Guest Articles:

1.  How to Finance Your Small Business

by Marina Lando

2.  Understand the Impact of Cash on Business Growth
By Lea Strickland, CMA CFM CBM

For more information on small business financing options, visit the Smartrack Blog

How to Finance Your Small Business

Copyright 2005 by Marina Lando

If you’re looking for small business financing, don’t be discouraged. Lots of options exist, but you need to know some facts before you try to get a loan.

Commercial lending is very different from residential lending. It involves more risk to the bank and you should expect to pay higher interest rates. The credit requirements for the borrower are also higher than for residential lending.

Banks make their decisions based on:

· the borrower’s experience

· the borrower’s credit

· the available collateral

· the available injection (down payment)

· the historical financial condition of the business (for existing company)

Experience. Banks favor borrowers with management experience and/or experience in the industry.

Credit. Banks favor borrowers with a better than average (680+) credit score. Bankruptcy in the past 7 years dramatically decreases your funding options. Bankruptcy due to medical circumstances can be excused. You can check your credit score by yourself (see the list of sources at http://www.blquest.biz/serv04.htm). Self check is considered a "soft hit" and will not decrease your credit score.

Acceptable Collateral includes real estate (commercial and residential), equipment andinventory

Injection/Down Payment. Generally, banks expect you to spend some of your own money and take some of the risk. 100% financing is available only for existing businesses in need of expansion and for venture capital deals.

Financial strength of the business (if you’re purchasing an existing business). Think about it this way: you are not going to buy a car that is falling apart. Not surprisingly, banks will not invest in any businesses in financial distress. There are other ways to fix it.

While choosing bank, keep in mind that banks are specialized entities If you wanted Chinese food, you wouldn’t go to a steak house, would you? Banks are organized the same way. You will never find a bank that does all types of businesses and all types of loans.

Do your homework. Call the bank, ask for a business loan officer and describe your business type and your financial needs. Try to avoid banks that will give you a general answer: "We make our credit decision on a case per case basis". Most likely you will waste money and most importantly your time.

In most cases it takes 5-7 business days to issue a commitment letter and 30 – 45 days to close the loan. Act in advance. Never shop for a loan under time pressure.

Loan types:

· Start-up Loans

· Expansion Loans

· Business Acquisition Loans

· Franchise Financing

· Commercial Real Estate Financing

Other ways of financing (outside of the scope of this article):

· Factoring

· Purchase Order Financing

· Account Receivables financing

· Contract Purchase

· Credit Card Financing

· Private money and VC

Loans can be secured and unsecured. Only a person with exceptionally good credit scores (680+) can obtain an unsecured loan. Secured loans are loans that are secured by collateral (real estate, inventory, equipment, etc).

Small business loans in the USA are available only to US citizens and Green Card holders with established credit (no bankruptcy or insolvency).

Let’s take a look at some of the basic loan types in details.

There are two types of start-ups: non-franchise start-up and franchise start-up. Franchise start-ups are easier to finance. For more information see Franchise Financing.

You can finance a start-up with unsecured loans, credit cards and secured loans. When you need a very small loan it is a wise decision to finance it with a credit card, home equity line or unsecured loan. It involves less paperwork and you can receive it faster. Interest rates that you will have to pay on, for example, a home equity line of credit are lower than commercial rates and are tax deductible.

General requirements for non-franchise start-up.

· Collateral is a must.

Some banks will finance up to 150% of collateral value. But as you can imagine it is hard to get this type of financing and it requires a perfect credit score

· As the borrower, expect to invest at least 30% or the total project cost. This investment cannot be money you have borrowed.. A home equity line is okay (but keep in mind that it will decrease your available collateral). If somebody gave you a gift, please make sure that you have a notarized document that the money is a gift and you do not have to pay them back.

 

Any business expenses that were paid by you during the initial stage can be counted towards the borrower’s injection:

· Travel expenses

· Legal expenses

· Business plan preparation expenses

· Equipment that will be used in the business

· Inventory expenses

· Etc.

 

Experience -- In most cases any management experience and/or industry experience is acceptable. Banks will not finance a change of career. For example, an experienced truck driver has no chances of obtaining a start-up loan to start-up a plumbing business. The way around this is to hire an experienced manager and give him 10% of ownership.

These loans are available for established (at least 2 years old) companies for expansion, leasehold improvement, FF&E (furniture, fixtures and equipment) replacement, equipment purchase, refinancing (no credit card refinancing), property construction and renovation. You can receive up to 100% financing.

Real estate collateral is not always required. Some banks will accept a business’ performance (good will) as collateral.

Be prepared to provide 2-3 years of business tax returns. The rule of thumb is that if your taxable business income is dropping more than 5% each year you will not be able to get the loan. For some industries that are considered riskier than others (automotive repair, gas stations), only stable or increasing income will be considered.

Sometimes people think a business acquisition is the same as a start-up. This is not correct, since you are not starting from scratch. It is like the difference between making your own clothes and buying them from Sears.

You should expect to put down at least 20% of the total project cost. The total project cost may include additional working capital in some cases. If you do not have enough for a down payment, ask for a seller’s second. A seller’s second is a loan from the seller.

