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Watch out for the credit card trap


The SBA hosts guest bloggers on the website from time to time.  There was a recent article on their website discussing this issue:

"Due to the growing difficulty in obtaining traditional business lines of credit from banks, many business owners are turning to credit cards for small businesses as their primary unsecured business lines of credit."

business loans

I had a client recently who was in the process of obtaining a debt consolidation loan which would've paid off several business loans and credit cards.  However, one of the credit card providers reported his business payment history to his personal credit bureau report.  This dramatically reduced his credit score and may prevent him from successfully completing his refinance.  Here's why:

Business owners are turning to credit cards as their primary source of unsecured working capital credit.  The unintended consequences of that decision is that they end up putting their personal credit on the line and their business credit cards show up on their personal credit report.

Any time you use a business credit card your personal debt/credit ratios are affected.  Many financial institutions offerring business credit cards report to your personal credit which can negatively impact your scores.  

So, before you apply, ask the lender if they report your business credit card to your personal credit report.  If so, continue the search for a business credit card that doesn't.  If you're having a hard time locating a business credit card issuer that only reports to a business credit bureau, then call the bureau and ask them which credit card issuers report to them.  If that's not practical, then conduct your own search, but that will probably take you longer.

Business credit cards have been around for a long time.  They are great cash flow tools and usually carry interest rates competitive with other unsecured business credit sources.  Just do your research before you apply.  Some additional due diligence can save you potential negative impact on your personal credit report.

Banking Humor Friday


Happy Friday! Enjoy some banking humor to kick off your weekend!

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What is global cash flow analysis and why do I care?


Your banker might have mentioned that they underwrite your loan using global cash flow analysis.  What is that and why do you care?  Let me tell a story and hopefully illustrate it along the way.

global cash flow analysis

I'm currently working with a personal services firm that has three affiliates.  They have 4 partners and at least 4 different product lines.  The firm wants to borrow $500,000 to payoff an existing line of credit and provide working capital to expand their practice in different areas of geography.  In presenting their package to the bank it occurred to me, what if the affiliates are losing money and the firm has no cash flow to service debt?  What's the impact if the partners pull all the money out of the firm and there's no cash flow left to service debt?  I carefully looked at the income statement of all the affiliates.  They are making good money and are not a drag on the firm.  I looked at the personal tax returns of the partners and determined that they are drawing ample salaries to cover their personal lifestyles and don't need to distribute profits. I concluded a global cash flow analysis was not necessary in this circumstance.

Professional and personal service firms (doctors, dentists, attorneys, consultants) are potential candidates for global cash flow analysis.  Global cash flow takes income from all personal and business sources, (salary, business profits, real estate, rental income etc.) and then takes the loan amount requested plus all other business debt and personal debt.  Since the cash flow of the business and the business owner are entwined, a banker wants to be sure that his business loan can be repaid without issue.  Additional items like interest expense from the business and non-cash charges (depreciation and amortization) are included.  Most bankers will take all income taxes paid (federal and state) out of their cash flow because they're not available for debt service.  Also, most lenders will make an allotment for living expenses too.

I hope I'm not getting too technical, but here is how you can calculate your global cash flow. Lenders will take the AGI (bottom of page 1 on your personal tax return) and add interest expense and depreciation from your business return, any other affiliate business tax returns you have and from your Schedule E.  The total of all that is the global cash flow.  You take the principal and interest payments of all business and personal loans.  That is your debt service. You divide global cash flow by all payments to come up with your global debt coverage.

The same standard for debt coverage applies for global cash flow analysis.  Banks are looking for a 1.2-1.3 cash flow coverage.  

You might be thinking so why do I care?  Well, my client I mentioned has a debt coverage of 2 to 1 much greater than the 1.2 required.  However, let's pretend that after you factor in personal loan payments that debt coverage is reduced to 1 to 1.  All of a sudden, this borrower doesn't have the capacity to take on additional debt because all of the cash flow is being used to cover personal loan payments.  It's important to know what your borrowing capacity is and if your bank underwrites this way.  You want to be sure you're asking for a loan that will be approved.  

If you are one of the professional firms I mentioned above, it's likely that your bank will use a global cash flow analysis to approve your loan(s).

