Tag Archives | line of credit

Why Don’t I Have Cash?

See Also:
Cash Cycle
Cash Flow Statement
Free Cash Flow
External Sources of Cash

Why Don’t I Have Cash?

I was involved in a meeting with a prospect a few weeks ago who we will call Don. Don owns a manufacturing company which is presently experiencing a growth rate of thirty percent annually. He is showing a profit, but his bank will not increase his line of credit. As a result, Don’s company is having cash flow problems. He told me that he has to extend payments to his suppliers, but they are not happy with him. Don also told me he is unable to call most of his customers for payment, because they are within their credit terms; he feels he would be harassing them. He asked me “Why don’t I have cash?”

Operating Cycle Trap

I told him he was caught in what I call the operating cycle trap. Don looked at me and said “What is that?” I told him his operating cycle is; 1) the time from when he first purchases raw materials, 2) converts the raw materials to a finished product, 3) sells the finished products, 4) converts the accounts receivable to cash. I continued by saying your problem arises when the operating cycle is greater than the credit terms you receive from your suppliers.

The operating cycle problem is increased when your bank, being a historical lender, bases your line of credit on what your company has done in the past, not the opportunities in front of you. They will not increase your line of credit. Finally, your profit margin is not large enough to fund your current growth rate. Don looked at me and said “Is there anything I can do?”

Alternatives to Improve Cash Flow

I said, “Yes, Don you do have some alternatives.” If possible, the way to solve this problem, at no additional cost to the company, is to get your suppliers to give you longer credit terms. Then, give your customers shorter credit terms. This will shorten your operating cycle, and a goal for any business should be to minimize their operating cycle. Don said “I know that will not work because my creditors are asking me to pay faster and the competition within my industry will not allow me to shorten my credit terms to my customers.”

Another way to solve your company’s needs is to consider approaching another bank that may take a more aggressive approach to increasing your line of credit. He then told me that he has been to three different banks. They all said they think they will be able to increase his credit line. The end result has been every bank has either a) they want Don’s business, but the line would be the same as his current line of credit, or b) the increase was so small it really wouldn’t solve his problem. I told him that is what I would expect. Bankers’ underwriting policies for lines of credit are similar.

A third solution would be to get an equity partner. A person or entity would invest the amount of cash to pay the bank off and to fund your projected growth for three to five years. He looked at me and said “The last thing I want is a partner.”

why don't I have cash

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Unsecured Credit

See Also:
Debits and Credits
Credit Letter
Direct Tax
Credit Memorandum (memo)

Unsecured Credit Definition

Define unsecured credit as credit not collateralized by an asset. It is a common form of credit used for business. Furthermore, an unsecured credit line comes in many forms, including the following:

Though it may go unmentioned, many businesses use it to successfully finance any of their operations.

Unsecured Credit Meaning

Unsecured credit means credit which, when unpaid, cannot be reclaimed through the seizure of an asset. This is important to note because unsecured credit facilities may be confused with secured credit. Though lenders have other methods to regain the value of the credit they offered (such as a court decree saying the lendee must repay the lendor), there is no asset promised by the receiver of the credit.

On a small scale, unsecured credit loans are more simple to acquire than secured credit. For example, credit cards are the easiest method of credit to acquire outside of the financing of “friends, family, and fools”.

On a large scale, an unsecured credit agreement is fairly difficult to acquire. The example of this would be mezzanine debt financing: mezzanine financing is virtually as difficult to acquire as venture capital. In this situation, companies generally use an unsecured credit facility when they can not receive secured credit. This situation occurs when the company can not meet the requirements or obligations of the secured credit lender or prefer to keep their assets free of obligation.

The business owner makes the final decision on whether secured or unsecured credit is the best decision. A general rule of thumb would be that if the company has more to lose by collateralizing an asset then not receiving the financing, unsecured credit may be their best option. consult a trained CFO to find the best option for your business.

Unsecured Credit Example

For example, Karl is an entrepreneur who has started a company which manufactures precision electronics for the military. Because Karl makes each item to changing specifications, Karl must keep a lot of supplies on hand. He must have a strong base of credit to cope with his customer’s changing demands.

Karl has recently outgrown his current lines of credit. To make matters more complicated, he already promised almost all of his assets as collateral for other loans. With no option left, Karl must find an unsecured credit provider. He knows that credit cards will surely not be able to support his needs. He sees mezzanine debt financing as the only option.

