From Inside the Vault...

Why Your Balance Sheet is more Important than your P&L

Posted by Bill McDermott on Tue, Nov 24, 2015 @ 09:11 AM

Many business owners look at their profit and loss statement and determine if they're profitable or not.  How is revenue tracking against last month or last year?  Any changes in gross or net profit margin?  If I'm making money then everything must be ok.  There is some validity to that way of thinking.

However, earlier this year, I attended a business summit where one of the guest speakers made the statement "your balance sheet is more important than your income statement" and then went on to explain why.  Here are some of the reasons she gave:

  1. While the P&L reveals the ability of the business to generate a profit, it does not reveal the amounts of investment needed to support sales and profits.
  2. The balance sheet reveals the liquidity of the business.  A balance sheet list assets from the most liquid (cash) at the top to the least liquid at the bottom (fixed and other assets).  You've heard the expression "cash is king."  Liquidity is needed to fund payroll, handle operating expenses and provide owners' distributions for taxes.
  3. Watching trends on the balance sheet (when paired with the income statement) helps you calculate changes in your key performance indicators over time.  Am I collecting my accounts receivable faster or slower?  How is my inventory turning?  Without the balance sheet, you couldn't monitor changes in these trends.
  4. Your balance sheet tells how much of your assets you own vs how much your creditors own.  When you buy a house and put 10% down, your lender "owns" 90% of your house.  Over time, you pay the loan down to the point where you have no debt and you own 100% of the house.  Think of your business the same way.  Financial leverage is using debt to finance your business with cash you don't have.  

The question is how much leverage is enough and how much is too much?  Most borrowing for a business starts with a line of credit and is secured by accounts receivable.  Most banks are willing to loan 75-80% of your accounts receivable as a maximum.  That means they're willing to give you $3-4 of debt for every $1 of equity you have in those accounts (75-25 is 3-1, 80-20 is 4-1).  Remember this is a maximum.  Just because they're willing to loan it, doesn't mean you should borrow it.  Leverage will vary from company to company, it depends on where you are in your growth cycle, what type of industry you're in and management style.  However, the rule of thumb is most banks are willing to loan to a balance sheet with 3-1 leverage or less.  If you're higher than that, it may be difficult to obtain the financing you need from a bank.

Since much of my career was in banking, I was trained to look at both the balance sheet and the profit and loss statement.  Bankers look for trends in profitability (the profit and loss statement), but also look for trends in liquidiy, activity (AR and inventory turns) and leverage (how much you own vs owe).  Since the balance sheet has 3 of the 4 things bankers look at when lending, I hold the opinion that the balance sheet is more important than the profit & loss statement.  What do you think?

Topics: balance sheet, debt, small business, cash flow, income statement, banking, cash flow planning, growth, profitability, line of credit, leverage, profit & loss statement

Why You should Consider hiring a Part Time CFO

Posted by Bill McDermott on Fri, Oct 30, 2015 @ 11:10 AM

Two things have become increasingly apparent to me.  If you're a big company, you have good access to capital and can find the funding needed to finance your business.  Small companies don't have that access to capital and finding funding is difficult.  Here's why:

  • Banks are consolidating and there are less banks focused on the small business market.
  • Many banks have gone up market to make larger loans to larger companies which are more profitable.
  • Regulators have caused lenders to increase lending standards making it more difficult to obtain credit.

Also, the median salary for a full time CFO is $150,000 plus bonus. Your company can't afford a full time CFO, but you have significant financial management issues to address: cash flow, finding financing, scaling the business, and exiting the business.  You need resources, just not full time.  

You're too small to be big, but too big to be small.

