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Building a Positive Banking Relationship

Building a Positive Banking Relationship

Building a Positive Banking Relationship

By Bob Palmerton

After listening to a plethora of quarterly earnings reports from public companies, I began to consider how the discipline and transparency of effective communications practiced by a public company can be replicated for a privately-held firm. Besides keeping owners and investors in the loop, an effective communications strategy with your company’s bank is just as critical.

The loan a company obtains from its bank will likely be accompanied by a variety of covenants. Delivering timely covenant reporting, however, should be merely a piece of your company’s communication strategy with its bank. Managing a bank’s expectations and staying ahead of the curve as the business grows and/or changes are similarly important to build trust and a positive, growing banking relationship.

Here are a few “good deeds” to help build rapport with your bank:

Quarterly Reviews

Bankers like to be informed (and not surprised) by their clients. Inviting the bank for quarterly reviews (just as public companies deliver quarterly reports) is key to building trust and keeping the bank educated about the nuances and shifting priorities of your business. These sessions are valuable not only to provide color on the quarter’s financial results, but to communicate business strategy (i.e. new markets, new products) and to share financial projections. Demonstrate to the bank your company’s ability to support its debt service as well as communicate your company’s growth plans.

Contingency Planning

Should risk suddenly appear on the horizon, resulting in a miss to projections or a weak quarter, your company should persuasively communicate contingency plans to mitigate that risk. “What If” scenarios should be analyzed and action plans defined and presented to get back on track both from a top and bottom line perspective. Share with the bank the degree of flexible, controllable costs in your business that can be reduced or eliminated to sustain adequate debt service coverage and to conform to the bank’s covenants. Calculate and communicate your fixed charge coverage (costs such as debt service, rent, equipment leases, and insurance that need to be paid regardless of your company’s revenue). Know your numbers! Again, this helps to build your company’s trust with its banker, and it demonstrates that you are taking care of your business as well as taking care of the bank’s senior credit position.

Timely Submission of Financials and Covenant Reports

Never let a bank chase you for something. And should the financial reports raise a red flag or two, jump in ahead of time to explain it. Stay ahead of the bank’s questions. A company should understand the key expectations of its banker and provide timely updates to manage the relationship. Be proactive! Remember, your banker will retain greater trust and confidence in you if you are forthcoming with information, however unpleasant that information might be.

Sharing of Financial Projections

These give insight as to where you are taking the business as well as the opportunities and obstacles your company faces in achieving its goals. Try to stick with quarterly financial projections rather than monthly (this can give you time to manage to a bad month). Focus your projections on cashflow, and don’t forget to support those revenue projections with realistic assumptions and contingencies should the projections not pan out.

Now that you have been on your best behavior with your banker, ask for more from your bank! You have provided a lot of information, spending time and energy on strategy, financial reporting and maintaining a solid banking relationship. So maybe it’s time for you to ask for free services, reduced fees, or even a relaxed covenant or a short-term credit line bump to handle a timing issue. If you are renegotiating a line of credit (or asking for an increase), a positive relationship can help close the deal, and the additional business will be appreciated by your bank

Bob Palmerton is a CFO for FocusCFO, based in Detroit, MI.

 

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Five Pitfalls of the Cashflow Forecast

Five Pitfalls of the Cashflow Forecast

Five Pitfalls of the Cashflow Forecast

By Bob Palmerton

Weekly cashflow forecasts are a critical financial tool for any company, especially small enterprises with frequently volatile timing issues in working capital. Here are FIVE pitfalls of the cashflow forecast and suggestions to overcome them.

Pitfall 1: Sales (and therefore collections) timing

I’ve spent much of my 30 years in finance dealing with unrealistic sales targets. The more early- stage (or start-up) the company, the worse the problem. And speaking of mature companies, although they may have a good handle on forecasting their legacy products, forecasting new product sales can be daunting. And a changing competitive landscape may thwart their sales forecast accuracy. Once a realistic annual forecast is determined, the next challenge is its timing throughout the year.

