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Key Elements When Seeking Financing

key elements when seeking financing

This past week, one of my clients met with a banker to develop a new banking relationship. He hands the banker the company’s financial statements, expecting the banker to look at the income statement. Instead, the banker flips to the back of the financial statements to look over the balance sheet. As the coach, I asked my client, “See what he just did?” Most financial leaders (and the owners of their businesses) are consumed with their income statement but the banks want to know are more interested in how leveraged their banking client is. Not surprisingly, there are a few key elements when seeking financing for companies to follow.

Key Elements When Seeking Financing

Every company cycles through good and bad times. Depending on what part of the cycle your company is currently in, your banking relationship may be influenced. There are some key elements when seeking financing that will keep you on the good side of your banker.
Identifying your KPIs is a critical piece of the process when seeking financing. Want to find your KPIs and learn how to track them? Access your free KPI Discovery Cheatsheet today!

Leverage

What is leverage? Financial leverage is the use of borrowing from the bank to offset the cost of sales. Many companies hope to borrow just enough to increase their capabilities to sell more. But if banks see that you are too highly-leveraged, it’s bad news!

As a key element when seeking financing, leverage is important to have as it provides credibility to your borrowing experience. A banker will see that you have maximized the potential of previous capital to increase sales. The “kicker” here is if you have failed to optimize the borrowed capital potential, then the bank is going to be more prone to backing out of (or not starting in the first place) a banking relationship with you.

Cash Flow

We say it often and we say it loud… Cash is king. Without cash and/or liquid assets in your company, the bank is going to turn its nose up at you. Be sure to communicate the availability of cash in your company. For example, if a friend asked you for $250,000 but had no way of paying you back, you would be wary and decline the ask. This is because there is no hope that you will get the money back that you loaned. The bank acts in its best interest.

Make it easy for the bank to make a decision. Communicate through the financial statements (especially the balance sheet) the availability of cash.

Not About Price

Oftentimes, business leaders think that the bank cares about the price of your product. They don’t. To the bank, price is the least important factor in their assessment of your company because money is a commodity to them. Price is immaterial.

When meeting with a banker, communicate the bottom line and what’s on the financial statements NOT how you price your product. The bank is not your business consultant. They have to make money off of you.

Creating a Banking Relationship

When seeking financing, it is essential to create a banking relationship. You wouldn’t get married to the person you passed by on the sidewalk, so why would you get into a banking relationship with someone you have zero connection with. There are a few things that you need to look for to have a successful banking relationship.

What to Look For

If you are just starting out in a new city or have no relationships with any bankers, one of the first things that you can do is connect with people that do! For example, as a consultant, I have multiple relationships with various banks. When one of my clients needs a banker, I make the connection. People love feeling like they have it all, so give them the benefit and ask for help.
key elements when seeking financingLook at the bank for their philosophy and how they take care for their customers. In addition to philosophy, look at their morals.
Some questions to ask your banker in the “dating” stage include:
  • How long is a typical relationship with your customers?
  • What are the communication boundaries?
  • What is the bank’s view of breaking debt covenants?

Relationship or Transaction

Another important question you need to ask yourself is: “is this bank looking for a relationship or a transaction?” If you answer the latter, then you are just commission to them. When times are rough, you’re going to get cut. But if the answer is a relationship, then you’re looking at a long healthy marriage.

Relationships are absolutely critical in business. Value these relationships and take care of people. It will reflect in your business.

How does the bank deal in times of crisis?

A few years ago, I had a client that went through a period of stress. In the last quarter of their fiscal year, the business was growing and was doing well. They had 4 quarters of decline, but had tracked their KPIs. Although they had broken a few debt covenants, they were tracking their progress carefully with the bank. This client had a strong relationship with their bank. Without that relationship, the bank would have taken my client to the “workout” group.
Don’t have KPIs to help your banking relationship? Learn how to identify your KPIs and how to track them with our free KPI Discovery Cheatsheet. Click here to download your cheatsheet!
When you stub your toe, how does your bank react? Are they willing to let you slide on debt covenants for a few quarters as long as you have a plan to get out of the downturn? Often, people don’t see the importance of knowing how your bank is going to react in times of crisis. The economy continually ebbs and flows, changing for good or for bad.
Also, how does the bank deal with growth? You need more financing, but you are breaking covenants. Are they willing to provide financing with the knowledge that things won’t pick up immediately?