So, you need access to capital to fund your business and you need financial management resources to help you with the overall financial strategy for your business.  But where do most business owners find these resources?  Here are a couple of things to consider:

  1. Your banker: Most business owners have a bank, but not a banker.  Banks consolidate and many bankers move to another bank hoping the business owner will follow, but that doesn't always occur.  When bankers move, the trust relationship can change and takes time to develop again.  Plus most bankers have never run a business from the inside. They have never had to sweat out a payroll, so it's hard for a banker to relate to what you're doing inside of the business.
  2. Your CPA or attorney: Most business owners will trust their CPA or attorney more than their banker.  These two professionals know things that most business owners wouldn't tell their banker for fear it would jeopardize their credit arrangement.  CPA's and attorneys do have financial management expertise because they manage their practices, but a CPA or attorney are trained in their professions.  They don't think, talk or act like bankers, so helping you find access to capital can be difficult for them, especially because the capital markets and players change.  It's hard to stay current.
  3. The part time CFO might be the right person to help you with access to capital, but also help with the financial management of the business.  The CFO needs to have a good grasp of accounting and finance and preferably banking experience in their background to navigate the banking markets for you.  

Generally, it's a good idea to staff your core competencies and outsource your weaknesses.  If financial management is a weakness and outside your core, then consider adding a part time CFO on your team.  You get the benefit of their expertise without paying for it on a full time basis.

Topics: CPA, small business financing help, small business, strategic planning, cash flow, finance, credit, profitability coaching, finding financing, banking, business owners, cash flow planning, growth, profitability, line of credit, CFO

3 Things to Know Before you Buy a business

Posted by Bill McDermott on Thu, Oct 22, 2015 @ 10:10 AM

The baby boomer generation is retiring and those who are business owners are selling their businesses.  So, where do you start?  How much do you pay for the business?  What's it worth? How do I get if financed?  Depending on your situation, you may only buy and sell one business in your lifetime, so you want to do it right.  Here's 3 things you must know when buying a business:

1) Set up your team.  Buying a business is a complex transaction for a large amount of money.  You should hire an attorney to help you with business formation issues, corporation (LLC), partnership, and proprietorship.  They will walk you through any and all personal and business liability issues.  You may want to set up 2 LLC's if the business you're buying includes real estate, one for the business and the other for the real estate.  You want a CPA to help you with all the tax implications of buying the business.  Typically, a business is purchases for a value in excess of the assets.  So, you have an intangible asset called goodwill on the balance sheet when it's purchased.  Your CPA will help you with determining the best way to structure your purchase from a tax point of view.  Finally, a business broker/advisor rounds out your team and will coach you through the negotiating process from Letter of Intent (LOI) to due diligence to the actual purchase agreement.  There are numerous terms and conditions that can be included or are important to buyer and seller.  Rely on a professional to guide you through the process.

2) Determine what you're willing to pay.  Ultimately the purchase takes place at the point where a willing seller and a willing buyer agree.  You can rely on your business advisor/broker to do industry research to determine the multiples of cash flow or revenue that businesses like the one you're buying go for.  They can pull comparable sales to determine what the current market value.  But setting all those aside, you have to be comfortable with the price you're paying and all the terms and conditions of the sale.

3) The business acquisition loan of choice is the SBA 7a loan.  The 7a loan provides 10 years terms, about 80% of the purchase prices can be financed (in some instances a higher %) and the rates at about 3% above Prime, some higher, some lower.  The term extends to 20-25 years if the transaction involves real estate.  If you're buying both a business and the real estate, the lender will blend the term based on the weighted average of the 2 values (business value and real estate).  So, it's likely you'll end up with a 17-18 year term for the loan.  The bank gets an SBA guaranty of 75% of the loan amount.  This covers them in liquidation if there's a default and a collateral deficiency after all assets are liquidated.  You pay a premium for the guaranty which is about 3% of the loan amount.  It can be financed in with the loan amount, if there's sufficient collateral.  The lender is required to but forth "best efforts" to fully collateralize the loan with business and if necessary personal assets.  You'll want to deal with a "preferred lender" a designation given by the SBA to a lending institution.  It speeds up the process.

Buying a business is an incredibly difficult, but ultimately rewarding process.  It's important to take these three things in to account before you begin.

Topics: SBA loan, entrepreneurship, small business, cash flow, collateral, credit, business banking advisor, finding financing, business owners, profitability

3 Things You Need to Know about Debt Restructuring

Posted by Bill McDermott on Tue, Oct 6, 2015 @ 16:10 PM

So, you took out a line of credit, but you forgot about the 30 day annual payout requirement on the line when you signed the commitment letter.  You don't have the cash to pay the line in full.  So, what's next?  Maybe you took out a term loan for a piece of equipment.  Cash flow is really good and you're thinking about prepaying the loan to save interest expense.  Good idea or bad idea?  Well, it depends.  