Suggestion: Build bottoms up sales plan with defensible metrics (i.e. number of salespeople, sales calls per day, success rates based on experience), and risk-adjust the new stuff. If you have a large collectible item scheduled for a certain date, plan ahead to call early and grease the skids for that payment to arrive on time. And as with any sales forecast, don’t forget to consider contingency planning should the numbers not pan out as expected.

Pitfall 2: Under-estimating what it takes to deliver those sales

It may be labor, materials, internet bandwidth, or any vendor-supplied resources that would need to be carefully assessed not just for their front-loaded costs (i.e. before the cash is collected on those those forecast sales), but for their ability to deliver when they are needed (based on the timing of those sales).

Suggestion: To start, integrating delivery (operations) with sales planning is key. When sales and operations are on the same page, when they communicate effectively, many delivery hiccups can be avoided. Also, know your vendor limitations. Keep key suppliers appraised of your business so that they can plan ahead too, in anticipation of any upside (or downside) sales surprises.

Pitfall 3: Relying on unreliable sources.

Often the person compiling the cashflow forecast will take input from leadership for granted (they should know what they’re talking about, right)? But there may be various reasons why they don’t know what they say they know, or motivations to avoid the cold hard truth.

Suggestion: The best you can do is know what questions to ask, push back where necessary, and risk-adjust any assumptions that might be questionable. Learning as much as you can about the business and its past performance is key, as researching past results can help support your adjusted estimates. Remember what W. Edwards Deming said: “Without data, you’re just another person with an opinion.”

Pitfall 4: Missing contractual timings of outflows

Run rate or one-time costs may change in a material fashion at a certain point in time. For example, commercial loans may include ramp-ups in principal (or higher rates driven by Fed policy). A line of credit may convert to P&I at a certain date (or there may be a 30-day “rest period” during which the line needs to be drawn down to $0). Payroll raises may go into effect at a certain date. How about employer taxes and how they start at their highest level when the New Year begins? Many nuances of timing occur throughout the calendar year and many are driven by anniversary dates (like the annual rent increase).

Suggestion: Review historic financials to see the step-ups and review contracts and bank agreements to pinpoint rate increases and changes in debt servicing.

Pitfall 5: Failing to share the 13-week cashflow forecast with your senior management and/or partners.

Many times, I have come across a senior member of the staff contributing a unique solution to an emerging cashflow problem. It may be a strong business relationship with a key customer or vendor that may shake loose early cash or defer a payment to a vendor to buy some time when cashflow is tight. That revelation would likely not emerge without sharing the cashflow forecast with that person.

Suggestion: Reserve the time to review the forecast with key stakeholders, and solicit their valuable input and perspectives on the business and the market

A well-oiled cashflow forecast process will enable management to focus on items to fix ahead of time so that they can stay on top of their day-to-day business.

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Three Financial Problems to Derail Business Owners

Three Financial Problems to Derail Business Owners

Three Financial Problems to Derail Business Owners

By Bob Palmerton

Business owners often get immersed in day-to-day operational activities and lose sight of key financial indicators that can impact the health and value of their company. Any good CFO will march through a checklist of items that, if managed effectively, can build value in the company and help it pursue profitable growth. Here are three financial problems that can derail business owners.

The loan a company obtains from its bank will likely be accompanied by a variety of covenants. Delivering timely covenant reporting, however, should be merely a piece of your company’s communication strategy with its bank. Managing a bank’s expectations and staying ahead of the curve as the business grows and/or changes are similarly important to build trust and a positive, growing banking relationship.

Dozing Off at the Cash Spigot

It’s no surprise that cashflow is a core CFO hot button. Besides simply finding ways to boost cash, there are cash considerations that go well beyond the monthly bank statement and the cashflow forecast (if the business owner has one).