 The Workout Group

Several years ago, the bank wanted to meet with another of my clients because they had broken their debt covenants. The client calls me after meeting with “great news”! He said that the Bank had offered to work out his problems in the workout group. This “workout” group isn’t to work out your problems and put you back on track. It’s to work you out of the bank. This is not a good thing.
You don’t think your house will ever burn down, but what happens if your house does burn down? You don’t think you need a bank to weather the storm, but what happens when you need the bank to weather the storm with you? Assess whether or not your current banking relationship will be your insurance in the case of a fire or storm.
One way to do this is to look at the bank’s philosophy of business and their internal culture. How tight are they with the rules? Are they willing to stretch a little on their debt covenants and step up to help in times of distress? My client’s bank was unwilling to stretch its debt covenants. Instead the bank just wanted to wipe their hands clean of my client and move on to the next sale.
This willingness to be flexible all boils down to relationships. I have to warn you though, not every bank is similar in their goals.

key elements when seeking financingGet in Line

To prevent being put into the “workout” group, it’s crucial to start out on the same page. Get an alignment of interests, philosophies, culture, and anything else that would impact your company.

Interest and Philosophies

If the bank is only interested in their bottom line, then it may not be a good fit. If the bank is truly invested in your company and is willing to help you out in any reasonable way, then it’s a perfect match.

As I’ve built The Strategic CFO, it’s been a priority of mine to create relationships with bankers as they are going to reap the benefits of my clients doing business with them and I value their expertise. As a result of our mutual interests, the bankers in my network continually push potential clients towards my consulting practice. Those bankers and I have a strong relationship where we understand each others’ needs and desires as well as feed each other.
Of course though, I have had bankers tried to take advantage of my generosity and not return the favor. As a result, those relationships did not last long. It’s all about getting ones’ interests and philosophies in line.

KPIs That Influence Debt Covenants

Banks monitor your debt covenants. To help them (and you) out, identify KPIs that influence debt covenants to help track where you are and where you’re going. Picture this, your significant other or spouse comes home and lets you know that they’ve purchased a house, car, and boat without ever discussing it with you before. If you’re like me, I’d be surprised and would want to control the situation. If your significant other continues to make extravagant purchases or decisions without your prior knowledge, you would have trust issues and may want to cut up their credit card while they’re sleeping.
People see banking relationships as far-off and a different type of relationship. But the truth is, it’s all the same. Relationships are relationships. If you or your company or your significant other continues to create negative surprises, it’s not going to help with the relationship.
First, fix the problem before it becomes an issue. As soon as you see a yellow flag, jump on it!
Then after you fix it, let your bank know what has happened and how it has been resolved. This not only comforts the bank but builds trust. If the yellow flag starts turning red, alert the bank and outline the consequences. This helps you prepare and for the bank to prepare. Procrastinating this step can result in devastating consequences. The bank may be able to help you if you give them enough time.
Start identifying and tracking those KPIs that influence your debt covenants. For help and tips on how we measure KPIs, download our KPI Discovery Cheatsheet today! Know your numbers and where your company is the weakest so that you can start turning around your future.

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Key Elements When Seeking Financing

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Business Advisory System

DHS warning systemYou may be familiar with the advisory system (pictured at right) formerly used by the Department of Homeland Security to disseminate information regarding the risk of terrorist acts.  Despite its being replaced by a new system in 2011, most of us remember the color-coded warning system that came in the wake of September 11.

SCFO advisory systemBut, in the midst of a financial crisis (or when planning for a downturn), businesses need to be aware of their surroundings as well. To help companies analyze their environment to determine when action is necessary, we translated the Department of Homeland Security advisory system into the Strategic CFO Business Advisory System.

The Strategic CFO Business Advisory System

Best Case

Under the Best Case scenario, you’ve probably projected the crisis to resolve in less than 6 months. In this case, simple frugality might be enough to weather the storm. Generally, no systemic changes are needed to get through the trouble.