In both of these examples, either you or the bank might restructure the debt.  If your line of credit has a 30 day annual payout and you don't have the cash sometimes the bank will term out the line of credit and you can make monthly payments.  In the second example, you're thinking about accelerating the amortization by prepaying the loan.  While you're not signing a new note, indirectly you're restructuring the debt and paying it off in a shorter period of time.  To determine if debt restructuring for you is a good idea or a bad one, here are three things you should know.

  1. When making loans, bank matches sources and uses. What I mean by that is banks determine whether the use of funds is short term or long term. When the banker asks you what the loan is for is you're borrowing money to carry your accounts receivable or inventory that's considered a short term use (1 year or less), so a line of credit is used. If the loan is being used to purchase equipment, real estate, or acquire a business, that's a term or mortgage loan because the term is longer than a year.
  2. Banks will attempt to match the depreciation schedule of the asset and the loan amortization so that the loan is paid out as the asset is fully depreciated. Generally, this is 3 to 7 years on equipment or other fixed assets and 15-25 years on real estate. The one exception to this is business acquisition loans. Amortization of good will can sometimes be longer than 10 years, but most business acquisitions through banks are funded with an SBA 7a loan. That loan has a maximum term of 10 years.
  3. If the use of funds for the loan changes, then the debt may need to be restructured. This occurs all the time in a line of credit. You initially intended to use your line of credit to pay expenses before your receivables came in. This is called temporary working capital (you borrow the money and pay it back when the receivable comes in). But what if your business is growing and you can't pay the line back? Or you need that money for payroll or some other purpose? This is called permanent working capital. As your business grows, the amount of receivables you have grows with it and you can't use your cash to pay back the line you need for growth. When this occurs, your line of credit can be restructured to a term loan. Many banks will term out lines of credit for this purpose on terms ranging from 2 to 5 years. Other purposes could be you used the line to purchase equipment, fund losses in your business or fund special projects that may not have an immediate payoff.


There's nothing wrong with restructuring debt if needed.  The things to keep in mind are:

  • How will this decision impact my cash flow? Is there more or less cash required for debt service?
  • How will this affect profits? Am I paying more or less in interest expense overall?
  • Is the decision to restructure my debt in line with my overall business strategy?

Topics: debt, cash flow, credit, bank loans, line of credit covenants, loan modifications, cash flow planning, growth, line of credit, refinance, term loan

Are you Under-banked?  3 Sources You Must Consider

Posted by Bill McDermott on Fri, Oct 2, 2015 @ 11:10 AM

Are you under-banked?  If so, you're not alone.  A recent article I read indicated that among CFO's, being under-banked has landed on the growing list of challenges most CFO's face.  Here's why:

  • A recent report stated the financial landscape for small to medium sized businesses (SMB's)has changed significantly.
  • Credit markets have become increasingly biased toward bigger businesses.
  • 89% of SMB's report having the enthusiasm to execute growth strategies, yet just 52% have the necessary financial resources to successfully do so.  
  • The National Small Business Associaton reports that 31% of small businesses are without the capital they need.  That translates into over 10 millon businesses nationwide.

So, what does under-banked really mean? And how do SMB's get creative to find the capital they need?

Traditional banks rely on the credit worthiness of the SMB (not the owner) to determine when and how to lend, and at what rate.  With pressure from the regulators after the passing of Dodd-Frank, banks have been tightening commercial lending standards again.  With lending from commercial banks hard to find, many are seeking financing from alternative capital sources, as banks struggle to compete in that space.  Here are some alternative sources to consider:

