If your business is growing, you’re going to find that the credit line they’re offering you isn’t at the ideal limits of where you’d like it to be.
This is the second in a series of articles on using short-term loans to help small businesses succeed
A financial strategy isn’t just something for those large corporate entities you see on Bay Street in Toronto, 7th Avenue SW in Calgary, Portage & Main in Winnipeg, Jasper Avenue in Edmonton, or West Georgia Street in Vancouver. Every business needs one, even if it’s relatively informal. When you’re borrowing money, having a strategy becomes even more important.
With the emergence of numerous alternative lenders in the marketplace – being people like ourselves who provide short-term working capital loans and equipment financing – to others such merchant cash advance companies, peer to peer lenders, and others, many people have the impression that the best way to use an alternative lender is to replace their bank.
That notion forms the basis of an extremely poor financial strategy.
First off, your bank (or credit union, with all due respect to both institutions, we’ll use “bank” to mean either/or) should be your first and primary source of working capital financing. They will typically be your senior secured lender and the source of your lowest cost of funds. They’re important to your future success. They’ll look at your inventories and receivables, calculate a margin limit, and then provide you with an appropriately sized credit line.
If your business is growing, you’re going to find that the credit line they’re offering you isn’t at the ideal limits of where you’d like it to be. When underwriting (credit evaluating) your file, they must rely heavily on your financial statements. So, in effect, they’re always having to deal with historical information. For them, the proof of how your business is doing is in your final results.
This is where an alternative lender can be effectively utilized. Through alternative lenders, you can access a short-term loan facility which will bridge that gap between what your bank can provide you based on your historic results, and what you believe you can do, based on contracts in hand or sales trends, or sales opportunities under negotiation.
Here’s a suggested strategy. Revolve your credit line with your bank as much as possible based on your cash flow cycle and your availability based on receivables and inventories. Try to do two things – revolve your line (this will show your bank you’re using it in the way it’s meant to be used and build trust) and try not to use it in full – leave some room for those unexpected expenses.
Work only with lenders who have your best interests at heart. If you borrow too much, this strategy simply isn’t going to work. Your bank won’t be happy. Your short-term lender (who may have helped you get into the situation) won’t be happy. Most of all, you won’t be happy – you’ll be stressed financially and not able to focus on your business.
Address the issue of financing your sales increases, new contract requirements, etc., using a short-term loan product such as we offer. Borrow only what you need to facilitate the growth in your business, and set up repayment for a term that matches the completion of your seasonal sales cycle or contracts, for example, six months. When you reach your next quarter-end, make sure your financial statements are up to date – everything on them – DO update inventory counts, DO reconcile your accounts receivable, DO push to collect your accounts on time. Then go back to your bank and talk to them about increasing your line based on the results you can prove you’ve achieved. Work with them to increase your availability to reflect your new sales level.
Repeat this process as necessary – if you think you can once again achieve another, higher sales level, take another short-term loan. Grow your business. Update your financial statements. Visit your bank again. Keep revolving your credit line. Continue this cycle and keep growing.
Here’s a graphical representation as to how that cycle would work in the ideal circumstances.
This, of course, is the ideal scenario, and we know in the real world it’s not always that simple. But if you follow the process, build an effective relationship with your bank and with your alternative lender, keep them both informed, and only use your borrowed money for their intended purposes, it’ll pay off. By doing this, you’ll enhance your relationship with both your bank and your short-term lender, and you’ll grow your business without taking on undue risk.
Finally, don’t judge your short-term lender by who offers you the most money. Borrow just the right amount, for the reasons as outlined in our first blog in this series. Work only with lenders who have your best interests at heart. If you borrow too much, this strategy simply isn’t going to work. Your bank won’t be happy. Your short-term lender (who may have helped you get into the situation) won’t be happy. Most of all, you won’t be happy – you’ll be stressed financially and not able to focus on your business.
Read about the first blog post in the series: Keys to Successful Borrowing: The Importance of Borrowing the Right Amount
Watch for our next blog post in the series which complements the topic in this one: the importance of having a great accountant.