not. If this is you, consider either a co signer or guarantor (with a good credit score) or talk to a professional about what you can do to improve your credit score.

2) Lack of collateral- A little know fact about the SBA 7a program is that the lender has to put forth best efforts to fully secured the loan with margined collateral. If the business doesn't have sufficient collateral to secure the loan, the bank is required to obtain additional collateral from the owner's personal assets. For example, if the loan amount is $500,000, then you need between $625,000 and $666,000 of assets with a 20-25% margin to get the loan. Each type of asset has a different margin requirement (SBA has their guidelines and so does each bank). Most banks will loan 75-80% on real estate, accounts receivable or equipment. In rare circumstances, banks do make loans that are slightly undersecured.

3) No business plan or 2 years of projections- About 80% of the businesses started fail in the first five years. The number one reason is that they are undercapitalized. So, a bank is looking for you to do a full business plan explaining the business, the market, the competition, the management team and two years of projections that are based on sound assumptions consistent with the industry performance and trends. Banks are not venture capitalists because they loan their depositors money, not their own. The business plan and projections along with the other factors involved need to show a high likelihood of business success with acceptable risk for the bank.

Lending to start ups is very risky because there is no historical performance of the company. This is not an exhaustive list of deal breakers, but these are three that bankers incur most often. Do your homework before you go see the banker to be sure your request doesn't have one of these.

Topics: debt, loan package, SBA loan, small business, SBA loans, small business loans, strategic planning, cash flow, collateral, credit, bank loans, finding financing, banking, business owners, cash flow planning, line of credit

4 Ways to Increase Profitability

Posted by Bill McDermott on Wed, Jul 1, 2015 @ 15:07 PM

Fundamentally, there are four ways to increase profitability (without merging with another company).  There are no quick fixes. Gradual progress will get you there, but you must focus your strategy and execution on one or two to be successful.

4 ways to increase profitability

1)   Raise prices. 

When’s the last time you had a price increase?  Most of us are afraid to raises prices because our client may go to the competition.  However, clients that come to you on price will also leave on price.  More often than not, your clients do business with you because you have differentiated yourself from your competitors for reasons other than price.  A 1% price increase can mean a significant change in your bottom line, as we’ll see in a minute.

2)   Increase volume. 

This means more clients or more revenue per client.  However, I would discourage discounting prices to get more volume.  I had a client that was recently approached by a client asking for volume discounts.  He discovered a1% decrease in pricing meant an 8% decrease in his bottom line.  If your clients are asking for a volume discount, don’t be deluded that you can make it up on volume.  Often, you can’t.

3)   Reduce COGS (cost of goods sold). 

If you’ve been doing business with the same material supplier for year, their pencil may not be as sharp now as when they first got your business.  I’m not suggesting you shop based on price only, but if you’re not current on competitor’s pricing, you may find you can get as good or better materials or labor for the same or even lower prices. 

4)   Reduce overhead. 

When times are good and the money is flowing, we don’t pay as much attention to overhead as we did during the recession.  It’s very easy for overhead to become a larger percentage of revenue than necessary.  You and your financial manager should be diligent in looking for ways to cut cost to be more efficient.  Trimming the fat every once in a while is healthy for all businesses.


Look for 1% improvements.  Here’s why:


$5 million revenue                1% increase in prices or volume is $50,000 each

$3 million COGS                     1% decrease in material cost is $30,000

$1.5 million in overhead      1% decrease is $15,000


The total opportunity in this example is $145,000 in profit improvement.  The reason for 1% is it’s incremental and certainly attainable.  Over time, this can have a huge impact on your business.  Pick out where you want to focus your time. 

Topics: entrepreneurship, strategic planning, profitability coaching, business owners, cash flow planning, growth, profitability

5 Barriers to Growing your Business

Posted by Bill McDermott on Tue, Jun 9, 2015 @ 09:06 AM

Trying to grow your business and having a hard time?  Join the club!  Growing your business can be one of the most challenging things you do. If you're having a hard time, here are 5 of the most common barriers to growing your business.


