Are You Making These 4 Banking Blunders?

When I started my CFO and controllership practice back in 2001, I was in for a rude awakening in the world of small business finance. In larger sized businesses, we have the capital structure nailed down, which includes debt financing.

But in the the small business world, here’s what I quickly learned when I started working with CEOs:

• Small business owners view their bankers as investors
• Small business owners expect their bankers to be investors
• Small business owners expect their bankers to take care of their cash flow deficiencies regardless of the circumstances
• Small business owners expect unconditional love from their bankers at all times

And what I found more surprising years ago was that these same bankers only did a so-so job in educating CEOs on debt management.

Accordingly, here are the top four small business financing blunders I have encountered during my CFO career. Take note if you have violated one of these blunders.

Blunder #1 – Improper Use of the Line of Credit

This has to be the biggest problem I see with small business owners. When I take on a new client, I review the balance sheets over a trailing 60-month period. The typical pattern I see is a flatline LOC over the course of the year.

I do not know who coined the term yo-yo notes for LOCs, but the metaphor is appropriate. As cash is positive, the line should be paid down. And vice versa as cash starts to go negative. Ideally, your bank should have this process automated, but in smaller communities, this automated treasury management feature is sometimes lacking.

Looking back in my free agent CFO career, there are two primary reasons the LOC stays flat over an extended period of time. Ignorance. And that’s not meant to be critical. Many bookkeepers and the CEOs they serve are not aware they should be paying down the line when cash is positive. The next reason is one that bothers me the most–laziness. “It’s too much of a hassle.” Yes, I’ve heard that on numerous occasions.

Case in point. Several years ago, I was working with a small specialty contractor. They generally maintained a flatline LOC. In my first month on the job, I noticed one week they were sitting on $400,000 in cash. I asked the bookkeeper to pay down the LOC immediately. Her boss agreed.

Do you think it happened? No. A week later she had a large payroll deposit due. She said it was too much trouble to pay down the line and draw it right back a few business days later.

Let’s do some simple math. Let’s assume an average LOC balance of $1 million over the course of the year at 3.25%. And let us assume the LOC is never touched (a little unrealistic, but bear with me). That’s $32,500 in rent paid to your banker for short-term financing. Now let’s say we pay down the LOC regularly and the average LOC balance is only $500,000. The interest paid now is only $16,250 over the course of the year. Needless to say, this difference is significant.

But some business owners might say their balances are not that high and the constant movement is not worth it. There’s another reason we want to manage our line regularly–enhanced credibility with the banker. When the banker reviews your line periodically and sees the movement in regular intervals, trust me, he or she will be impressed. In the banker’s mind, this shows you are a financially intelligent CEO, at least in banking matters.

And this is a big deal when it comes time to renewing your LOC and requesting new debt for capital purchases.

To summarize, your LOC is a short-term tool for financing short-term cash flow gaps. Your LOC is not term debt. Nail down a process for paying or drawing on your LOC. I’ve created such a system, and if executed properly, the daily treasury management process can be performed in less than 15 minutes per day.

Blunder #2 – Mismatching Debt with Assets

This is somewhat related to the first blunder. Many times in the past, I’ve heard a CEO say he can use the excess capacity to acquire a new piece of equipment. Please don’t do that. Lines of credit are for financing short-term working capital requirements like receivables and inventory. Use term debt for capital assets.

By matching debt with assets, cash is less likely to be squeezed. For example, inventory is converted to receivables, and receivables are ultimately paid. Reductions in working capital allow the credit line to be paid down. Conversely, cash generated from business profits is used for term debt payments (which should have already been planned ahead of time).

Small businesses typically misuse their LOC when collateral is tight and the debt-to-equity ratio is already at alarmingly high levels. In these cases, the banker may not desire to extend additional funds. Using the line to fund these longer-term assets is really a symptom of a much bigger problem. Poor cash flow management, weak executive leadership, and declining sales are contributing factors.

Blunder #3 – Lack of Transparency with the Banker

My top clients allow me to do something that is extremely important to me–to share our detailed financial reporting package with the banker and meet with them monthly to go over the numbers. This exercise is something I look forward to doing every single month. No, I never skip a month if we’re having a bad month, bad quarter, or even a bad year.