Probable Case

As Mr. Murphy would have it, generally Best Case scenario isn’t probable. More likely than not, it will take 6-12 months for the crisis to resolve. The bad news, you’re going to have to make some changes in your processes other than keeping a lid on costs to ride things out.  The good news, this is the most likely situation that you will find yourself in and you can manage it.  At least it’s not the Worst Case scenario…

Worst Case

Under the Worst Case scenario, you probably don’t expect the crisis to resolve within the next year. In fact, you may have no idea how long it will take for things to return to normal. In this case, you’re going to have to make some tough decisions to survive.

What To Do For Each Case Of The Business Advisory System

You need to create a plan for each of the cases above. What will each case look like with regards to your financials – revenue projections, cash flow projections, etc. How much overhead can you carry in these stages?

How do you know which stage of the Business Advisory System you’re in? This will require some serious evaluation of Key Performance Indicators (KPIs). You’ll need to know major KPIs in your industry.

(NOTE: Need help finding your company’s KPIs? Check out our KPI Discovery Cheatsheet!)

Once you have identified some KPIs, it’s time to track them. Track KPIs and analyze variances. Then you may use trend tools, what-if scenarios, and breakeven analyses.

Monitor where you are on the Business Advisory System month-by-month and be prepared to take necessary steps to ensure that your business is profitable and cash-positive.

Use KPIs to identify what stage of the Business Advisory System you are in.  Create a plan for each stage so that you are ready to act if your KPIs indicate it’s time.

Download our free KPI Discovery Cheatsheet and start tracking your KPIs today!

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How long can a company lose money without running out of cash?

Only when the tide goes out do you discover who’s been swimming naked.
– Warren Buffet

Is the Houston economy’s metaphorical “tide” going out?  It’s hard to say, but some businesses are definitely feeling a bit “naked” these days.  They may not even realize the peril they’re in because they still have positive cash flow despite the fact they’re losing money.  This begs the question…

How long can a company lose money without running out of cash?

The simple answer to the question “how long can a company lose money without running out of cash?” can be found by using this equation:

Liquidity / Burn Rate = Timeline

… where Liquidity = the amount working capital of the company that can be converted into cash

… and Burn Rate = the amount of cash spent each month

This formula can be very helpful in projecting how much time you have to find a solution to turn things around.

Let’s assume you have $1,000,000 in working capital and are losing $100,000 a month.  According to the formula, you will only have 10 months before you run out of cash. The trouble is, you’ve predicted the downturn to last up to 18 months. 

Now what?

Managing “Crisis”

How long can a company lose money without running out of cashThe character for the word crisis in Chinese is actually comprised of two other characters  – danger and opportunity The key to surviving, even thriving, during times of crisis is to find the opportunity amidst the danger.

Your first answer to the crisis was probably to cut costs.  Most likely, you’ve already done as much of that as you can so let’s look at some other ways to weather the storm.

Improving Productivity

One way to stretch your working capital is by improving productivityProductivity can be defined as:

Productivity = Throughput/Resource

 Examples of throughputs are hours worked, widgets produced, etc.  Resources are people, materials, etc.

 In order to improve productivity you must:

  1. Understand the processes – How do we do things around here?
  2. Identify and measure drivers – What’s really driving results?
  3. Identify bottlenecks & inefficiencies – What’s going wrong?
  4. Simplify the process – What can we cut out?
  5. Communicate to everyone – Everyone needs to be on the same page.
  6. Tie rewards to results – What gets rewarded gets repeated.

Improving Cash Flow

If you’re worried that you’ll run out of cash before things turn around, it’s time to focus on reducing your cash conversion cycle

Cash conversion cycle = DSO + DIODPO

Where:

DSO = Days Sales Outstanding

DIO = Days Inventory Outstanding

DPO = Days Payables Outstanding

Some of the ways to reduce your Cash Conversion Cycle are:

Lastly, you must measure cash flow on a daily, weekly, quarterly and annual basis.

You can’t manage your cash flow if you don’t measure it!

Want a step-by-step guide to improve your cash flow?  Download our free tip sheet 25 Ways to Improve Cash Flow.

