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Because of a deteriorating commercial lending environment, some of our earlier advice is now likely to be especially relevant for many businesses. Banks are currently saying “no” more frequently than they have in decades, and we provided advice a few years ago about what actions business owners should consider if their bank rejected a small business financing request.

As described in this article, while a bank saying “no” is not an outcome that any business owner would hope for, it can eventually lead to an overall improvement in commercial financing options under many circumstances. Small business owners are increasingly hearing their bank say “no” to requests for needed business financing and working capital. Most commercial borrowers are often not sure what to do next since such an awkward situation represents uncharted waters for them.

Banks are routinely saying “no” to small businesses which are both profitable and long-term customers. It is now common to hear phrases such as “thinking outside the bank” and “business loans without banks” when talking about strategies small business owners might need to analyze because this has become such a widespread commercial lending problem.

There are two financing situations that businesses should especially be prepared for banks saying “no”. One of these involves commercial real estate loans and the other working capital financing (including business lines of credit). While a small number of banks are still proving to be reliable sources for some business financing options, recent nationwide commercial lending reports clearly show a drastic reduction in commercial loans for commercial real estate financing and working capital loans.

Small businesses have only rarely pursued the option of replacing their bank. However, an astute business owner will quickly realize that they have little recourse but to pursue such a path when their bank says “no” to routine requests for business financing. Improvements to the overall financial health of a business will be achieved in a pleasantly surprising number of cases even though this search for new commercial finance alternatives is undertaken under protest by most commercial borrowers. Keep in mind that in many cities and communities, one or two banks frequently operate in a near monopoly environment. When small business owners have literally been forced to find new business finance options, they are often pleased to discover that they can not only replace existing bank financing satisfactorily but also improve their bottom line in the transition.

A prudent starting point for commercial borrowers to adequately evaluate how to get working capital and other business loans when their bank says “no” is likely to be a lengthy conversation with a small business financing expert. Finding and selecting such an expert will not be a quick or easy task for business owners, but this step is likely to be critical to eventual success in formulating a strategy for obtaining new sources of effective commercial finance funding. Ensuring that the commercial financing expert chosen is totally independent and not affiliated in any way with the bank which said “no” is an especially crucial aspect not to be overlooked in locating a reliable expert to help.

Make or Break

Managing working capital is a critical component of financial management. It can make or break a company.

Inadequate working capital can put a company in jeopardy rather quickly due to liquidity problems. On the other hand, excessive working capital strains the companys finances.

Accounting Definition

Accounting defines working capital as Current Assets less Current Liabilities. It is also known as Net Current Assets. Current assets are those which are considered liquid and are convertible or expected to be realizable in cash within a period of 12 months from the date of the financial report. Common examples include cash, inventories, accounts receivables, prepayments and marketable securities. Current liabilities are those which are expected to be repaid within a period of 12 months. Examples include bank overdraft, short term borrowings, accounts payables and accrued expenses.

Operating Standpoint

Operationally, working capital indicates the ability of the company to finance its current operations and to meet obligations when they mature. It measures the companys ability to pay daily bills from a liquidity

standpoint.

When it is Inadequate

If there were more current liabilities than current assets, the result is called Net Current Liabilities, Working Capital Deficit or simply Negative Working Capital.

If all the liabilities were to become due and payable immediately, the company does not have sufficient liquid resources to pay them. This could potentially lead to a going concern problem, which means that the company may not have the ability to continue in operations if it could not successfully find sufficient liquid resources to settle its obligations quickly.

From a financial ratio perspective, a companys working capital position is also represented by its current ratio. Current ratio is calculated using current assets to divide by current liabilities. A current ratio of

less than one means that working capital is negative. For example, if current assets were 0 and current liabilities were 0, the working capital deficit calculated would be (). The current ratio is computed as 100/120, giving 0.83, which is less than one.

Remedial Strategies:

To relieve working capital deficit, the following strategies are commonly adopted:

a. Raise Equity

A company can issue more shares to existing or new investors to bring in fresh funds. This infusion of equity will help to raise cash. The side effect of this may be to dilute the interest of existing shareholders who do not wish to inject further equity into the company.

b. Selling Non-current Assets

Non-current assets are those which are not expected to be convertible into cash within a period of 12 months from the financial report date. These are typically fixed assets such as property, plant and equipment. Included

here are also long term investments in other companies. A company can sell its non-core assets to raise cash to enhance its working capital position.