In every case, I have not ever encountered problems renewing existing lines or asking for more money for capital expenditures. Why is that? Because this approach leads to more trust between the banker and my clients, even if we’re having off years. I cannot begin to tell you how much bankers appreciate these monthly meetings. When I ask them how often they do this other client CFOs, the answer is always the same, “Rarely ever.”

Several years ago, I was working with a large vineyard and winery owner on the west coast. The debt level was high. Cash was tight about nine months out of the year. The internal financial reporting was a train wreck. Even though the company was audited, the banker received little in the way of assurances throughout the year because the reporting he received was hard to read.

Well, that didn’t last for long once I jumped on board. Within three months, I was meeting with him going over our lengthy but meaningful reporting package. The numbers were not pretty, but the banker was thrilled because I was providing him peace of mind about our current condition each month. He was so happy, he wanted to introduce me to his other ag-related customer base.

The opposite of bank transparency as I have described it is fear and insecurity. If that’s the case, you have to get over it. Sure, easier said than done. But in the long term, this is a great strategy and one that will bridge the bond between the banker and CEO.

Blunder #4 – Getting Frustrated with the Lender Because They Do Not Like You

Peculiar? I see this periodically, and recently had to walk away from a business because they were too frustrated with the banker’s opinion instead of listening to their constructive criticism.

If a banker does not like you, it’s typically not personal. It’s because the business is probably mismanaged. Or there is not much to manage (in terms of sales). Sales could be declining. Margins could be shrinking. AR could be going down the tube. Owner distributions are out of line. You get the idea.

If the banker is uncomfortable with you and your numbers, there is a reason. Don’t criticize the banker. Instead, criticize the strategies that got you into your mess and start finding a way to turn the business around. And you will need help. Seek it out.

I’m Throwing in a Bonus Blunder – Too Much Start-Up Debt

As a rule, I do not work with start-ups. I’m really expensive because I’m extremely effective in what I do. Start-ups are unproven and have little to no cash, and the founders have to play the role of CFO themselves.

Yet, these same start-ups will go out and borrow to the max to launch their start-ups. And their bankers allow it because personal collateral may look decent and the marketing plan looks somewhat doable (I’ve yet to see a great marketing plan from any start-up, the very first document I study hard when mentoring start-up owners).

Just because you can doesn’t mean you should. That’s the message from Carol Roth in her book The Entrepreneur Equation which could easily be the forward to The E-Myth Revisited.

Borrowing to fund a start-up is seductive, alluring, and even reaps a little with an obsession once the decision has been made to borrow. The honeymoon starts once the money is in the bank. It ends when the first bank payment is made. A divorce is in the making when the perfect marketing-plan-on-paper is not so perfect after all.

In no way am I saying start-up debt is bad. I am just against poor decision making. Many start-up owners I have mentored (mentored usually means free in this context) have not one iota of financial intelligence in their brains. Harsh? Not really, because these same start-up owners typically have emotional intelligence that’s off the charts along with great social skills. It’s the lack of financial intelligence that knocks them off track, and sometimes in a disastrous way.

I’ve Never Had a Bank Loan Go Bad on My Watch

And there’s a good reason. I never fall into the traps listed above. And that’s why the bankers I meet with monthly or quarterly enjoy working with me. They trust me because I share everything. The good. The bad. The ugly. Yes, the ugly. You see, my clients are generally confident and do not lack self-esteem in their numbers. No insecurities.

We get it right on using the LOC correctly. We manage it. We are not a slave to the LOC. The LOC obeys us.

We match our debt with our assets. Yes, that’s fundamental, but the LOC is for working capital, and that’s how we use it. We use term debt as it’s meant to be used.

Transparency? That’s why most of my client base allows me to meet with their bankers each month. Think we ever have issues when it’s time to renew the LOC? Not at all, and chalk up one less headache for the owner/CEO.

So where are you with your relationship with your banker? And bankers, what percentage of your customers are getting it right? Or are they committing these blunders?

The Incredible Leaders Behind the Bank Shown in the Image Above

The bank in the image above is Commercial Trust Company based in Fayette, Missouri and was founded more than 100 years ago. Janet Jacobs, Mark Harbison, Gina Sanders, Kyle Elliot, and the remaining dream team members at this bank are truly special, and their customers are blessed to have them servicing them on a daily basis.