  1. Asset based lending: ABL is lending against the value of the collateral, not the balance sheet of the business.  It's expensive (often overall cost between 18-24%). Most ABL lenders will advance between 80-90% of accounts receivable, depending on the quality of the receivable.  They often will use a lockbox where all your AR comes in to a lockbox to the lender (which is unknown to your clients).  That way they can control advances and payments to your line of credit.  The monitoring required is fairly heavy.  An ABL lender will charge a service fee for administration, typically 1-1.5% per month and will charge interest at Prime plus 3 (give or take 1%) for the period of time the money is outstanding.  
  2. Non-Bank SBA lenders: To fill the gap in the SBA lending space vacated by banks, several non-banks that are privately funded will do SBA loans on similar terms to banks.  They don't have the same regulatory reporting/pressure that banks receive.  So, they are less conservative than many commercial banks.  If you're buying a business, the SBA provides a 10 year ammortization and can typcially finance about 80% of the business subject to an appraisal.  There are SBA programs that also finance up to 90% of commercial real estate on favorable terms.
  3. Private Debt and/or Equity: Many individuals or family offices are tired of receiving less than 1% on their short term money accounts or mutual funds.  So, they are willing to allocate a portion of their wealth toward investing in business ventures.  This is high risk lending because these businesses can't receive credit from other sources.  However, the returns are high (typically in the 18% range and there's a fee to the person or company that raises the money.  Some of these sources will also require a portion of the company (referred to as an equity kicker).  This is common when a company is in a growth phase and will sell to a strategic buyer or do an IPO.  The equity kicker provides an increase in the overall return due to the increase in value they received from the stock at the sale.

Given an environment where available sources come in all shapes and sizes, the smart choice may be to seek an experienced advisor that knows the market and can create the best outcome for you and your company.


Topics: balance sheet, debt, SBA loan, small business, small business loans, cash flow, finance, collateral, credit, bank loans, banking, growth, line of credit

3 Ways to Manage Sales and Growth for Long Term Success

Posted by Bill McDermott on Fri, Sep 25, 2015 @ 13:09 PM

Have you ever had the experience where sales and growth were either happening way too fast or not fast enough?  The success of both requires management on the part of the owner and his or her management team.  The size of the business will determine what the division of labor is for these management tasks.  Here are three ways to manage both:

  1. Sales management-Do you have a person who is accountable for the strategy and execution of your company sales goals?  Having managed sales people in the banking industry for over two decades, it requires attention to specific metrics. How many calls are they making? What's their close rate? What's their average sale?  In their execution of the process, you have to be sure they've properly identified an opportunity, determine if they have the resources to handle the opportunity, if they're talking to the decision maker(s) and have they got the decision maker to the point of saying yes or no. The maybes can kill you!  Having or not having someone accountable the process and the execution will be a determining factor in your success.
  2. Financial management-Do you have a person who is accountable for making sure you have the cash required to handle the growth? Growth always requires cash. Can the cash come from internal funds (profits) or is a line of credit needed? You also need to be mindful of how much you can borrow on your line of credit. If you finance your growth with debt, there will come a time when you become so leveraged that you're no longer bankable. As you grow, you will watch your gross and net margins.  Often, growth will come at the expense of margin and it will take more sales to make up for the loss of margin.  At that point, you may decide to raise prices or slow down to avoid profit erosion.
  3. Operations management-Do you have a person who is accountable for productivity and process analysis, managing the operations workforce, facility layout and purchasing and inventory management?  Often, when sales go up quality can go down. And if you don't have the right people in place, your reputation as a provider can suffer in the marketplace.  Also, if you don't have someone watching the overal quality of your people, processes and execution in your product or service delivery, the operation can become less effective and efficient.  

Having a balanced approach and having people accountable in sales, financial and operations management are key to managing sales and growth long term.  When growth occurs, it always requires cash and increases the complexity of the organization.  People need to be hired and processes and execution change along with strategy.  It's up to the management to constantly monitor their efficiency and effectiveness in these areas.  Often this will include establishing key performance indicators in each of these areas.  We will discuss those in our next blog.

Topics: strategic planning, cash flow, profitability coaching, cash flow planning, growth, profitability, line of credit

How to Pace Sales and Growth for Long Term Success

Posted by Bill McDermott on Tue, Sep 15, 2015 @ 15:09 PM

Success should not come as a surprise. It’s something you’ve planned for. You have the right people in place with good processes and execution.

However, sales growth can happen rapidly. Sometimes it can get out of control and even become unmanageable. When that happens, it can hurt your clients, your employees and your business reputation.