After consulting with a trained CFO, Karl realizes that his company will actually lose profit by receiving the funding. The CFO clearly spelled this out in the financial analysis he provided. It seems the best option is for Karl to grow a little slower. Though he will have to deny some customers, it will ultimately result in a stronger business. Going forward, Karl’s company will be financed by free cash flow. Though Karl does not feel like as much of a “high roller”, he is happy that he made the prudent decision.

unsecured credit, unsecured credit definition

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Line of Credit (Bank Line)

See Also:
5 Cs of Credit
What are the 7 Cs of banking
Credit Rating Agencies
How Important is Personal Credit in Negotiating a Commercial Loan?
Improve Your Credit Score

Line of Credit (Bank Line)

A line of credit (bank line) is a type of loan agreement between a bank and a borrower. Basically, a line of credit states that a borrower can borrow funds from the bank at will, up to a certain limit and within a specified period of time. During the specified time period and within the limitations of the allowable amount, the borrower may borrow and repay funds at the borrower’s discretion. When the line of credit expires, the borrower must repay all borrowed funds as well as any unpaid interest.

A bank charges interest on the borrowed money, charges a fee for the unused portion of the loan, and requires a collateral deposit from the borrower. A line of credit (bank line) typically has a maturity of a year. However, there are contracts with longer maturities, called revolving lines of credit. There are also contracts with no maturities at all, called evergreen credit. A line of credit is also referred to as a bank line.

Line of Credit Interest

Banks charge interest on lines of credit (bank line). The interest rate charged depends on the borrower’s creditworthiness and risk of default. The interest rate on a bank line is often a benchmark rate. For example, this benchmark rate may be a Treasury bill rate or another market based rate, plus a premium. For example, the interest rate might be the rate on two year Treasuries plus 1%. Different borrowers with differing degrees of creditworthiness will be charged various interest rates on lines of credit.

Line of Credit – Other Requirements

Banks typically require the borrower to maintain a compensating balance. A compensating balance is a percent of the value of the bank line that must be maintained as a deposit at the bank. For example, if the line of credit goes up to $100,000, and the compensating balance is 10%, then the borrower must maintain a deposit at the bank of at least $10,000. This compensating balance serves as collateral.

Banks often charge a commitment fee to borrowers for reserving the unused portion of the line of credit. For example, if the line of credit goes up to $100,000, and the borrower has borrowed $60,000, then $40,000 is left on the balance of the loan. The borrower may be required to pay a commitment fee, of perhaps 0.5%, on the $40,000 that is not being utilized. This fee represents the cost of keeping that amount available to the borrower, or committing the money to the borrower, so that it may be accessed as needed.

Line of Credit vs Loan

There are several advantages to using a line of credit. First, a line of credit (bank line) is flexible. It allows the borrower to take out loans as needed. Then the borrower repays them when convenient, within the limits of the contract. Second, the borrower only pays interest on the portion of the loan that is used, and does not pay interest on the unused portion. However, the borrower may have to pay a commitment fee on the unused portion of the loan. Also, using a line of credit can reduce the paperwork and administrative tasks involved with taking out loans.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

Line of Credit (Bank Line)
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Line of Credit (Bank Line)

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Dilemma of Financing a Startup Company

See Also:
Working Capital
Angel Investor
Venture Capitalists
Why Venture Capital
Mezzanine Debt Financing

The Dilemma of Financing a Startup Company

I had a meeting the other day with a prospect named Chris. Chris owns a distribution company he started fifteen months ago from his home. He has grown his company to annual revenues in excess of one million dollars and has opportunities to double the revenue over the next fifteen months. This article is all about the dilemma of financing a startup company and how to manage that startup growth.

Chris’ story is one I hear all the time… He got tried of working 50-60 hours a week for somebody else. So, he decided to start his own business. The business he started was the same as where he had been working for the past ten years. He started with the blessing of his wife and used their savings to get the business off the ground. After about six months, they no longer had sufficient savings to continue to invest. He did not want a partner, so they decided to take out some credit cards and use the money to fund the next level of growth for the business. Now, the credit cards are at the maximum credit limit. Chris and the company are experiencing real cash flow needs because of the rapid growth of the company.