Top 5 Budgeting Tips for 2015


As we enter the fourth quarter, it's time to start planning for 2015.  I have a client that is beginning the budgeting process for the first time.  We're looking at their opportunities for new business. They have a lot!  We're looking at how they've calculated their costs in coming up with sales and profitability assumptions that are realistic and attainable.  On a regular basis, we will track our actual results vs. budget to see how accurate our assumptions were.  It's likely mid year adjustments will be made. Here's my top 5 tips to maximize profitability as you plan for next year.

top planning points


  1. What's my tax liability this year?  It's time to figure out what your actual liability is going to be for the tax year 2014.  Get with your CPA and get their help in calculating how much of a check you are going to have to write in April.  Will you trigger AMT?  There are rules as to how much you need to withold this year to avoid penalities.  They can make suggestions on how to reduce your tax liability by making contributions to a retirement plan or health savings account or taking accelerated depreciation on fixed assets purchased in the current year.  These are just a few.
  2. Think ahead. What's your strategy for this year?  Will you grow? Are you changing your management model to increase sales or improve internal efficiency?  What about marketing?  Will you go after new markets or introduce new products?  If you grow, will you need money to do so?  It's time to dream a little bit and convert those dreams to plans.
  3. Take your plans and convert them to actions.  What assumptions do you need to change?  Revenue or profit growth?  Will you add any one time or recurring expense as a result of your strategy?  Those assumptions should include two factors (internal and external).  What's your average growth rate (internal)last year? For the last three years?  I had a client who was trying to grow 20%, but his historical growth rate was 1/3 of that.  Make sure you're being reasonable.  Also, compare your assumptions with industry forecasts and benchmarks provided for your industry by third parties (external).  If you forecast 10% growth, but your industry forecast is 20%, you may be missing an opportunity.
  4. Budgeting is part art and part science.  Compare your actual results against your budget monthly.  If there are significant variations in categories, it's time to figure out why.  That may help in your budgeting process next year.  
  5. Do your budget for 2015.  I would suggest starting at the bottom and work up.  How much profit do you want to make?  Add your expenses on top of that to derive your revenue number.  Is the revenue number reasonable given the internal and external factors in #3?  Many people start at the top and work down.  They may end up with a profit number that's not acceptable.  So, start with profit first.
I know this is a lot of questions to ask yourself, but they are important for a business owner to consider. If you'd like help planning for your company's success please contact us. What top planning points do you use as you begin the budgeting process for 2015?  

To consolidate or not to consolidate?


Consolidation loans, do they help or are you just paying more interest for the money you've already borrowed?  When do you consolidate your loans and when do you do nothing and let them run their term?

sba loans

I worked with a professional practice earlier this year.  The practice obtained an SBA loan with another lender several years ago and had taken out equipment loans and other lines of credit to finance the practice.  The practice had a 60% gross profit last year, but even with a nice cash flow they were struggling to grow the practice.  A majority of their cash flow was going to debt service and supporting the doctor's personal expenses.  In addition, they had used the original SBA loan to do some marketing which really helped the practice and they wanted to obtain some working capital for marketing again.

Because of the high gross profit, it made sense to consolidate these loans and obtain some marketing money for working capital.  The cost of this capital is currently about 6%.  Investing that capital to grow the practice would still net a 54% gross profit after borrowing if their margin holds.  Plus, the lower payments would provide other dollars to cash flow the practice and pay the doctor.  While they are paying more in interest expense, the key is to use the cash flow previously paid to lenders to generate additional sales with a high gross profit margin.  If they can't achieve that, then they shouldn't consolidate the loans.

If your firm is in a growth mode and you can use the cash flow created from the consolidation loan to generate sales and you have a high gross profit margin, then it should make sense to consolidate.  If your growth rate is moderate or your cost of capital is high, then it may not make sense to consolidate your loans.

Have you consolidated your loans to free up cash flow lately?  How did it work for you?


How strategic are you?


I took a vacation in July and decided to read Mastering the Rockfeller Habits by Verne Harnish.  It was recommended to me by a friend who uses it in her business.  I recommending reading it.  It was one of the best books I've read recently.

Mastering the Rockfeller Habits are:

  1. Establish your top 5 priorities that you focus on daily, weekly and one BHAG (big hairy audacious goal).  It's the balance of short term and long term.
  2. To be sure you're acting consistent with your priorites, obtain data that you can measure in real time.
  3. Set regular meetings to be sure you and your team are properly aligned with your priorities and are accountable.
strategic planning
I have a client who has had an internet based sales strategy.  He has been very successful in his business, but has sensed there was a better way of doing business.  He has about 2400 prospective/current clients with 4 sales people and the client list grows regularly.
Over time he has come to understand that 80% of his business comes from 20% of those clients (yes, you remember the 80-20 rule).  His sales people continue to focus on the 80% that don't contribute as much business. They have lower productivity and lower close rates.
By changing his sales people's focus from an internet based strategy to a relationship based strategy, he is slowly changing how his sales people do business.  By building relationships with that 20% of his client base, he will become more efficient in his sales process and will grow sales.  He had to change his priorities and that of his sales people.  He looks regularly at the data provided by SalesForce and holds regular meetings with his sales people to get them properly aligned with his way of thinking.  It's not coming as fast as he would like, but he makes steady progress.
We all spend too much time working in the business instead of working on the business.  Set aside some time, read this book and implement the principles in it, to increase your effectiveness.

