Banker's Advice for the Self Employed Business Owner: Update
On January 29th, 2009, I wrote, "Banker's Advice for the Self Employed Business Owner". As a Commercial Banker, I would like to update this topic based on what I'm seeing within the world of small business owners and the banking industry in general.
Your Banking Relationship: As the banking industry continues to tighten credit standards, and given the correction in commercial real estate, which should further tighten lending standards into 2010, your banking relationship is more important than ever, especially if you borrower or plan to borrower from your bank to support your business. It's imperative that you maintain the very best relationship and image with your bank/financial partner.
If your bank requires regular monthly, quarterly, or annual financial reporting on your business or you as an owner, get that information into your bank in a timely manner. It sends up a red flag that you might have financial issues.
Keep outstanding financial records on your profit and loss statement, balance sheet, and AR and AP agings. Good accounting makes you look like you know what's going on within your business. Bad or sloppy accounting sends up a red flag at your bank.
If you have a business loan, keep your business deposits with that institution. More and more banks are not lending to those who don't, and some banks are kicking out clients who do not maintain deposit relationships with the bank that has financed that business. It's becoming a hard and fast rule within the banking industry.
It also benefits you to know the key decision makers at your bank, and meet with them on a regular basis to let them know what you are doing with your business and how you are handling this economy. Communication in any relationship is vital.
Understand the Health of Your Bank: In today's world its quite easy to find out the financial performance of your bank. Every bank is required to file financial statements every quarter with the FDIC. The FDIC makes this information public to all through their website: www.fdic.gov. Ideally, your bank should be reflecting net profitability on their profit and loss statement. In addition, you should take the time to understand their delinquencies greater than 30 days, and more importantly the level of loans they have on non-accrual (these are the loans that are not making principal or interest payments to your bank). Bad loans are an indicator your bank might not be around, and your relationship will be handed off by the FDIC to a larger bank, which might not be in your best interest.
Your Business Balance Sheet: If you haven't figured it out, more and more, banks are lending to individuals or businesses that don't look like they really need money. Get over it. So, one of the things you can do is retain more profitability within your business and build your company net wroth.
Yes, this goes against what most CPAs have been recommending that you take the profit out of your business and pay taxes on it from your personal side because the rates are lower than corporate tax rates. The problem with this strategy is that it depletes your business balance sheet (net worth), and it makes you look less credit worthy in the eyes of the bank.
By retaining profits, it makes your bank feel like you are far more interested in running a tight and prudent operation and it allows you to weather financial distress more easily, and that puts your bank at ease on a relative basis.
Business Expenditures: The large corporations went through a massive wave of cost cuts including layoffs, reduced salaries, and inventory reductions. The small business owner really lags this process because they either think the economy will return in the near future or they have emotional attachments to long standing employees, or they just have unfounded hope.
It's imperative to right size your business on the expense side of the business. You might need to cut salaries, and more than once. Frankly, there is no where for your employees to get a job in this high unemployment environment, and they would probably prefer to retain a job at a lower salary than be unemployed all together. I'm starting to see more and more small businesses convert salaried people to hourly or part time to reduce expenses.
Also, you might want to think about employee benefits. I'm starting to see employers eliminate health, dental, and 401K all together and they are not losing employees at all. It's a relatively drastic measure, but for some it's a necessity to stay in business.
It also makes sense to evaluate non essential expenses. If you are washing personal expenses through your business than your not reflecting true profitability, which makes you look less credit worthy to your bank! Make sure you are squeezing price concessions from your vendors. And review every expense to gauge its necessity. Maximizing your profit is in the best interest and health of your business.
It's imperative to protect the profitability of your business, its key to staying in business and key to maintaining your relationship with your bank. Your bank wants to see you make the tough and hard decisions to protect them and your business.
It's only the big banks and GM that can run a losing operation and get government money to bail them out. It's highly unlikely; the small business owner will ever get such support.
Your Personal Balance Sheet: Most business owners are required to sign a business loan as a guarantor, and that puts your entire net worth on the hook essentially for the loan. The more cash and liquid assets you have on your personal balance sheet the better you look as a guarantor, and that carries a great deal of weight with your bank in this new lending era. Again, banks want to lend to people who have the means to handle financial distress.
Also, I still see too many small business owners who haven't gotten real about their real estate holdings. Many of these real estate holdings burn personal cash flow, which places greater pressure on the performance of the business to maintain personal lifestyles, which is dangerous in this environment.
The Vacation Home: If there's one thing that makes little sense in this environment its the holding of a vacation home. There's no rental income, so it's a pure drain on personal income and places a great deal of pressure on owners to maintain a lifestyle that their business might not be able to justify. Get real, if your business is off from peak levels, this is an easy way to reduce the financial pressure by getting rid of unnecessary vacation real estate.
Negative Cash Flowing Rental Property: Again, this is a drain on the personal cash flow, which places pressure on the business that is unwarranted. Remember it's your business that is your lively hood, not speculative real estate with negative cash flow.
The Big House Trade Up: In the bubble days, many flourishing business owners traded up to the big home, a bigger mortgage payment, bigger real estate taxes, and bigger utilities. Again, if your business is off in gross revenues and net income is down, it's time to consider if you should scale back down and take the pressure off your personal cash flow and corresponding business profits and cash flow.
Land: Land might be the most useless assets on one's personal balance sheet, especially if it is a lot that creates no cash flow. It's the type of real estate in this environment no bank really wants to lend on. Again, sell this type of property and create cash on your personal balance sheet.
If you haven't realized it yet, its time to lose your emotional attachment to real estate holdings/investments, especially if you are upside down and have negative cash flow. Cash and cash flow is king and queen in this new era.
Your Personal Expenditures: I still see to many business owners trying to maintain a life style that is close to peak business levels of a couple years ago. If you haven't, it's time to trade down in the value of your automobiles, and get rid of big car payments, they are cash flow killers. Get rid of the big toys (boats, RVs, or other recreational vehicles). Reduce debt payments and creating cash make you look better as a business owner (guarantor), and that supports maintaining a strong banking relationship and reduces the pressure on your business to perform at levels that just might not be there anytime soon.
Talk to the Spouse. I still see too many spouses who don't really get how the world has changed financially or inside the world of a small business. Open communication is a necessity, so your spouse understands the changes that need to take place at home to maintain a healthy financial home world. This is usually not the most favorite thing for a business owner to do, but you need to protect your business because it provides the lively hood of your business and making financial adjustments at home can reduce the pressure on the business.
Spending Your Wealth to Remain in Business:
This might be the biggest mistake of all, and the one I'm seeing far too much. It's one thing to financially bidge the gap of seasonal issues or one time problems within the business, but in this environment where business revenues and profits might not return for many you have to protect your wealth. This might be one of the most difficult things for a business owner because they have spent years in their business and returning to the world of working for someone else is not the most pleasant idea. However, it's a far better idea to understand the reality of where your business is, and protect your wealth, and maybe someday in the future you can return in a healthier economy.