M&T Bank : Cash Flow and Borrowing
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Business Resource Center

Cash flow and borrowing: How they work together
By Richard Siedleck

Plan on approaching a lender for business financing anytime soon? Then you should keep in mind that creating a realistic cash flow budget (or projections) will be an absolute necessity. While a lender will want to see your balance sheet and income statement, the historical and projected cash flows will be "must" documents.

Since one of the keys to raising capital is managing your cash effectively, here are some tips on cash flow management, as well as a few questions you should ask yourself before you approach a lender.

What exactly is a cash flow budget?

One of the three components of your business financial statements (along with the balance sheet and income statement), your cash flow budget is an estimate or projection of your business' cash inflows -- i.e., money expected to come in, such as cash from sales or the collection of accounts receivable -- and the time period when you expect to receive it. It's also a projection of your cash outflows -- all the money you'll need to pay to suppliers, accountants, utility companies, etc., i.e., your accounts payable.

Your cash flow budget is critical to the success of your business, because you could have great profits on paper, but still experience a cash flow shortfall. If you just concentrate on profits, such a cash flow shortfall could crop up and cripple your business.

For some businesses, a six-month cash flow budget is realistic and practical, while others prefer to project cash flow annually. If you are applying for a bank loan, though, your projections should cover at least the next three years. Be sure you understand and can explain the assumptions behind your projections, because your banker will likely question them. In the end, your banker will analyze your business' overall financial health in trying to assess your ability to service the debt, both now and in the future.

Keep in mind that if you plan to apply for a loan in the next year or so, your cash flow and other financial records should reflect a positive picture on how well you manage your cash and the financial aspects of your business. Your records should demonstrate that you know how to prepare a sales forecast (perhaps based on previous years' sales), you've projected your anticipated cash inflows and outflows accurately, and you've created a cash flow budget that is logical and meaningful.

Questions to ask yourself

Before you meet with a lender, ask yourself these questions:

  • How much money will I need? If you are a retailer, for example, you may get a loan for 50- 75 percent of the value of your inventory (your collateral). Keep in mind that most lenders will discount the value of collateral so they don't risk 100 percent of its top market value.
  • When will I need the money to cover my needs based on my projections? For example, perhaps you plan to buy new equipment in about eight months.
  • Will I need additional money -- and, if so, when? Maybe you anticipate you'll need more money for new business growth in about 10 months. But be aware: The more you grow your business -- i.e., the more sales you generate -- the less cash flow you will actually have to work with.
  • For how long will I need the money? Some businesses need a short-term bank loan to carry them through slow periods, perhaps over the summer months when sales slow down, for instance.
  • How will I be able to repay the loan? This, of course, is of primary interest to your lender. According to the Small Business Administration, if you need working capital, the lender may want to know how the loan can be reduced during your business period of greatest liquidity covering the business cycle, or over a one-year period.

Conversely, if you are looking for growth capital, the lender may want to know how the loan will be used to make your business more profitable and generate extra cash, which can be used to repay the loan in several years.

What if you spot a potential cash crunch?

If your cash flow projections flag a potential cash crunch, you can start correcting the situation before you meet with the lender. A few ideas:

  • Get rid of slow-moving or obsolete inventory, and order as little inventory in the future as you can get away with. Also, determine if you can extend or delay paying vendor invoices without affecting your credit and business relationship with them.
  • Get tough with slow-paying customers. Be firm and persistent by making it clear that you intend to enforce your payments terms, perhaps by even using a collection agency in extreme circumstances.
  • Change your terms with customers who buy on credit. For example, reduce net-30 days to net-15. Also consider other options for collecting your money faster, such as offering a small discount (perhaps 1-2 percent) if customers pay upfront (cash with order) or if you receive their payment within 10 days of your invoice date.
  • Put idle checking account cash into a liquid savings instrument, such as a basic savings or money market account. Ask your banker about a sweep account, which sweeps idle checking account balances into an interest-bearing account daily. And don't leave cash or checks in your register or safe for several days -- get it into your bank account on a daily basis, if possible.
  • Finally, ask your suppliers for more favorable payment terms. You may find that you are
    still getting the same terms you got several years ago, even though your buying power or volume has increased.

Get close to your lender

One of the most important things you can do as a business owner is to build a close working relationship with your lender. Ask for advice regarding treasury management and credit. Know what the lender's procedures and expectations are for approving loans. And keep the lender current on your business plan and the actual results. It all will benefit you tremendously over time.
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Richard Siedlecki is a self-employed management consultant who focuses on business and marketing plans, new business start-ups and direct marketing via direct mail, catalogs and the Web.

If you'd like to meet with an M&T small business specialist, call 1-800-724-6070 to set-up an appointment.

 
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