One Lender's Trash is Another's Treasure


After 10 months, we accomplished our goal.  This business owner found financing for his real estate project and negotiated a discount to settle his prior loan with his old lender.


A bank helped this client build his real estate project.  The bank failed.  It was acquired by another bank, it also failed.  The third bank survived, but notified my client that they did not finance his type of project.  So, last summer they told him they would not renew his loan which matured this past July.  At least they gave him plenty of notice.

lender's trash/treasure


Several lenders said they were interested, but when it came down to it, they couldn’t get comfortable with the special purpose nature of the project.  In January, I was introduced to a non-bank SBA lender that said they like this type of project.  Year end financials were complete and we put together a loan package for this lender.  This client had ownership in multiple entities, so the package was quite large.  There were a couple of credit issues in the borrower’s past which made underwriting even more challenging.  Finally a letter of intent was issued in March with acceptable terms and conditions.  Now, would the loan get approved?  Is one lender's trash another's treasure?


Finally, we received approval at the end of March with terms and conditions that were acceptable.  However, the proceeds were $700,000 short of the payoff.  Because the value of the property had declined since the loan was made, the project was valued at a lower amount than the payoff.  Would the lender that wanted out be willing to accept a discount?  So, phase 1 was complete.  Now, Phase 2 was negotiating a discount so the borrower could accept the new financing and move his loan.


The bank knew that the project was valued less than their loan balance.  However, any discount would have to receive bank and regulator approval before it could be accepted.  I met with the banker handling the loan in late April.  I explained the situation that we had a commitment for financing, but it was less than the payoff amount.  The lender wanted this loan off their books by June 30 so it could be reported as paid off for the quarter.  Their willingness to accept a discounted payoff was based on what the current appraised value was.  Our lender had received an appraisal.  However, since the lender was a non-bank, the appraisal was not acceptable because it didn’t meet regulatory standards.  The end of May was approaching and a new appraisal had to be ordered before a decision could be made.  The appraisal came back $500,000 higher than the last one the bank had and it raised the question, would the bank really accept a discount?  


Finally, two weeks before July 1, the bank decided that they wanted the loan paid off more than attempting to negotiate a higher amount.  So, the loan payoff was sent, a $700,000 discount was accepted by the bank and the client got a new loan.  Both banks and the client were happy!


Solved: Problem Loan Negotiations


After almost 4 years, it’s done. Finished.  A business owner and a bank have settled their debt.  Both parties probably feel a huge burden has been lifted.


The bank helped this client build a multi-tenant retail property.  It was built at the top of the market.  My client owned the largest part of the property and started a business in it.  When the Great Recession hit, my client couldn’t get to break even, pumped more money in to the project and business.  Tenants had a hard time making rent payments because they had their own issues.  Tenants vacated or went out of business.  New tenants that came in negotiated lower rent rates which decreased the amount of cash flow to make the loan payments.  It was a perfect storm of circumstances and the property began to decline in value.  Pretty soon the owner was upside down.

problem solved

The lender declared a default and went in to a forbearance agreement.  There was a cash flow covenant that had been broken.  For the next two years, we intended to refinance the property and hoped the cash flow from the business and the rental income from the tenants was sufficient to cover the debt.  However, when year end tax returns came back from the CPA, the business still wasn’t at break even. The cash flow from the business and the rent payments weren’t sufficient to refinance the loan.  The owner was hopeful that the future was going to be better than the past, but the numbers never proved that out.


To renew the loan, the lender asked for more collateral than what was previously pledged. They also increased the rate and the fees in exchange for more time, but the lender was quickly losing patience in giving more time.  Finally, the last renewal was based on all the properties securing the loan be listed for sale in hopes of liquidating a substantial portion of the loan.  At that time, the bank was holding a loan balance of $2.3 million with properties listed for sale at about $1.3 million, a $1 million deficiency.  We were successful in selling one of the five properties for $300,000 which decreased the loan balance, but made no progress toward the deficiency.


The properties were not selling, there was no dramatic improvement in the cash flow of the property and the owner’s business.  Finally a settlement was reached.  The lender agreed to take back the properties they held as collateral, settle the debt for a portion of the balance outstanding in exchange for cooperation of the borrower during foreclosure proceedings and the turnover of the property to the bank.  My client was allowed to stay in their business for at least another two years in hopes of getting it turned around.  