Sales Cartoon resized 600


  1. You've outgrown your money. Sometimes you take too much money out of your business and there's none left for growth. You can certainly borrow up to a point, but when your leverage gets high enough, the bank will say no and you will be left to either borrowing against your accounts receivable (very expensive) or taking on an investor (even more expensive). Calculate your sustainable growth rate (SGR) which is the level you can grow without borrowing. The calculation is ROE x (1-distribution rate). So, if your return on equity (profit/net worth) is 20% and your distribution rate is 50%, your sustainable growth rate is 10% (50% x 20%) 
  2. You've lost momentum. Momentum is defined as force of motion or impetus of human affairs. If you feel your company is stagnant, regaining momentum starts with you, the owner. Start with a little optimism. Your belief will become contagious and will quickly spread throughout the company. Clarify decision making processes. Clear direction is empowering. Finally, if you need to be a little dramatic, give the organization a kick in the pants.  
  3. You've outgrown your management. Growth increases the complexity of your business. If you don't have the appropriate expertise needed in sales, operations or finance, it becomes a barrier to your growth. Here are some signs that management may be struggling: all decisions rely on you, you're feeling stretched too thin, your team is frozen in it's tracks.
  4. You've outgrown your model. If your current model is not yielding the income you think it should, consider a forward looking forecast to see what changes you might make. To yield results, your operating model must be scalable so you can experience profits at a higher volume. It's critical to have a dashboard with key performance indicators to see how you're company is performing when you scale.
  5. You're not aligned with your market. If you're not properly aligned with your customer's needs, a gap can open between what a company has promised and the operations required to satisfy them. You achieve market alignment when a business consistently delivers a value proposition in a simple exchange. If you can keep things simple so your company is easy to do business with, you will maintain alignment. However, when growth occurs, it increases complexity and keeping it simple becomes more difficult.
Sometimes we're so busy working in the business, we don't take time to work "on" the business.  It's during these times when we step back and gain perspective that we can make the right diagnosis for barriers that exist and then prescribe a solution to re-position the company for growth.

Topics: financial health checkup, financial statements, entrepreneurship, small business, strategic planning, the customer, solutions, business owners, leadership, cash flow planning, growth

3 Ways to Get Working Capital for Your Business

Posted by Bill McDermott on Thu, Jun 4, 2015 @ 14:06 PM

Your business is growing, cash flow is tight and you're wondering when that next big receivable is coming in to cover expenses.  Does that sound about right?  

cash flow resized 600

In a perfect world, you would have working capital for your business before you get in this situation, not after.  Here are three ways to do it.


  1. Go to your bank and obtain a line of credit through a conventional lending or SBA lending program.  Banks provide lines of credit for timing differences between when you collect your AR and when you have to pay expenses.  There's typically a 30 day payout requirement.  They don't intend the loan to be permanent.  SBA can provide a permanent working capital loan through their 7a loan program (amortized over up to 10 years) or through the SBA cap line, a line of credit for up to a 7 year term, (4 years revolving and three years amortizing).  Either program may be best for you, but talk to your banker about it or a business advisor if you don't feel like you have a banker.
  2. Asset based lending. (ABL) Banks loan money to companies based on their balance sheet strength and the cash flow/profits reflected in their income statement.  If your balance sheet leverage is above 4-1 and if you were unprofitable last year, you should probably skip the bank step and go directly here.  Most of these lenders will charge a 1-1.5% monthly service charge and Prime plus 3 or so for the money.  When you annualize this out, your cost of capital could easily be 18-21%.  It's expensive, but available.  
  3. Bootstrap your business. Tal to friends and family or an investor.  This is the least attractive way to obtain funds.  Depleting your personal assets can be risky if you're planning to use those as your rainy day fund.  It can be awkward to borrow from family or friends.  So, that leaves an investor.  It's very difficult to find investment capital from amounts under $500,000 because the investor would rather make a big investment vs a smaller one.  The cost of underwriting the investment is the same for both and while the risk is smaller on small investments, so is the reward. Plus, it's not out of the question that the investor may want control of the business, if the investment made is greater than 51% of the business value.  That's a non-starter for most owners.
Establishing working capital is a requirement for a solid financial foundation for your business.  It's important to understand and meet the requirements for each type of working capital option so you can get the best terms available and make the most of your cash on hand.

Topics: balance sheet, debt, credit, bank loans, income statement, business owners, cash flow planning, line of credit