As the saying goes, “An ounce of prevention is worth a pound of cure.”
Your company’s financial security is contingent upon good business practices. Here’s a quick refresher.
1. Cash is king
Money is the engine that drives every company. It is even more important than profits in the short term. Bankers, investors, and advisors are paying more and more attention to the oft-ignored cash flow statement (where funds are coming from and how they are used). If profits are growing faster than cash flow, alarm bells are sounded.
What can you do?
“Take a close look at your business operations and how they affect liquidity. Focus on your working capital and your operating cycle. Keep cash on hand. When finances are tight keep a cash reserve, even if that means increasing your interest-bearing credit facilities. Forecast your near term receipts and disbursements based on realistic financial projections and a sound starting point, and analyze how these assumptions will affect your borrowing base. Analyze the discrepancies and learn from them. If you can’t do this with the information you have, ask for help. You have to look beyond sales and expenses and focus on real money, not on earnings or EBITDA,” suggests Jean-Paul David, Managing Partner, Financial Advisory Services.
Negotiate aggressive credit terms with your customers. Once bills are overdue, apply subtle but firm pressure. If customers think they can use you to meet their own financial needs, they will. Reduce inventory levels and replenish them just in time whenever possible. Sell the oldest stock. In the short term it may be wiser to sacrifice profitability to generate cash, but don’t lose sight of your borrowing base. Interest rates on inventory tend to be low, so focus on selling inventory to generate cash.
What should you avoid?
“Remember that bigger isn’t always better,” advises Marc Bergeron, Partner and Vice President, Recovery & Reorganization. “Growth consumes capital. A significant sales or expansion opportunity may seem profitable, but it may directly affect the company’s operating cycle and ability to find financing. Lengthening the operating cycle is a bad sign. Think long and hard about how cash flow will be affected by increasing sales that require capital expenditures and ramp-up periods. Imagine the worst-case scenario and act accordingly.”
2. Get closer to your bank
What can you do?
Treat your bank like a business partner. Keep them informed and help them understand your business, your industry, and the competitive landscape. Tell them how you plan to deal with the new economic challenges and make sure you give them plenty of notice if you need help. The last thing a bank wants is to find out a week ahead of time that you want to double your line of credit. Be proactive with your lender. Banks make money by lending money—they want you to thrive so they can continue to lend you money.
If you have to get help or take out a new loan from your bank, discuss the best approach with your advisors. In many cases, getting your bank to work with you has a lot to do with how you ask for help. Even if your business prospects take a turn for the worse, it is always better for you to be the one to tell them. However, you must have a well-thought-out plan in hand when you show up.
What should you avoid?
Don’t fall into the trap of thinking it’s up to the bank to guide you through any issues or problems. If you let your bank know early enough, they may be much more inclined to help you find a solution to your problems. Don’t forget, however, that you and your management team are ultimately responsible for the choices you make.
Do your best not to breach the terms of your loan agreements, as doing so could result in irregularities. Also do all you can to stay current on your debt payments. In the end, you want to make sure your company has the financing it needs to operate efficiently while preventing your credit lines from being limited, loan applications from being cancelled, and your name from being added to the list of “special loans.”
3. Step up your efforts to control costs
During tough economic times, you must contain costs and cut them if possible.
What can you do?
Make a zero-based budget to carefully bring all your costs in line with what they actually contribute to the company. What costs do you need to run your business? Compare your costs to those of your competition and look for ways to improve your performance. Minimize your expenses and hold employees accountable for all expenditures and disbursements. Set up a cost justification system and assess the return on investment for new projects.
Gain a solid understanding of your fixed and variable costs and any outstanding liabilities not reflected on your balance sheet (e.g., operating leases, rents, performance agreements, etc.) and look for ways to cut costs. Pay special attention to variable costs and carefully reconsider any capital expenditure decisions. Institute policies that encourage and reward cost savings and cash conservation.
Really look at one major cost area: people. Make those tough decisions now. Don’t let your emotions influence your thinking. Use objective criteria to make sure your decisions are made with the company’s best interests in mind rather than making them based on personal relationships. Communicate effectively and show integrity throughout the process, but move quickly. Inspire confidence in your decisions and motivate your employees.
