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A cash crunch necessitates a trip to the bank for a loan

“Creditors have better memories than debtors.” – Benjamin Franklin

 “John, are you ready for our meeting? We said yesterday that we were going to meet to go over our financial projections and review a possible bank proposal.”

“I’ll be right there, Tom,” John Wilson, company CEO said to his controller. He reflected on their earlier conversation about the company’s expected negative cash flow and the need to borrow from their bank, most of which resulted from giving extended terms to their customers. John learned his lesson and wanted to avoid borrowing, but Tom had been pretty explicit about the need.

“John, I’ve gone over our short-term cash needs again,” Tom said as they were looking at some numbers on the overhead projector. “I’ve created a simple example on the screen with all the numbers shown in thousands.

“I’ve assumed a $200K line of credit. On Line 1, you can see the expected negative cash flow in the next three periods – $161,000, $75,000 and $40,000, respectively. If you look on Line 3, you’ll see how much cash we’ll need in excess of what we have to pay our payroll, tax and other regular expenses on time. Line 4 simply shows the borrowing for each period that we’ll need to provide sufficient cash to cover those working capital needs. Below that is the total balance, and below that is our remaining borrowing availability.”

“Tom, I’m not following you.”

“Sorry, John. Staying in Period 1, take a look at Line 4 where you’ll see the borrowing of $96K against the line of credit of $200,000. The ($96K) on the Cash Required line represents the difference between our opening cash balance of $65K and the negative cash flow of ($161k) in Period 1. Line 4 then shows us borrowing to meet that need. A line of credit of $200,000 will give us enough money to get through the first two periods, but after that it gets pretty tight for a while. You can see the Net Cash Balance after borrowing on Line 6.”

“Thanks, Tom, I’m with you. It looks like you’ve set up the financial model to borrow enough money to cover our cash needs and to show what borrowing power we have left.”

“That’s right, John. You can see from Line 3 that we need to borrow $40,000 in Period 3 to meet our cash needs. However, we’ve already used up most of our line of credit by then so we can only borrow $29,000. In theory, we’ll have a negative cash balance of $11,000, but we can probably manage that by deferring a few payables.”

“So, if I’m reading this right, the good news is that we return to positive cash flow in Periods 4 and 5, and our cash position starts improving again, and we can even start to pay back some of our loan.”

“That’s right, John. It gets pretty close in Period 3, but our borrowing capacity starts to grow after that. It improves because we expect to have a large, positive operating cash flow in the 5th period, when our receivables finally get collected.”

“Tom, are we sure we can get a line of credit of $200,000? That’s your assumption, isn’t it? ”

“Yes, I used an average $200,000 line of credit. In reality, our balance sheet is probably not strong enough to justify anything other than an asset-based loan. In that situation, the bank advances money as a percentage of our outstanding receivables and inventory. The line of credit will vary based on those balances each month, but it should be in that ballpark.”

“Tom, I think I get the general idea, but I do want the specifics. Can we reconvene this afternoon and go over the details? Maybe you could update this table to reflect how the loan availability changes based on inventory and receivables. You can also teach me a little about an asset-based lending program and educate me about your concerns with our balance sheet. I really need to understand this. Can I check back with you sometime after 3 p.m.?”

“Sure, no problem, John. I’ll be waiting.”

 [Author’s note: For more detail and a step-by-step description of a more comprehensive table and example, visit www.exkalibur.com/example1.]

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Lary Kirchenbauer is the president of Exkalibur Advisors Inc., providing practical business strategies for family and other privately owned businesses in the middle market. He can be reached at 415-602-7870 or lary@exkalibur.com. His Web site may be found at www.exkalibur.com.