May 1, 2011
Dealing with the bank
BY GEORGE URVARIOver the years, I have had many dealings with banks to finance the growth of our business. One thing I learned for sure is that I need to learn Bank Speak if I was ever going to get respect as an entrepreneur. Bank Speak is all about numbers and ratios. Translations follow.
Total sales: What is the total volume of business you will be doing, and when?
Profit: Is there a history of sufficient profits to indicate that the company
is well managed and consistent in its performance?
EBIT: What are the company's earnings before interest and taxes?
Gross profit: How efficient is the company and what is the labour-to-sales ratio?
Is the staff productive? Is the equipment-to-sales ratio at the right balance to maximize labour productivity?
Material/sales ratio: Is the company utilizing materials to maximize profit?
Overhead: Are the owners paying themselves enough, or too much? Can the company support management salaries?
Is there a history of steady income for the owners? Is the overhead-to-sales ratio high or low?
Net profit: At the end of the day, is the company profitable?
Inventory and cash on hand: Does the business have enough cash to comfortably
cover the time between payables and receivables?
Cash flow: Does the company pay its bills on time?
Retained earnings: Does the company have cash reserves?
Credit history: Does the company string out its suppliers to support its operations?
A typical business needs about 20 per cent operating capital to survive. Operating capital is the money you have in your business for day-to-day operations — making payroll and paying immediate bills. It is the cushion that keeps your head above water when receivables are slow.
In addition to this capital, banks often provide lines of credit to help with cash flow. Companies in growth cycles can have as much as 50 per cent of their revenue in receivables. In our industry, it is not uncommon to wait 45 to 90 days for payment. The analogy here is that it is not much good to throw someone a life-vest after he has drowned. Many businesses are profitable, but still go out of business because there have insufficient funds to cover day-to-day operations, or seasonal downturns in revenue.
Most recently, I wanted to borrow money for a large tri-axle truck. The interest rate with leasing companies was over eight per cent and the bank was closer to 4.5 per cent. This would make about $7,000 in interest savings per year, or $35,000 over five years.
Using our budgeting software, we were able to demonstrate the positive impact the new truck would have on our equipment-to-sales ratio. It increased by less than one per cent as a total ratio to sales. This revelation indicated that we could easily afford to make payments on the truck, even if it sat idle.
Better news, however, was that our material ratio went down substantially, as did our truck sub-contracting costs. In fact, the purchase of the truck would increase our gross profit. I could also demonstrate mathematically that our overhead, was fixed and the truck was priced as a direct cost. This meant that we were now paying down our own overhead instead of someone else's, while reducing our customer prices. Our new bill-out rate was more competitive, and our vertical integration of this new service, which we used to outsource, actually added to net profit without requiring more sales.
I then discussed how our investments in efficiency were going to reduce waste and increase capacity. No more waiting for the disposal bins to show up. The bank offered to lend us more money after that!
At the end of the day it's about numbers, and not intuition. Manage your numbers well and the bank will speak your language and help you grow your business. Financial literacy starts with your budget.
George Urvari has been a partner in a Toronto-based design-build landscape firm, for over 20 years.