Debt Financing

There is an old adage that banks only loan money to those who don’t need it. Since 2007, that adage has more and more become reality as we have faced such a severe credit crunch. Organizations that have had bank relations going back two to four generations are finding themselves with reduced credit at a time where credit is vital to staying in business. And they are sometimes the fortunate ones.

It’s not that the banks are purposely squeezing their customers. Many are faced with regulators telling them they have to reduce their exposure in certain industries. The bank can’t comply by calling the notes of their underperforming clients as those loans might slide into the non-performing loans. The result is that good long term customers are forced to find financing at a different bank.

How do you prepare for the unexpected in such turbulent times? The first step is to focus the organization on producing Cash Flow from Operations. The difference between cash flow and Net Income is that cash flow for an organization is like blood flow for our bodies. It also tells a bank how their loan will get paid back. Adding a cash flow statement to the monthly financial reports allows management to monitor cash flow and set in motion events that can improve it. Building a cash flow forecast to the documents a company presents to its bank allows the bank to see when it will be re-paid. Of course a forecast needs to be revised and adjusted to meet market conditions.

An increase in revenue may lead to an increase in Net Income. However if the resulting sales are increasing Accounts Receivable and are not being collected, cash flow will suffer. At the same time, collecting Accounts Receivable quicker than sales, you will be generating cash flow from operations. Accounts Payable also feeds into cash flow. Paying down accounts payable consumes or reduces cash flow while stretching your payables improves cash flow. That as well as non-cash expenses are all accounted for in the Cash Flow statement. We start with Net Income, add back non-cash expenses and then adjust out changes in Balance Sheet accounts to determine how much cash flow we generated from operations.

There is an old accounting saying “Profit is an opinion, Cash is fact”. Managing cash flow allows an organization to be proactive in planning what it needs to do to in order to meet its obligations while implementing its strategic plan. Keeping your bank aware of your progress builds a relationship. However, building relationships with multiple banks is a strategy that will allow an organization to survive difficult credit markets and have cash to be ready when the economy rebounds.

© Strategic Financial Leadership, Inc. 2009