In order to measure cash flow effectively, you’ll need to take a look at your cash flow statement. On the cash flow statement, you’ll see three different type of cash flows:

Operating

Your operating cash flows focus on the measurement of cash generated by your operations.  This is the most important cash flow type to look at when experiencing a positive cash flow and a negative net income. Because a positive cash flow is able to maintain current operations and potentially grow the operations, operating cash flow could be the main determinant in why you’re running out of cash in a positive cash flow period. If you’re experiencing this, you either are hiring personnel and can’t avoid it, OR you’re experiencing collections problems and/or have poor debt structure.

The bottom line of your operating cash flow determines whether your company will make a profit or not.

Investing & Financing

This type of cash flow deals with the cash flowing between the firm and its owners. For example, any technology investments or meeting requirements (payroll, etc.) would be considered investment cash flow. This type cannot be controlled like the operating cash flow due to the investment of necessary items.

If you’re experiencing this in your investing cash flows, look at your assets to determine if each asset is absolutely needed. The solution to an investing cash flow problem would be to sell some of these assets. In addition, consider raising capital to get over the hump.

In the end, you need to be mindful of where your working capital is going. Managing your cash flow is just as important as growing your revenue streams. To learn more ways to improve your cash flow, click here to download our free guide.

For more tips on how to manage your cash flow, click here.

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Black Swan Events

black swan events

The “mythical” black swan

You may have heard the term “Black Swan Event“, particularly recently.  But what exactly is a black swan event and what can, and should, we learn from them?

The notion of black swan events was first set forth by Nassim Nicholas Taleb. Taleb, a finance professor and former Wall Street trader, wrote about this concept in his 2001 book Fooled by Randomness which concerned financial events. In a later work, The Black Swan, Taleb extends the metaphor to events outside the financial markets.  He defines three attributes that are common to all black swan events:

  1. The event is unpredictable (to the observer)
  2. The event has widespread ramifications
  3. After the event has occurred, people will assert that it was indeed explainable and predictable (hindsight bias).

Where did the term “Black Swan” come from?

The origin of the use of the term “black swan” to characterize such events is interesting.  Prior to 1697, any Western civilization has not observed any black swan. This gave rise to the notion that such creatures didn’t exist.  Hence, the term became used to describe situations of impossibility.  After a black swan was finally observed in western Australia in 1697, the notion was disproved.  Since then, “black swan” describes situations where perceived impossibilities have been disproven and paradigms have been shattered.

What are some examples of Black Swan events?

Examples Taleb gives of black swan events include the rise of the Internet, the personal computer, World War I, the dissolution of the Soviet Union and the September 11, 2001 terrorist attacks.  He underscores the point that the black swan event depends upon the observer.  The Thanksgiving turkey sees his demise as a black swan, but the butcher does not.

Isn’t a Black Swan just another way to define a crisis?

It’s important to draw the distinction between a black swan event and a crisis.  Not all black swan events are crises, any lottery winner will attest to that.  And not all crises are black swan events.  Terrorist attacks are an almost daily occurrence worldwide, but the terrorist attacks of September 11, 2001 were of unprecedented magnitude and unpredictability, hence their characterization as a black swan.

How can we deal with Black Swan events?

How can we avoid becoming the Thanksgiving turkey?  According to Taleb, not by attempting to predict the unpredictable.  Rather, he says our time would be better spent preparing for the impact of negative black swans that occur. In addition, he advises that we position ourselves to be able to exploit the positive ones.

Download your free External Analysis whitepaper that guides you through overcoming obstacles and preparing how your company is going to react to external factors.

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5 Stages of Business Grief

stages of business griefDo companies experience stages of business grief? No college psychology class would be complete without a discussion of the 5 stages of grief outlined by Elisabeth Kubler-Ross in her 1969 book On Death and Dying.

The Stages of Business Grief

For those of you who skipped (or slept through) the lecture, the 5 stages are:

  • Denial
  • Anger
  • Bargaining/Rationalization
  • Depression/Despair
  • Acceptance

So, do businesses experience similar stages of business grief when faced with crisis or catastrophe? In a recent post, we explored how (and whether) Houston businesses are dealing with the sharp drop in oil prices over the past 6 months. It would be naïve to think that the situation won’t result in a crisis for at least some of Houston’s businesses.