Is the business optimizing its cash management? This could mean being more selective on accepting a new client, a job, or buying equipment, all depending on the potential cashflow and ROI of the job or investment. The distress of fluctuating cash balances driven by seasonal trends can be forecasted and prepared for ahead of time, perhaps by identifying profitable opportunities to smooth variability and mitigate those dips. Similarly, if the business is flush with cash, is that cash being deployed for optimal return? An investment should return more than the company’s cost of capital (a discounted cashflow analysis will help here), and not hijack working capital. And beware of investing in earnings-diluting activities (see below for more details). At a minimum, don’t let that cash balance sit idle without earning something, if you can help it.

If the business is tight on cash, does leadership know if and when it might run out? Run projections based on reasonable assumptions and consider risk-adjusting the results by 10%- 15% to account for the unforeseen. Understand which levers can be pulled to increase cash: the
company may be experiencing value erosion (more on that below), or might face working capital issues like aging inventory, bills being paid too soon, or idle assets to liquidate. Sometime, business owners don’t fully know where the cash goes, stating “Revenue is higher and I’m not a wasteful spender, but what happened to my bank balance?” Think about how best to prepare to obtain financing from a bank or investors. Know what the bank wants to see ahead of time to make the credit decision easy for them, an approach that will also help nurture the banking relationship. Seek financing when the business is not desperate for money, and while financial statements are strong.

Value Eroding Behind Your Back

Are the company’s products, services, and locations delivering profits that are accretive (rather than dilutive) to existing earnings? Key financial indicators that address this question include Gross Margin, the breakeven sales point, and EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) as a % of revenue. Wouldn’t it be great to know your profit by client? I find that plotting client margin on a bubble graph is often a revealing exercise. The results may encourage the business owner to revisit the client’s pricing (raise price) or even drop the client.

Every business has a bottom line EBITDA as a % of sales. When resources such as labor, capital and other expenses are deployed in an activity that generates a lower EBITDA % of sales than the business as a whole, value erodes. A business can’t just “make it up on volume.”

Every business should know its breakeven sales for products, services and locations. Slice and dice expenses into variable and fixed costs, then take those fixed costs and divide them by gross margin as a percentage of sales, to arrive and how much sales revenue is needed to achieve breakeven. Just remember, breakeven is not good enough! Strive to meet or beat your overall EBITDA % of sales and/or the goal set for the company. In fact, check industry benchmarks to see how the business stacks up against the competition, and determine why or why not the business is achieving that standard.

A Weakening of the Foundation

What indicators may be silently pointing to increased risk festering in the business? A “roll up your sleeves” CFO attack of a company’s financials involves trending monthly historic data, preferably over two years of history plus the current year. Then run all kinds of ratios, such as gross margin, EBITDA % of sales, working capital measures such as inventory turnover, and much more. Update the spreadsheet with each new month’s data. Why is this helpful? Seeing trends (plot them on a graph too) helps to reveal symptoms of problems that have yet to surface. Trends can also point to poor operating practices and a lack of oversight. Awareness of
trends and what a solid number looks like will help the business owner routinely “inspect what he expects.”

But history is just part of the story. A Company’s systems should be “real time” enough to catch trend outliers as they happen. For example, in the restaurant business, a point of sale (POS) system can capture daily sales, average guest check value, waitstaff labor as a percentage of sales, overtime, and much more. Seeing a shift in these indicators can point to changing customer attitudes, dining behavior, the quality of customer service, and more. On a monthly basis, a prompt monthly close such as three days after month-end is also helpful to catch shifting business dynamics and provides flexibility to address issues before the current month adds to the problem.

At the end of the day, the business owner should take advantage of these financial tools to be aware of what drives value in the company, and how to spot shifting indicators that might compromise value, cash, and profitable growth. A CFO can help pull together the analysis and provide suggestions to drive the company forward and help to accelerate its growth.

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