The other way of liquefying its balance sheet may be to enter into a sales and leaseback transaction of its property. This would result in cash infusion into the company.

Ceasing further capital expenditure would be wise till the cash situation and working capital position improve.

When Having Too Much is Bad

On the other hand, having too much working capital may not be ideal either. This is particularly so if the expansion of working capital is due to the rise in inventories and trade debtors, especially when they are

rising faster than sales revenue.

Inventories

Excess inventories pose several problems for businesses. The first is that of obsolescence risk. It could mean physical deterioration as well as technical or market obsolescence.

The second problem is that inventories drain cash. Liquid cash is tied up until the products are sold and the money collected from customers.

The third problem is that inventories require storage facilities. This takes up valuable space and may cost a business in terms of rental expense or opportunity cost in terms of facilities tied up.

If a business has old inventories, it would be advisable to clear them out quickly and free up the cash so that it can be redeployed for better uses.

Trade Debtors

Trade debtors represent financing by the company to its customers. Most often, this is interest and collateral free. On the other hand, the company may need to obtain bank financing on which it incurs interest.

When trade debtors build up, it may also be an indication of lax credit policy and poor follow up on outstanding debts. It may be worthwhile to engage additional resources to recover these receivables more quickly than letting customers take their time to settle their invoices way beyond the credit limit given.

It Boils Down to Efficiency

The more efficient a business can manage its inventories and trade debtors, the better it is for liquidity. More cash would then be available for growing the business, reducing finance costs and paying shareholders

dividends.

Conclusion

As we can see, it takes prudent financial policies, management discipline and vigilant monitoring to ensure that a fine balance is maintained for working capital. But the effort will pay off handsomely for the business

with the will to do so.

An important tool companies adopt to send a message to the investors that the company means business is to cut capital expenditure and reduce non-core assets.  Usually this is met with more investment or better stock price from the market. What is the message that the investors are receiving that entices such a reaction?  Usually, the message means that the company is trying to reduce cost and become more efficient. They are indicating that the company is trying to get more assets available that they can use for operational expenses in the short term for their financial health. In financial metrics this means increasing the current assets or decreasing current liabilities.

A good measure to identify this is the Working Capital (WC).

Working Capital = current assets – current liabilities.

Current assets are cash and other assets that can be converted to cash within a year. Current liabilities are obligations that the company plans to pay off within the year. Working capital indicates the assets the company has at its disposal for current expenses. It can be thought as the circulating capital of a business. The process of managing the WC efficiently is called Working capital Management. It’s one of the important aspects of financial management. An excess of working capital many mean that the company is not managing its assets efficiently. It’s not using its assets to get a bigger return or better profit. An aggressive company may keep its working capital smaller. A very low working capital may mean the company may not be suited well enough to payoff its short term obligations.

This decision of how to manage the working capital of the company depends on the Working capital policy of the company. An important factor that determines the policy is the industry in which the company operates.  For Example, an IT service company may not have a lot of shot-debt in terms of inventory but it still needs to pay wages, insurances and other expenses like rent. The company needs to have a policy that makes sure it sets targets were it gets paid as the project progresses so it can keep paying its staff in time. The company has to manage its account receivables according to this policy. Some industries operate in a high profit margin that they can afford to have a longer term on the account receivables because the higher cash balance part of the current assets. A good example is a company like BP, which is able to survive till now after the big oil spill disaster in the Gulf.

The Collection Ratio helps project this aspect of a company

Collection Ratio = Accounts Receivable/ (Revenue/ 365)

Collection ratio tells us the average number of days it takes a company to collect unpaid invoices. A ratio which is very near to 30 days is very good since it means that the company is getting paid on a monthly basis.

Cutting costs and shedding non-essential assets to make the company leaner is one of the attributes of working capital management. But this strategy cannot be sustained. The company cannot keep cutting costs without sacrificing service. Once the company becomes lean enough cutting costs will become detrimental to its operations.

Another attribute that strongly impacts working capital is sales. It is the ability of a company to sell its products fast enough to get the money back to put back into operations or supplies for producing more materials. Moving inventory fast is always a good plan for a company. It also helps in reducing costs associated with holding and moving inventory. A good ratio that helps put the attribute in perspective is inventory turnover ratio.

