Picture this: You are on your roof cleaning the gutters when suddenly, you start sliding down. Whatever you do only slows your descent. You will eventually fall and hit the ground hard. This is similar to the nightmare faced by your business-owning clients when they have cash flow crisis.
This is an area where accountants add real value. They must get out in front of this problem. Drum it into their heads: Your client must open a line of credit with their local bank. They should accept offers from the bank for business loans, borrowing a little and paying it back quickly, even if the money just sits in an interest-earning account. They need to establish and maintain a good credit rating.
In the investing world, when financial advisors talk about mutual funds, they often caution, “Past performance is no guarantee of future results.” In the banking world, the situation is reversed. Your credit history (past performance) is a major deciding factor when they determine if they will extend credit when you need it.
Unfortunately, many small businesses let themselves slip into serious trouble before they sound the alarm. They fall behind on their bills, paying only the critical ones. Penalties mount up. There are companies that are willing to lend money, but when you are a business “the banks won’t lend to,” the rates can be astronomical. In peer-to-peer lending, rates might be 35–40 percent.
Let’s assume your client isn’t desperate. They heeded your advice. Things are going well, but they want to be prepared. Maybe they have a seasonal issue but are confident it’s only a temporary condition. The first person they should be talking to is you. You can take an objective view of their cash flow management problem and potential solutions. They likely already have a working relationship with their local bank.
Here are a few ways they can obtain the necessary funds:
- Line of Credit: This is exactly why it’s there. Is the line large enough? Talk with the bank about increasing the size, if necessary. Their longevity as a client should work in their favor.
- Short-Term Loans: Banks also lend fixed sums. Before all those credit options proliferated, individuals used to take out personal loans. Large corporations go to the commercial paper market to borrow for short periods of time.
- Secured Loans: The bank lends money, but it’s collateralized by an asset like equipment or secured by a claim on anticipated revenue, specifically accounts receivable. Even in municipal government, cities would borrow against future revenue by issuing tax anticipation notes.
- Securities-Based Lending: The financial services industry used to call borrowing against stock a “margin loan.” They expanded into another area, securities-based lending. Essentially, the business has securities, but it’s a bad time to sell because they would be selling a bond before maturity in a rising interest rate environment. The financial services firm may offer this as a borrowing option.
- Personal Guarantee: Your bank might agree to lend to your business, but they like your credit profile a lot better. You have assets and a house. They want your personal guarantee on the business loan.
- Peer-to-Peer Lending: This type is also called P2P. According to an article on Nerdwallet.com, there might be an investor, hedge fund or investment bank behind the intermediary. You need a good personal credit score. Interest rates can be high. It’s not a first alternative.
- Credit Cards: You’ve heard the stories. “We maxed out the credit cards to get the business through tough period.” You know what those rates look like. This is not a prudent option. You tend to only hear about the stories with a happy ending.
- Equity Loans: Many business owners put their own money into the business. It might be equity or an outright loan. This needs to be documented. An article on fitsmallbusiness.com documents the steps. You can see the role the accountant plays.
- Equity Sales: Take on a partner who believes in the business. They put up cash. You sell them a stake. They are becoming an equity owner.
- The Well-Heeled Friend: Someone they know and trust, outside the banking system, puts up money, expecting to be repaid. Think in-laws or parents who want their child’s business to succeed. They may be the lender of last resort. The existence and terms of the loan should be spelled out in case things don’t turn around and the business goes into liquidation.
Your business-owning client has options. Hopefully, time is on their side. After talking with you, their local bank should be their first stop. If it’s practical, they should shop competing banks. The Small Business Administration may also be able to help.