Here are a couple of things to consider so your pace of sales and growth don’t get out of control. There’s a fallacy many business owners belive. Growth is good, but rapid growth is better. The truth is too much of a good thing can be a very bad thing. Many business owners are caught off guard by rapid sales growth. They choose to borrow money to support that growth which adds interest expense and cuts in to profitability. The money they borrow also adds leverage to the balance sheet, which if not managed properly, can create significant issues for the business.

As in most instances, failing to plan is planning to fail. Any manager should know their tipping point, when more sales switches from a good thing to a bad thing. Here are some things to consider:

  • Have a plan and work it. Analyze your sales forecasts and revise them as you see sales increase.
  • If you see a tipping point coming reallocate sales resources and processes to keep growth manageable.
  • Growth will come at a price. It will change the way you operate, it will often change your employee culture and create new management challenges.
  • It may take you outside your comfort zone and do the same with your management team and employees.

Many managers use the Sustainable Growth Rate as a tool for growth. The premise is how much sales growth can I sustain without increasing the leverage of my business. To calculate it, you take your Return on Equity (ROE) and multiply it by 1- your distribution/dividend rate.

So, is your ROE is 25% and you distribute 25% of the profits, then you sustain a growth rate of 18.75% (25% x 1-25% or 75% ) 25% x 75% =18.75%

You might be thinking I’d like to grow more than that. Well, you have a few choices.

  1. Take on a little debt. Just don’t get crazy. Most banks are comfortable lending up to a leverage ratio (total debt/total net worth) of 3-1 debt to equity.
  2. Increase your profitability. If you can raise prices/volume or cut expenses, you increase your profitability which should increase your ROE in the short term.
  3. Reduce your distribution/dividend policy. If you take a large amount out of the company in distributions, consider reducing it. The more you leave in the company the more you have to finance your growth.

Many companies are facing growth challenges in the current economy. Formulate a plan, watch out for your tipping point and consider some strategies to increase your ROE and reduce your distribution policy to enhance your growth opportunities.

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

5 Signs You're Growing Too Fast

Posted by Bill McDermott on Wed, Sep 9, 2015 @ 14:09 PM

The Great Recession is clearly a thing of the past. The economy appears to be expanding. Businesses are seeing sales, growth, and profits. Entrepreneurs are experimenting with new products and markets, starting new divisions and making investments in people.

Growth is good. But too much of a good thing can become bad. So how do you know if you’re growing too fast? Here are five signs that you might be growing too fast.

1) You’re just about out of cash. Growth always requires cash and increases complexity. Growing companies always run in to unforeseen costs. A growing company will run tight on cash as expenditures outpace sales. Companies with inventory or receivables will run in to this situation particularly fast.

2) Management is stretched way too thin. Sooner or later, a company will grow beyond the core management team’s ability to micromanage it. As a CEO, the company you founded may be doing quite well, but you’ve never had to share decision making authority with someone else. Delegating is the number 1 challenge for CEO’s in most small businesses. Whether your company is stretched in sales, operations or financial management, you may need to delegate those responsibilities to someone who can take your company to the next level.

3) You haven’t revised your projections. You may have done projections annually, but a fast growing company should revise their projections multiple times annually as management sees major deviations (good or bad) in collections and expenditures. This updating will tell management when to slow down growth or cut expenses so you don’t run out of cash.

4) You stopped planning for taxes. As your company becomes more profitable, it’s tax bill will likely increase at a higher rate than anticipated because it will move into a higher tax bracket. Don’t get surprised a month before April 15th that you have a big tax payment to make with no cash to make it.

5) Profits fall of the radar. When a company is expanding quickly, it’s very easy to become excited about rapidly rising sales and lose track of profits. This is particularly true when the company reaches a stage where it has many managers. It's important to keep an eye on margins.

So what’s the right amount of growth? Many financial managers use the sustainable growth rate calculation to come up with that answer. This is the maximum growth rate a firm can sustain without increasing leverage. It’s calculated as return on equity x 1 – dividend/distribution payout ratio.

So if your ROE (return on equity) is 20% and you pay out 50% of your profits as dividends or distributions, then your sustainable growth rate is 20 x .5 or 10%.

Topics: small business, cash flow, finance, business owners, cash flow planning, growth, profitability

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