Need Money?

A short time ago, we had a small get together and two local lenders gave some "Straight Talk" about what it takes to get bank financing for your small business. We had some great questions from the audience and Lisa Roberts from Champlain National Bank and Allen Racine from Glens Falls National Bank provided some information on fostering better relationships with your banking partners.

One of the items that we discussed included dispelling the myth that "Banks only want to lend you money when you don't need it and they don't want to lend to people who need money." This is not a new sentiment, nor does it relate to the so-called "credit crisis" of the past few years. Mark Twain is reported to have said, back in the 19th Century, "A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain."

Banks need to lend money to make money and my guess is that most commercial lenders out there would welcome an increase to their business loan portfolios. Yet at the same time, we have to remember that bankers only make money on their loans if the customer can make the loan payments.

Both bankers noted that what banks do is "manage risk." They lend, using resources from customer deposits, money their clients require today and expect to be able to pay back in the future. For the privilege of getting this money in advance, the borrower pays interest to the banks.

Of course, there are no guarantees of future performance, so the banks are assuming risk in using their assets. Bankers want to help their small business clients, but they also have a responsibility to their depositors to carefully assess risk and ensure those loans are paid back. They manage this risk by using what is often referred to as the five C's of financing:

* Character - the borrower's credit history and demonstrated ability to manage financial responsibilities
* Capital - the borrower's willingness to invest their own funds as a part of the project (banks don't want to own 100% of a venture)
* Capacity - the borrower's earning history. Should a deal not go as planned, does the borrower have the ability to still service loan payments?
* Conditions - does the local economy or borrower's knowledge of their industry demonstrate a likelihood of success? Like most intelligent investors, banks also tend to manage diversified portfolios and try not have too many loans in one particular industry.
* Collateral - does the borrower have something of value to guarantee the payback of the loan?

The best way to show banks that you are worth the risk of financing is to develop a clear business plan. An effective business plan will address not only why you need money, but also that you have developed a course of action to be able to make payments on the loan. As Allen Racine said, "Cash flow makes loan payments," so any good business plan will have a detailed cash flow analysis demonstrating that you have developed a plan to keep your business operating and the ability to still make loan payments.

Quite some time ago, I referenced Robert Kiyosaki's book, "Rich Dad, Poor Dad." In this book he references a simple process for cash flow that shows investing in assets that generate income. It is this process that every borrower should keep in mind when they approach a lender for financing. Income generation and cash flow analysis must be clearly identified.

Think of the typical proceeds of financing. Maybe the borrower needs money to purchase production equipment, to purchase more inventory, to cover accounts receivable for an interim period or just to have working capital for operations.

While it seems like I am stating the obvious, that equipment, inventory, accounts receivable and operating expenses must generate a profit above the cost of financing to justify the need for that money. An effective business will not only show how the funds will be spent, but specific benefits that will be achieved from the use of those proceeds.

So if you are purchasing equipment, there should be some analysis of the productivity that will be gained from that purchase. If you need inventory, there should be some analysis of your mark-up percentage and your expected turn rate on that inventory. If you need money for accounts receivables, you should show your average days receivables, along with your profit margin on those receivables.

The most difficult financing is for working capital, as this is the most unsecured level of financing. If your businesses' income can't cover operating expenses, there should be a clear reason why, but more importantly, a detailed timeline explaining the temporary nature of this and a plan of when the profit from operations will no longer require this level of working capital. If you can't do this, borrowing money will only create more expenses, and therefore, more trouble.

There is nothing wrong with going to a bank and presenting a plan that shows that you need money. That is as long as you are prepared to show that you figured out a way to generate even more income from the use of those funds. My clients often tell me they could make more money if they had access to money. Yet telling me and showing me are to different things. For those who need money, be prepared to show a plan that quantifies how you plan to generate more profit from those funds. If you need assistance, stop by your local SBDC and we would be glad to help you in those efforts.