The owner has been released of the cash flow burden of an underperforming property and the settlement of a huge debt which could have had a devastating effect on their estate.  With that behind them, hopefully they can focus on the business and improve it’s profitability and maybe get some of their investment back over time.

Inside the Mind of a Banker: 5 Keys to Loan Approval


My banking career started out learning how to collect loans.  The conventional wisdom back then was in order to learn how to make good loans you need to experience how to collect bad ones.  So, my job was the “repo man” for a large commercial bank in North Carolina for the auto dealer department.  Any car loan that was past due, I had the responsibility of either bringing the payments current or repossessing the car.  Oh the stories I could tell.

inside the mind of a banker

From there I learned how to make personal loans usually car loans or home equity lines of credit.  Early in my career, I learned the 5 C’s of credit:

  • Character-Will this person pay me back?
  • Cash flow-Can this person pay me back?
  • Collateral-If I have to take the collateral back, can I liquidate it and pay back the loan?
  • Credit-Does this person have a good payment history?
  • Conditions-Is the economy or this person’s industry favorable?
I was only allowed to loan a certain amount (a lending limit).  Above that, I had to get approval from my supervisor.  This is how the bank handled risk.  The more experienced you were, the higher your lending limit.


You see, it’s all about risk for a bank and a banker.


I did a really good job lending money to individuals so the bank promoted me to the commercial banking department.  Loaning money to individuals is easy, but loaning to businesses is much harder.  An individual has cash flow as long as they’re employed. However, I did learn about the 3 D's (death, disability and divorce) which also affect cash flow.  These things also made lending to individuals a little harder. Also, if they’re unemployed, then you’ve got a problem. 


But, businesses have more moving parts. So, the perceived risk is greater.  The 5 C’s are still used, but the lender has to go deeper.


  • Character- Will this person pay me back and does the company have a solid balance of sales, operations and financial management?  A weakness in any one of the three can create a problem in the business.  Most bankers know for a fact, the Achilles heel for most business owners is financial management.  
  • Cash flow-Will this person pay me back and does the business generate the amount of cash flow to pay the loan back consistently over time?  The bank will look at three years of financial information and analyze the trends in your business to determine if those trends jeopardize the ability to repay.  Banks can only afford to lose 1% of their loans, so they have to be right 99%, 100% of the time.  It’s really hard to be that accurate.  That’s why bankers appear to be so tough.
  • Collateral-If the bank has to take assets back from a company, the liquidation value is usually so much lower than the value for a going concern.  Most banks will do 75-80% of account receivable and equipment, but a much lower value for inventory usually about 40-50%.  The margin hopefully gives the bank sufficient collateral to liquidate.  However, the bank requires a personal guaranty of the business owner in case there’s a shortfall.
  • Credit-Does the person have a good payment history and does the business have an established payment record that can be verified?  Credit references seem to be a thing of the past.  So, the banker uses the personal credit score of the individual to determine if the company is creditworthy.
  • Conditions-Is the overall economy favorable and is the particular industry this company is in trending up or down?  Residential real estate four years ago was in trouble.  Now, it seems to be booming again.  


In today’s market, the banker you’re dealing with probably has no lending authority.  That authority rests with a person you may never see.  Try to get to know that person with your banker’s help.


The mind of a banker thinks in terms of risk and reward.  They have to be right 99% 100% of the time, so you have to help them by reducing the perceived risk of your loan.  If you know you’re weak in one or two of the 5 C’s, then you have to make a compelling presentation to mitigate those with strengths in the others.

Why are my sales up and my gross profit down?


I've had two clients this week ask me this question. "Why are my sales up and my gross profit down?"  One is in the manufacturing distribution space with four distinct product lines.  The other is a rental product business with three separate products that feed each other.

shift in product mix

The answer to this question is easy if you have one product line.  Either you're discounting your price or you've had an increase in costs that you haven't passed on.  If you have multiple products it becomes more complicated.  It can be either of the above or it can be a shift in your product mix.

To demonstrate the impact on the shift in product mix, let's pretend you have three product lines which each comprises 1/3 of your total revenue. Product 1 has a 40% margin, Product 2 has a 30% margin and Product 3 has a 20% margin. Your overall gross profit margin should be 30%.  

If all of a sudden Product 3 becomes 100% of your mix, your gross profit margin drops 10% if the mix becomes 100% of product 1 the reverse happens.

The issue of shift in product mix adds a level of complexity to understanding changes in your gross profit margin beyond discounting or an increase in cost of goods sold.

The best thing to do is to analyze your revenue by product line and gross profit this year against same period last year to uncover what's going on. (ytd July 2014 vs July 2013.)

All of us want to have the most profitable companies we can and this is a good way to understand what's driving your changes in gross profit up or down.



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