Inventory turnover ratio= sales / inventory

Alternatively,

Inventory turnover ratio = Cost of goods sold / inventory

The ratio shows the efficiency the company has in selling its products. The higher the ratio the better the company is able to move the products. Again this could be dictated by the industry, for example, a daily products company is usually forced to sell its products fast enough or lose it. The ratio also provides a good insight into how a company is doing within an industry. The direct ratio of companies can be compared to see how well the company is able to sell the products in comparison to its competitors.

Financing is another attribute of Working Capital management. Companies tend to finance their way out of a need for short term expenses by taking loans. From the balance sheet it is clear that financing increases liabilities, so the only option companies have to increase Working capital is though long-term debts that have a smaller impact on current liabilities. This way their short term cash balance increases providing the cushion the company needs for its short-term operating needs. Since obtaining long term debt depends on the credit rating of the company it becomes difficult for smaller or newer companies to use this attribute of working capital management.

Debt-Asset ratio provides a good insight into how much of the company’s assets are being financed though debt

Debt-asset ratio = Total liabilities / Total assets

Financing for short term operations may not immediately signal an issue with the company, it may be that the company has realized an opportunity that it needs to act on immediately which would increase the prospects of the company in the long term. Companies that have an aggressive working capital management policy would be using this strategy. But this is always riskier since the company would accumulate a lot of long-term debt that could eat away at the profits or even become so big that the interest expense can impact the current liabilities.

Working capital management becomes a very important aspect for a company since it is the first line of defense against market downturn cycles and recession. A company with cash is usually in a good position to make better use of the opportunities the markets provide. Its can spend the money on R&D for coming up with better products. Increase in current assets, especially, increase in account receivables due to growth is sales have to be managed efficiently. Ability to control working capital plays a significant role in the survival of the company.

As business owners develop their small business loan plans for future financing and refinancing throughout the United States, there is an increasing awareness that there have been significant business finance changes that cannot be ignored. Some of these measures are likely to end up being permanent, and even the temporary commercial mortgage loan and working capital loan changes are expected to be in place for an extended time due to the severity of the current financial climate.

The net result from business finance changes has been a reduction in commercial lenders as well as stricter standards for acquiring commercial loans and commercial mortgages. Unfortunately there has also been no shortage of misinformation about the availability of commercial funding.

A significant reduction in business lending activity overall is perhaps the most dramatic change. This has been due to several events occurring almost simultaneously. Several major commercial lenders have gone out of business altogether. Even though they have continued consumer lending, many banks have stopped commercial finance lending. Numerous business lenders have enacted stricter standards for the commercial financing transactions they are still willing to consider.

It remains to be seen how many changes will be permanent or temporary. But from a practical perspective, commercial borrowers are left with no choice but to adapt to the changing business finance environment. Business owners must be prepared to operate within a more complicated climate for commercial mortgage loans and small business loans regardless of how long the changes might be kept in place.

What should borrowers do about this? A primary option that business owners should explore involves looking beyond their local market area for help with commercial loans. A commercial financing expert operating throughout the United States should be helpful in improving upon this situation.

In addition to fewer business lenders to choose from, there are two other significant changes which must be anticipated by business owners before seeking new commercial loans. First, commercial lenders are increasingly demanding more collateral for virtually all business finance funding. Second, most lenders have cancelled or are about to eliminate unsecured lines of credit (usually called working capital loans) for many businesses.

Considering a business cash advance program based on future credit card processing transactions is likely to be an effective commercial financing strategy for overcoming the combined obstacles of more collateral, reduced unsecured credit lines and fewer lenders. This is proving to be one of the few sources of business funding that has not been adversely impacted by recent events. It will be productive to discuss the potential with a business finance expert who can provide advice about small business financing solutions including business cash advances and other financial options.

It is increasingly obvious that many banks will continue to modify their business lending programs in response to changing conditions. This means that another key change issue for working capital financing and commercial mortgages is the likelihood that more changes will be forthcoming in the near future.

To adequately prepare for future commercial finance changes that might (or might not) occur is a daunting task for a business owner. A commercial financing expert familiar with Plan B contingency financing for small business loans will prove to be a valuable resource for any borrower wanting to seriously deal with both current and future changes impacting the financial health of their business. By having a candid conversation with a commercial loan expert, business owners should be more capable of implementing an appropriate strategy for the vast changes which have recently occurred or are about to become effective for most business financing and working capital finance funding.