What should you avoid?
Don’t automatically cut your marketing expenses. While they may be an easy target, slashing them may have a significant impact on your competitive position. Think about your company and, more importantly, your strategy. You cannot take cost cutting measures at the risk of diminishing value.
4. Evaluate your customers and suppliers
What can you do?
Reevaluate credit terms with your customers and negotiate the shortest reasonable terms. Carefully review (and continuously monitor) the creditworthiness of every new and existing customer before extending any credit to ensure you receive payment in full in accordance with the stated terms. Monitor outstanding accounts receivable and quickly address any problem accounts that are past due. Ask yourself a simple question: If your customer declared bankruptcy tomorrow, what would happen to your business? It’s good to know the credit profile of any customer that could seriously affect your business if it had trouble. In case of bankruptcy, as an unsecured creditor you probably could not collect anything because certain government agencies, employees, and secured creditors would be paid first.
Negotiate the longest possible credit terms with your suppliers. Most suppliers are hungry for cash, so if you have excess cash available negotiate early payment discounts. Seriously consider whether you have the right number of suppliers. Should you expand your supplier base because some of your suppliers are financially unstable? Should you use fewer suppliers and negotiate more favorable terms? Either strategy could work, but you will have to analyze both options carefully to choose the right one.
What should you avoid?
Never assume that your customers or your suppliers are financially stable. Look for signs of trouble. If you do not receive payment quickly from accounts receivable you may find yourself with a cash flow shortfall that could affect your entire business. It may therefore be equally detrimental to extend unreasonable credit terms in hopes of increasing revenues. Find out right away if any of your suppliers are having trouble. Make sure that any delivery or quality errors are not really signs of more systemic problems.
5. Consider your financing options
What is at stake?
What happens if you have problems with your bank? It could severely restrict your ability to borrow or, even worse, it could pool all your financing facilities.
What can you do?
Make sure you know all of your company’s financing options. Start with your current lender and consider alternative ways of structuring your credit facilities (e.g., a term loan instead of a line of credit). Understand the default provisions of your loan agreements. Depending on the size and location of your company, consider other potential lenders. Also keep in mind other sources of secured financing such as leasing, asset-based financing, and factoring companies. Government-sponsored financing programs may be available in some places.
Other types of outside financing include subordinated debt, private equity, and venture capital. These financing sources generally have longer terms and take longer to negotiate. If you have enough time and flexibility, these sources may help improve your capital structure over a longer period of time.
Finally, don’t forget about creative ways of accessing cash that might be tied up in your business. As discussed earlier, shortening your operating cycle should be your top priority. Look at negotiating payments on long overdue accounts receivable or get financing from outside sources. Consider sale lease-backs on real estate to generate cash. In some lines of business you can ask your customers to make early payments or set up a progress billing system.
What should you avoid?
Don’t automatically assume that the relationships you currently have with your lenders will remain the same. Avoid getting into a position where you will have trouble coming up with alternatives if you are forced to cut ties with your bank, your lender, or other investors. Look for other sources of capital just in case. Don’t be left without a contingency plan.
6. Protect your personal finances
What is at stake?
When a company is going through tough financial times, its owners should not rely on the company too heavily. You should have a clear understanding of the distinction between your personal assets and your company’s finances. Banks will probably start asking for additional security, whether a company asset or personal property. Business owners should exercise caution.
What can you do?
If the company has generated profits in recent years, consider pulling that money out of the company. However, make sure the company is not insolvent or that dividend payments or other such transactions do not render it insolvent. If possible carefully consider the company’s strategic options, including transaction alternatives, with a professional advisor to help you make quick decisions to preserve value.
If you have to put money back into the company, make sure there is a business reason for doing so. Do not invest simply because you have the money. If you must lend the company your own money instead of extending an unsecured loan, consider supplementary bank financing secured with these assets or take out subordinated financing instead. That way if the company declares bankruptcy, you increase your chances of recovering these funds.
What should you avoid?
Don’t waste your money.
If your company is having financial trouble, it is important to act right away. But before you take decisive action—such as injecting new capital, refinancing, or selling your company—let our experts help. Our advisors can assist with all negotiations with your bankers, creditors, lessor, union, etc.
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