Deal with Crisis

To explore how a business might deal with such a crisis, we wrote an article that talks about the 5 stages of grief and how they might manifest themselves in a business setting. Click here to check it out.

To learn more financial leadership skills, download the free 7 Habits of Highly Effective CFOs.

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The 5 Stages of Business Grief

In her 1969 book On Death and Dying, Elisabeth Kubler-Ross outlines the five stages of grief individuals experience when faced with catastrophic personal loss. The five stages are as follows:

The 5 Stages of Business Grief

In one form or another, businesses too experience these five stages when faced with crisis or catastrophe. These 5 stages of business grief are related to loss. For a business, this can be loss of income, customers or the enterprise as a whole.

While an individual must progress through the grief cycle at their own pace, it’s important for businesses to arrive at the final stage of acceptance as soon as possible so that corrective action can be taken before things get too far out of hand. The following is an illustration of how each of the 5 stages of business grief might play out in a company.

Stage 1 – Denial

The first stage of business grief is denial. The business owner may try to shut out reality or create an alternate reality that is preferable. They may also try to convince themselves that the situation is just temporary or that the crisis won’t affect them or their industry. Some may even hire consultants to validate the status quo rather than deal with the problem.

Stage 2 – Anger

The delayed reaction caused by denial gives rise to feelings of anger. At this stage of business grief, the business owner may start to play the blame game. Why are greedy suppliers flooding the market and driving down prices? Also, why are my customers so disloyal and squeezing me on my pricing? Why can’t my people just do their jobs right? Eventually, some owners may turn the blame inward and chastise themselves for not seeing the crisis coming.

Stage 3 – Bargaining/Rationalization

At this stage of business grief, business owners will often reach out to third parties to weather the storm. Some will ask vendors to extend payment terms. Some will negotiate with bankers for cushion on debt covenants or to extend lines of credit. Many daydream about the big contract they’re about to win that will turn things around.

Stage 4 – Depression/Despair

Oftentimes, bargaining during a crisis doesn’t solve the problem. Vendors are often over-extended to their suppliers, banks are having to tighten up on controls and customers are hesitant to take on new projects due to uncertainty. When the reality of the situation dawns, owners may fall into despair. After all, what’s the point in soldiering on if the underlying cause is out of your control?

Stage 5 – Acceptance

Most business owners are made of pretty sturdy stuff and will not allow themselves to wallow in self-pity for long. Consequently, they will make peace with the threat and begin to develop a strategy to deal with it. How? By focusing on what’s working and eliminating what isn’t. Transfer resources to more profitable products and eliminate those products that kill margins. Hug their best customers and fire the problem ones. Unleash the creativity in their best employees and purging the ranks of bad hires.

Crisis and catastrophe are inevitable in a business. The key is to recognize the crisis and resolve the 5 stages of business grief quickly to get back on track.

To learn more financial leadership skills, download the free 7 Habits of Highly Effective CFOs.

5 stages of business grief

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5 Stages fo Business Grief

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If They Will Buy, Then I Will Sell!

If they will buy, then I will sell! Or stated another way, if I can sell it then buyer beware! That seems to have been the motto for the sub prime mortgage industry. Over the past five years a looming crisis has been in the making. Mortgage brokers would originate the loan then immediately pass on the risk to the investors. Few would keep the loans for a month let alone ninety days. Consequently, they were assuming little risk and had no incentive to police the quality of the loan.

If They Will Buy, Then I Will Sell!

Some people are questioning whose responsibility it was to police the market. At some point in the cycle someone needed to say no to the level of risk being assumed. Some say we should have government oversight. I say it is the job of Mr. Market!

The only thing that keeps people from taking stupid risks is the fear of loss. Until recently we haven’t had that in the past five years. During this time period we have experienced low cost of capital, high liquidity and increasing productivity of employees. Now the market forces (i.e. losses) are policing the sub prime markets.

Other Markets in the Economy

The real question is what other markets in the economy are in line to be disciplined? The economy is beginning to look like a slow moving train wreck. This scenario is not unlike the dot com bust where few of us were directly in the business but all of us were effected. Now is the time for entrepreneurs and their CFOs to take action to weather any possible storm. Download the External Analysis to gear up your business for change.

If They Will Buy, Then I Will Sell!

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