Banking Basics 101

"Let me see if I have this right. In order to provide adequate working capital to your $7 million business this year, you're going to need to borrow as much as $3 million?"

The banker approached the issue in matter-of-fact fashion. He understood that we were in a seasonal distribution business — bicycles — in the Northeast, that we were sourcing our product in Japan and Taiwan, that there was a six-to-eight week period when the bikes were "on the water" en route, preceded by a four-week production lead time. After all of that, it took two to four weeks to clear this pre-ordered inventory out of the warehouse to our dealers and thirty to sixty days for them to sell it out and pay us.

Our overseas manufacturers, of course, wanted assurance up front that we had the means to pay them, which meant opening a bank letter of credit when we placed the order. This allowed the vendors to be paid by the bank when the containers of bikes were loaded on ships in Yokohama or Yokosuka.

So we were asking the bank to commit funds in January for bikes to be shipped in February, received in April, sold by our dealers in May and June, and paid for in late June or even July — a finance cycle which stretched 5–6 months. A lot could happen in six months — starting with the weather, which could make or break a bike-selling season.

Assessing this risk was as much an art as it was a science — one part history (results during the past three years), one part internal economics (our margins), one part external economics and politics (market trends, exchange rates, and tariffs). A large final component was the banker's experience — with related markets, with international finance, with our products, and especially with my client and with me.

The year was 1985. The banker had been with us for three years. When he changed banks a year later, we followed him. The relationship was that important to us. He knew our economic model. He understood the bike business. His insights about parts of it were better than ours, based on information that flowed through his banking channels. As a result, he minimized the bank's exposure by helping us to avoid risky situations, operationally as well as financially.

Small business doesn't see that kind of banking very much any more. It's too expensive for the bank, especially the big banks. Loan officers today get paid at least two or three times, in real dollars, what that rep was earning twenty years ago. And the banks' overhead has gone way up — for executive salaries, for IT, for insurance and compliance, and for bad loans. They simply can't afford to take the time any more to learn their customers' businesses. They have had to be selling, constantly bird-dogging new prospects.

As a result, many (but not all!) loan officers are salespeople first, analysts second (or maybe third or fourth, depending on their personal ambition and political instincts). They require periodic financial reports from their small business clients, but they are often not diligent in following up when the reporting is delayed. In an effort to mitigate their risk, they in many instances rely on such restrictive loan documentation that the entrepreneur ends up with obstacles to, rather than opportunities for, growth.

So what, then, are the ground rules for small business owners in this new banking ball game? In celebration of that first real harbinger of spring — the start of Major League Baseball's spring training — we offer Brad's Baseball Banking Bible:

1. Step up to the plate. Be proactive in keeping your financing sources informed. If there's bad news, don't sugar-coat it — leave out the "juice." Wrap it in the context of a realistic turn-around plan. The best defense is often a good offense (just ask A-Rod!).
 
2. Make a good pitch. You, as the owner, have to be able to explain concisely how you make money in your business. You should describe your key financial measures, especially those that are reflected on your financial statements.
 
3. Put people on base. Give the bankers more than enough information about your business and your industry to enable them to make the case up the line, to the loan committee. Force them to take the time to understand.
 
4. Give them a common scorecard. Don't challenge bankers to interpret or recast your financial reports. Make the numbers transparent, standardized, comprehensive, and consistent, month-to-month and year-to-year.
 
5. Don't swing for the fences. From basic financial ratios, determine a reasonable debt load for your business, and show the loan officer how you'll pay it back, using conservative assumptions.
 
6. Keep the bullpen armed and ready. In the current environment, your bank's situation can change quickly. You should be warming up alternatives.

Financial Managers helps the managers of smaller companies and non-profit organizations develop reliable financial information for operational decisions.

On an affordable retainer basis, FM serves as the part-time controller and senior financial manager for multiple clients, leading them to profitability and positive cash flow.

The goal is for the organization to outgrow Financial Managers' services, at which time FM will take the lead in identifying and hiring the right full-time financial person for the firm, and effect a smooth transition to his or her management.