Banks favor buy-outs by existing manager/partner/shareholders with little or no down payment for an obvious reason: experience Real estate collateral is not always required. Some banks will accept business’s performance as collateral.

Be prepared to provide 2-3 years of business tax returns. Check financial documents by yourself first or ask an experienced CPA to do it for you. If the taxable profits are dropping more than 5% - choose another business to buy. You are not going to buy a broken car, so do not spend big money on broken business. Banks will not finance this project. The best way to find reliable business is to hire a business broker. Their job is to make sure that the business is in perfect shape.

Banks favor franchise businesses. But be aware that not all franchises are created equal. Get a copy of the Franchise Offering Circular. Under the FTC's Franchise Rule, you must receive the document at least 10 business days before you are asked to sign any contract or pay any money to the franchisor. Show it to your CPA and lawyer. Some banks rate franchises based on profitability and number of existing locations. Preferred franchises can be financed with no collateral and a lower down payment. Check with your local bank. Most franchises will be financed as a start-up (new location) or business acquisition (existing location).

Be aware that investing in a financially unstable franchise is a significant risk; the company may go out of business or into bankruptcy after you have invested your money. Relevant management or industry experience is a plus: however, some franchisors have such excellent training and support that banks will even fund an inexperienced entrepreneur.

When a bank requires relevant experience that you do not have, hire an experienced manager and give him/her 10% of the ownership. Don’t look at this as extortion. What is good for the bank is good for you. Banks base their requirements on statistics, which show that certain types of businesses, if run by an experienced person have approximately five times less chance to file for bankruptcy.

Commercial real estate loans are easier to obtain than business loans. Real estate is considered as very strong collateral. However, properties that are difficult to convert such as gas stations, c-stores, marinas, etc are hard to finance. You should find a bank that will do the loan for your particular property type.

The purpose of the loan can be for: purchasing, refinancing, cash-out refinancing or construction.

Refinancing and cash-out refinancing require no down payment. In all other cases expect to pay up 10% - 35% in down payment. SBA loans will finance up to 90% of the purchase price. However, income property like apartments, duplexes andB&B’s are not eligible for SBA financing (exceptions can be made for properties in rural areas). Some working capital can be obtained as a part of an SBA loan.

A seller’s second is an acceptable type of supplemental financing. The seller’s second is a loan from the seller and should not exceed 20% of the total purchase price. 10% down payment is a must, unless you are dealing with private lenders. Private lender financing is outside of the scope of this article.

Save this information and review it carefully when seeking financing for your business, and your search will be much easier.

Marina Lando is an experienced small business loan expert and President of Business Loan Quest, LLC.

Contact Marina Lando

Business Loan Quest, LLC

Bus: 919-469-1505 Fax: 919- 386-8013

www.blquest.biz

Understand the Impact of Cash on Business Growth
Coyright 2005 by Lea Strickland, CMA CFM CBM
President - F.O.C.U.S. Resources

Cash is the life blood of any organization. Without cash to pay vendors, employees and other stakeholders, the organization isn’t viable.  Revenue, profit and cash position are intrinsically linked and need to be pursued as interconnected objectives.

For example, if a sale is made to a customer for $1,000,000 on net 30 terms (the customer has 30 days from the date of a correct invoice to pay me), then I am essentially extending my cash collection cycle by 30 days.  If I purchased the materials to manufacture the product on 30 day terms, and it takes me 30 days to convert the materials to shippable, finished goods, then what is my cash cycle?

The materials cost $300,000 and are received them on January 15 on 30 day terms. Payment is due to the supplier on February 14. The materials go into production on January 20.  The finished items are completed on February 20 and shipped.

The customer receives the goods on February 23. The invoice is included and has a due date of March 21. The cash balance on January 15 is $750,000 and monthly expenses (including payroll, etc.) are $250,000 and are paid on the last day of the month.  There are no other sales or pending receivables (cash due from customers).

Balance Sheet  

Income Statement  

As you can see from the above example, the company didn’t have enough cash to pay its bills on February 28, yet posted a $200,000 profit as of February 20.  Cash and profit in this example differ because of the timing differences in payments being made, conversion of materials, and collection from the customer.  Even when there are no complicating factors like customers disputing an invoice or paying late, companies can be cash constrained.

This is a good point to talk about the cash flow statement.  This financial report translates activities on the balance sheet and the income statement into the impact they have on cash.  The cash flow statement is divided into three sections based on activities:  operating, investing, and financing.

Cash from operations is simply that - the cash that is generated through the normal business processes of selling goods and services.  Typical transactions in this section are cash sales, credit sales, and changes in accounts receivable and accounts payable balances. This is the cash position (positive or negative) from running your business and is a measure of how well the organization is performing all business functions.  It reflects the efficiency of business processes (including production, collection and payment), appropriateness of infrastructure (efficiency and effectiveness) and the ability to produce (and deliver) to a customer a good or service that has a perceived value and that generates revenues in excess of the costs to produce and deliver.

