Batman villain “two face” could have been a banker

In the latest Batman movie, one of the villains is “Two Face” - a good guy turned bad guy who determines the fate of his victims by tossing a coin.

And some bankers today seem to be following his lead.

Bankers can be usefully divided into two categories - those in "sales", and those in “credit”. In the credit bubble environment, "sales" ruled and "credit" did what it was told. But now, what I call the "pendulum of bank benevolence" has swung from "profligacy" to "bastardry", and the credit people are back in the ascendancy.

When "sales" ruled, small business owners were seduced by their bankers to source all of their funding requirements with their bank, with offers of very low pricing, and the empty logic of “one stop shopping”. But now that "credit" is back in town, many SME's are finding themselves hog-tied and unable to restructure their business finances without refinancing every dollar of debt the business has.

An example will illustrate what I am talking about. I was asked recently to provide a debtor finance facility to an engineering business. They needed my services because they recently shifted premises. As always happens when a business shifts, they had underestimated the costs in terms of both expenses and lost sales through down time. Their bank (lets call them Big Bank) loaned the business nearly $1M to buy the new premises only months ago - the old premises had been rented. Yet Big Bank turned them down when they asked for an overdraft extension, and so their finance broker brought the matter to me.

I asked Big Bank to release the business's debtors from the debenture charge they (Big Bank) held over the business. The Relationship Manager agreed to help, but then, even though the debt was easily covered by mortgages held over the premises and two directors homes, he was over-ruled by “credit” (you can almost hear “Two Face” flipping his coin, can't you?)

The only option available to this client now is to refinance everything - the overdraft, the business loan, the equipment finance, the property loan on the new commercial premises, and the two directors home loans.

In this example, the client effectively has four classes of assets: Commercial property (the premises); personal property (the directors homes); the plant and equipment, and; the debtors of the business. I believe that each class of asset should be financed with different lenders – preferably specialists in those asset classes. That way, one asset class can be refinanced without the need of refinancing the other assets.

This client is now at the mercy of the decision processes of the bank, which frankly seem no more sophisticated than that of “Two Face”, with similarly dire consequences for the business.

Don't let a busted client send you bust!

How many times have you seen a small business experience distress, or even fail, as a result of the collapse of one of its commercial customers? I met one the other day that inspired me to offer a few tips and to post a cautionary tale.

So, can a business that supplies it's goods or services to other businesses on credit terms protect itself from this kind of disaster? How?

Aside from the obvious (and sometimes impractical) advice of not putting all your eggs in one basket, I have three suggestions:

1. Have clearly stated credit terms that are agreed to in writing up front.
2. Have a process for establishing the credit worthiness of your client. You should not extend credit to any business if you don't know how long they have been in business, their payment history with other suppliers, and something of the substance of the owners of the business.
3. Obtain personal guarantees wherever practical.

You can do all of the above with a simple credit application form that incorporates payment terms and a personal guarantee. I am sure you could find examples on the internet (google "credit application form"). Otherwise, nip down to Officeworks or Bunnings, and you will see the style of document I am talking about.

Now the cautionary tale. I met a chap last week who has a shop-fitting business. He completed a fit-out for a store in a major shopping centre and that was part of a small chain. He completed the job and handed over his invoice for $50,000. The same day, the owner of the business announced that she had placed the business into the hands of external administrators.

The external administrators sold the business to a "friendly" party (who by the way then kindly re-employed the owner of the busted business in a senior role). The shop fitter however was left high and dry. The new owners of the retail chain were not liable for the debt (the busted company was liable for the debt). The shopping centre managers would not give the shop fitter access to take back his shop fittings (which frankly would have been of little use anyway).

But the real insult came when the shop fitter learned that the owner of the busted business had substantial property holdings! It was the busted business, not the busted business's owner personally who owed the debt. So the shop fitter now had a $50,000 problem.

A simple credit process may have spared him of the whole sorry affair, but a personal guarantee would have given his lawyers an avenue for recovery of the $50,000 from the proprietor.

I am going to call on some friends with expertise in the area of credit and recoveries to post some comments here, so do check back if you want some more valuable tips!

How much does "debtor finance" cost?

Debtor finance is a great tool for financing business growth, but how much does it cost? This is a question accountants love to ask. Before I answer it however, allow me to point out that at a very basic level there are two determinants of business profitability: income and expenditure. Accountants, by training, are expenditure focused, which is why they love to ask "how much does it cost" instead of "how much value will it create"?

So let me answer the "expenditure" question directly by saying that debtor finance will normally cost a small percentage of the value of invoices financed. However, given that debtor finance facilitates revenue growth, the revenue or "top line" impact of debtor finance should not be discounted when the "cost" of debtor finance is being assessed.

Recently I spoke with a prospective client who was a business services provider. His Gross Profit Margin was 40%. He was turning over $300,000 per month. He had very real potential to double that turnover - but needed funding to do so.

I estimated that a debtor finance facility for his business, given its circumstances and debtor collection cycle, would cost him in the vicinity of 2.5% of invoices financed. His accountant thought that this was expensive.
Lets assume that a doubling in sales is realistically achievable. The client is now trading off:

1. Using my services and having a business that grosses 37.5% per month on a turnover of $600,000 per month, or;


2. "Going it alone" and maintaining his margin at 40% - but 40% of $300,000 in revenue per month.

The illustration below shows the clients existing GP, his potential additional GP (GP foregone if he decides not to grow) and the debtor finance fee. The whole "pie" represents total sales of $600,000 per month.

The chart illustrates that in the event the client takes his accountants advice, he runs the risk of missing out on $75,000 in gross profit per month!

So the cost of of debtor finance, in expenditure terms, is negligible when weighed against value creation debtor finance facilitates.

What advice would you give this prospective client if you were his advisor?

A simple tool for diagnosing cash flow problems

We have developed a simple tool - "The Cash Flow Diagnostic" to help the business owner consider which aspects of the business should be worked on to deliver a more robust cash flow. It is outlined briefly here, and in subsequent posts we will go into detail for each of the five alternative points of action suggested.

In the first instance, a poor cash flow can be attributed to either the timing of payments and receipts or on the actual level of cash generated by the business. Cash timing issues can be relieved by either extending terms with suppliers, reviewing and enforcing customer payment terms, tight cash budgeting and through the use of debtor finance to accelerate cash receipts.

If the timing of cash flows is acceptable but the business is failing to generate sufficient cash, this can be attributed either to a lack of revenue or high cost levels. Revenue growth is constrained by either marketing factors or the amount of working capital available to the business. A refinance may be needed if working capital is your constraint. If your growth issues are more marketing related, review your “four p’s” of marketing (pricing, product, place and promotion). Many good blogs and web-sites offer helpful marketing hints. You could start by visiting Microsoft - http://office.microsoft.com/templates/ - here you will find marketing plan templates that will help you step through the marketing planning process.

High costs also fall into two categories – high fixed costs (overheads) or high input/ variable costs that result in resulting in low margins. A third party cash injection can improve your bargaining power with your suppliers to drive down the cost of your purchases, thereby improving your margins. If fixed costs are an issue, you made need to consider restructuring your business – and again, you may need funding to help you through that process. But additional finance or formal restructures do not by themselves solve problems – they are simply mechanisms for buying time and negotiation leverage.

All of the above is fairly intuitive – but even the simplest of tools are often effective in helping business managers to prioritise their actions and thereby maximize the effectiveness of their efforts.Stay tuned in upcoming weeks when we tackle the detail.

Feel free to comment!