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Finance a Startup Company

Chris had gone to several banks requesting assistance in the form of a line of credit. But, the story is the same around every corner. All the banks told him his company was doing great; however, his personal credit was not. His personal credit score was low because of the high credit card exposure, so they would not loan his company any money. One of the bankers told him to give me a call to discuss alternative financing of his company’s accounts receivable to help finance a startup company.

Needless to say, our first meeting did not start out great. Chris was very frustrated with the banks putting so much emphasis on his personal credit instead of just looking at his company. After listening to his story, he asked me “Why won’t they just loan the money to my business?”.

Not knowing what to tell him but the truth, I said “Chris, you are the business.

He then said “What do you mean?

I responded, “Without you, the business would probably fail”. I continued by telling him that his banker looks at him and his business as one entity.

We talked a lot about his personal credit and determined that it was not that he was not paying his bills… He just had so many credit cards. I told him banks just do not make consolidation loans for credit cards. Because, once you pay off your credit cards, there is no guarantee you won’t max them out to the credit limit again. He then decided what he needed was a way out. He asked me “How can I get out of this credit card debt circle?

Rebuild Personal Credit

I told him to create a plan to rebuild his personal credit, which would allow his personal credit score to improve. He said, “But if I take the money from my company to pay the credit cards, then I will not be able to take advantage of the growth opportunities I have with my company.

I showed him how his company would be able to meet it’s growth. He would have the money to pay down his credit cards over the next fifteen months by creating cash flow using alternative accounts receivable financing. Then I told him he should show the banker his plan and stay in contact with him to show him the improvements. I continued by saying “If you follow through with your plan, then the banker will decide when he can satisfy your company’s needs and be happy to loan the money you need for your business.

After twelve months of dealing with Summit, I am proud to say that Chris did follow his plan. The company took advantage of all its opportunities. He now has good personal credit, a loan from his bank, and his company is continuing to grow. Dilemma resolved. Download our three best tools to prepare yourself as a financial leader to improve cash flow, profitability, and your effectiveness.

Financing a Startup Company

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Financing a Startup Company

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Can Factoring Be Better Than A Bank Loan?

See Also:
What is Factoring Receivables
The Dreaded “F” word
Accounting For Factored Receivables
Journal Entries For Factored Receivables
Working Capital
Preparing a Loan Package

Can Factoring Be Better Than A Bank Loan?

What I have found is that normally a business owner who needs financing for the growth of their business start their financing search by looking for a business loan or a business line of credit from a bank. The reason is that business loans and lines of credits from a bank are well known products. However, due to the regulations imposed on the banking industries loans are very hard to get. What I have found in the real world is few businesses actually manage to get them unless they are collateralized by equity in real estate or equipment.

As a result, the accounts receivable and inventory financing needed in a growth mode is the most difficult financing to obtain from a bank. There is an alternative for such growth needs, which is factoring. Factoring is offered by commercial finance companies. In the vast majority of cases, factoring may be a better and easier solution to obtain than traditional bank financing to fund the growth of a business.

Determine if Factoring is the Better Alternative

To determine if factoring is a better alternative than a business loan you just need to ask yourself these questions:

1. Does my company provide goods or services that are completed when I invoice my customers?

2. Are my customers not paying within the credit terms I am offering?

3. Are you turning away sales because you do not have the cash?

4. With cash, is your business growth potential greater than 20%?

If your answers were yes to these questions, then factoring your accounts receivable invoices is better for you than a traditional loan that you can obtain from banks. Accounts receivable factoring provides a business with financing flexibility based on your sales. A properly structured factoring program eliminates slow payment cycles by providing your business with cash to grow your business.

As a business owner, you should be aware and open to all financing products available to you by either a bank or commercial financing company and choose the one that best fits your company’s needs.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

can factoring be better than a bank loan
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The KISS Principle can be “Simply Stupid”

How often have you heard a business owner say “Why would anyone include depreciation, or rent, or insurance and many similar costs, in their Cost of Goods Sold? It’s best to keep it simple!” They want to apply the KISS Principle, but it can be simply stupid.

The KISS Principle can be “Simply Stupid”

Well for many reasons, such expenses should be included in COGS. Including:

So in many cases, the KISS principle – is “Simply Stupid” because it results in overpayment of the GMT, and obfuscates the real cost of a product or Service. And incidentally, it is GAAP. Just look at public company annual reports… Almost assuredly, your bank LOC requires financials prepared in accordance with GAAP.

Keep it Real.

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KISS Principle

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