Cash from investing relates to the activities that the business undertakes to increase capacity (capital projects), buy land, buying and selling equipment used in the business, and to utilize short term securities for temporarily “idle” cash. This is a measure of how successful the organization is at pursuing additional opportunities to expand operations and to do so through re-deploying cash from all activities.  The goal is to ensure that available cash is “invested” back into the business in a manner that generates additional cash for use in growing the business.  The ability to keep cash from all sources generating a return is being measured here.

Cash from financing represents the cash coming in and going out from debt and equity transactions – dividends, distributions, repurchase of stock, and sell of stock.  Cash obtained as debt and equity investment is necessary at various points throughout the life cycle of a business.  The ability to fund growth beyond levels that can be directly supported by existing operations is vital to most (if not all) businesses.  The mix of debt to equity and the ability to generate a return on resources invested in the business by stakeholders (versus “investing” of existing company resources as in cash from investing activities) are reflected in this section of the statement.  Debt and equity stakeholders look to see how much cash will be available to make the required periodic payments to them (interest, principal, dividends, owner drawls). 

Each section – operating, investing and financing – of activities plays a critical role in the long term viability of business growth and sustainability.  Understanding the components of your business that impact your cash position is imperative to your ability to manage the organization and to have the ability to be profitable and cash positive. 

The example illustrated that sales require investment of cash into inventory, labor, and other resources and activities to produce a product.  Sales also require business infrastructure to support the sale – before and after it is made.  The faster your business grows, the more “investment” is required to support the infrastructure, to obtain resources, and to produce the good or service.  The demands for cash increase and require synchronization of the time to convert inputs into saleable merchandise, the collection of cash in return for the delivered good or service and the payment for resources and materials used.

Every organization has a specific sustainable growth rate that is a function of the cash generated from the three activity categories – operating, investing and financing.  The mix of these sources in the equation is often determined by:

--       Historical levels of cash from operations versus cash employed in the process

--        Return on investment (equity and debt) from operations

--         Efficiency of operations (return on assets)

--         Historical record of returns to stakeholders

--         Projected demand for product/service

--         Performance versus competitors

--         Historical ability to raise and service debt and equity investment

These elements (and others) influence the internally sustainable growth rate and determine how much external funding you can obtain to fund growth beyond the level supported by existing operations.  When you are growing, you seek to expand your business base – equipment, manpower, etc. If it is at a rate in excess of the internally sustainable growth rate, you need to assure the external market that you can be trusted to get an acceptable return for them if they invest.

There is a sustainable rate of growth where the business is properly structured to maximize the return on expanded operations.  The activities and sequence of “doing business” are timed and refined to achieve the best results.  Anywhere above that point, the organization is failing to meet the demand for cash – payments due will exceed cash available – whether from timing or efficiency issues.  Below that point, the business isn’t taking advantage of “full deployment” of resources and the opportunities the business has aren’t fully realized.  Identifying and achieving “the” sustainable growth rate for your business isn’t a one time thing or even a periodic one.  It requires a continuous, dynamic assessment of your results and the impact of each change in variables and conditions to maintain the balance between falling below the point and speeding past the point.

The sales growth rate of a viable organization is a function of the cash conversion cycle, throughput rate for converting inputs into saleable goods/services, and the ability to obtain external funding for operations as needed.  Here are key areas to examine in understanding how to manage cash:

1.       Operating

a.       Sales Growth

b.       Cost Control

                                                               i.      Cost of products and services sold

                                                              ii.      Expense/cost of infrastructure and support services

c.       Cash Cycle

                                                               i.      Accounts Receivable – terms, collections, and aging

                                                                                     ii.      Inventory – levels, conversion time, management

                                                                       iii.      Accounts Payable – terms, management, negotiations, agreements

2.       Investing  

a.       Capital Projects to Maintain

b.       Capital Projects to Expand

3.       Financing

a.       Debt

b.       Equity

Each aspect of the cash flow equation requires an understanding of the relationship and impact that activities and actions have on the other variables.  The interconnectivity of operating, investing and financing activities becomes apparent when you attempt to influence or change one variable without examining the potential impact on the other activities. 

Having cash available to meet known and unexpected demands enables the organization to act on new opportunities and to respond to threats.  The companies that have a “cash advantage” are able to sustain through tough economic times and even thrive.  Take the time to understand your business results in terms of the impact on cash. 

Here are some reports you may want to add to your process, if you don’t already have them:

1.       Customer payments analysis – do they pay on time, the right amount, etc.

2.       Accounts Payable terms analysis – what terms do you have with your vendors

3.       Accounts Receivable terms analysis – what terms do you give to your customers

4.       Aged Accounts Receivable

5.       Aged Accounts Payable

6.       Inventory Composition

7.       Inventory Days on Hand (by type)

8.       Throughput Rate – time from dock to dock

9.       Cash Cycle in days

10.    Sales and Gross Margin by Customer

The more visibility you have to the financial results of your business, the better your ability to synchronize your business to maintain adequate levels of cash.   

Copyright © 2004 F.O.C.U.S. Resource, Inc.

Lea Strickland is President of F.O.C.U.S. Resources,