Business Management Articles
Need Financing? Better Build your Business Credit Profile
Glenn Agro, FCA*CF
Management
March 2009
We may be hearing that the government is supporting lenders in order to provide businesses with the capital they need to survive this economic hurricane; what we are seeing however, is not yet that rosy.
The fact is that Canada’s Schedule A banks – the primary lenders to the country’s small and mid-size businesses – have limited capital available and for the most part are deploying that capital to support current rather than new customers. And even existing customers are finding that the cost of borrowing is rising and often, monitoring is becoming more frequent.
Still, despite these challenges, banks and other lenders will support companies with solid fundamentals and healthy practices. Thus there are a number of things management teams can do to strengthen the corporate credit profile in order to maintain relationships with current lenders and to establish creditworthiness among new lenders.
Secure current lending relationships
Securing existing lending relationships requires staying in close contact; bankers don’t like surprises. It’s absolutely vital to keep lenders informed about the health of the business. While no lender wants to fund losses, they do understand that healthy companies experience temporary periods of difficulty. They want to know what steps management is taking to address economic challenges. Should extra support or capital be needed, it is critical that borrowers provide lenders with sufficient lead time to thoroughly assess the situation.
When renewing credit arrangements, prepare well ahead of agreement termination dates. It’s important to review loans, leases and mortgages to assess whether they represent the most appropriate and affordable forms of financing for the company’s needs during the coming months. What terms and conditions are manageable? Do agreements allow a buffer to enable the company to manage through a temporary period of financial difficulty? Do covenants allow some flexibility in case revenues fall?
It’s important to keep in mind that even though interest rates are at historic lows, new loan rates are not. The cost of capital is rising. Many of the banks are also introducing fees such as standby charges of one-quarter to one-half of a point for untapped lines of credit.
Lenders have also reduced the debt-to-equity threshold for transactions. Only a few months ago, a ratio above 3:1 was acceptable; now it’s closer to 2:1. Moreover, banks are instituting more restrictive covenants to direct cash flow into debt repayment and are also requiring more security. They expect companies to meet forecasts and to link commitments to plans.
When meeting with a lender, be prepared to demonstrate that the management team has a solid action plan. Include conservative projections of what the next one to two years are expected to look like under varying scenarios – a 15% decrease in sales for example, as well as a 30% drop. Projected financial statements should also have well supported assumptions. Indicate the trigger points when the management team will make decisions. Outline what support may be needed and what contingencies are in place to repay the loan should problems arise. Show that management understands the issues and can make the necessary adjustments or cuts to operate within the bank’s parameters.
Arrange contingency borrowing
Having a backup financing plan is essential in the event the bank or other lender restricts borrowing capacity or decides not to renew the company’s loan or line of credit. Begin the process of identifying alternative lenders several months ahead of agreement expiry dates, since it may take this long to establish a new relationship. As well, corporate customers have fewer lending options than only a few months ago. Most U.S. lenders have disappeared and every remaining lender is cautious about credit quality.
Investigate alternative sources of capital such as leasing companies, factors, commercial finance companies, private equity investors and government-backed financing initiatives. The 2009 federal budget provided a hefty capital infusion to support Canada’s businesses. The maximum eligible loan amount of the Canada Small Business Financing Program has been increased, for example, by $100,000 to $350,000 and to $500,000 for acquiring real property. As well, the budget introduced enhanced loan and credit support by increasing the limits for authorized capital, borrowing and contingent liability of the Business Development Bank of Canada and Export Development Canada. While these options are still more expensive than financing provided by Schedule A banks, they now have broader mandates as well as more capital.
Strengthen the balance sheet
To secure capital from any type of lender, a company must convey credible reassurance of repayment ability. Risk tolerance has declined along with economic conditions. A company’s current ratio, for example, needs to be at least 1.25:0 to demonstrate convincing capability of meeting debt obligations.
Generally, the first place lenders look to back their security is the balance sheet, thus it is vital to look at every possible way to strengthen it. Consider, for example, improving working capital position by consolidating debts. Are there opportunities to secure longer term financing, extend loan repayment schedules or to eliminate loans by selling non-core assets or orchestrating a sale-leaseback of land, buildings or equipment?
It’s also important to demonstrate that the company is managing costs. Regularly monitor the ratio of costs to revenue and eliminate expenses that do not contribute direct value to the organization. Don’t make rash cuts, but do create a contingency plan that outlines how management intends to reduce the cost structure in the event this may be necessary. Be prepared to make a strong case for any new long-term commitments, such as expansion, hiring or new supply contracts. Lenders will support synergistic acquisitions that make sense but will expect to see the combined balance sheet of the new entity support the financing of the transaction.
Reduce surplus inventory as much as possible. Where needed, monitor inventory turnover, track and measure lead times, review minimum order quantities and price quantity breaks and work with suppliers to improve delivery efficiency.
The quality of accounts receivable is also an important indicator for lenders. Review credit policies and collection procedures to reduce over-extended customers and eliminate any receivables lingering past 90 days. Consider accounts receivable insurance to provide lenders with additional reassurance.
Tracking the following ratios each month can help the management team monitor levels of profitability, liquidity and efficiency that lenders will assess.
- sales actuals to projections
- gross profitability (gross profits/net sales)
- net profitability (net income/net sales)
- debt to equity ( liabilities/shareholders' equity)
- current assets to current liabilities
When meeting with prospective lenders, a detailed business plan is essential – one that provides a realistic portrayal of the marketplace and the company’s position. Goals and strategies should be straightforward, achievable and capable of generating value for the company in the short term. Lenders will expect more security, so be prepared to offer additional collateral, guarantees or insurance.
As long as the world’s economies continue to struggle, lenders will continue to be concerned with credit quality. A strong credit profile will be the corporate ticket to capital, survival and success.
Glenn Agro, FCA*CF, is a partner of BDO Dunwoody LLP (www.bdo.ca), one of Canada’s leading accounting and advisory firms. Glenn provides auditing, accounting, advisory and corporate finance services to privately-held companies. You can reach him at gagro@bdo.ca or ( 905) 272-7803.
