Do you have too many customers?

Do you have too many customers?

/in , /by

The concept of having too many customers might seem impossible to some business owners. If your business is striving to be profitable, having a high volume of total customers may seem like an ideal scenario; however, the customers who aren’t profitable can cause your business wasted time and energy that may be better spent on those customers who are.

A high number of unprofitable customers may mean your business can’t provide the best service to the clients who matter most to your bottom line. This is why it’s important to identify and focus on the kind of customers who matter most.

Create Client Behavior Profiles

Matt Sharp, who operates a gym and a marketing company in Lexington, Kentucky doesn’t want too many customers — he wants ideal customers. Causely, Sharp’s marketing firm, helps small businesses promote and manage their philanthropic endeavors. After marketing his services, he realized that small businesses which weren’t already spending $100 a month on marketing were unlikely to be interested. Immediately after filtering prospects by that criteria, his sales staff saw dead-end inquirers drop by 30%.

As Sharp probed deeper, he found that the businesses most receptive to Causely were those whose customers were primarily moms and millennials.

Based on this insight, Sharp was able to create a profile of the ideal customer to target. These short profiles highlight the characteristics and concerns of customers who will provide the highest lifetime value — the people who like your offerings, and keep coming back for more.

Ask Lots of Questions

Score, a non-profit that offers business mentoring services, advises companies to pull together lots of data about their best customers to develop customer personas. For consumer-oriented companies, this can include age, gender, marital status, and life stage. For B-to-B marketers, the data could include industry, years in business, and number of employees.

Along with collecting data, it’s equally important to get insight directly from your customers. Social media provides a treasure trove of comments. You can also speak to customers one-on-one, or in focus groups, seeking out what they like and dislike about your offerings. Score suggests these insights to get started:

  • How do customers research product and services like yours?
  • What factors into how they decide on their purchases?
  • What newspapers, web sites, TV, and radio do they pay attention to?
  • What made them buy from you the first time, and what kept them coming back?
  • What do they get from you that competitors don’t offer?

It can be critical to approach this process with an open, unbiased mind, rather than guide customers to provide the answers you’re looking for. If you identify insights that surprise you — or even shock you — you’re on your way to improving your marketing.

Cut Through the Clutter

Based on this information, you can create a “persona” of your ideal customers that can guide your sales and marketing efforts. Many small businesses create a few personas that identify their goals, challenges and how their business can help, often including actual quotes from the focus groups as well as an “elevator pitch” that is targeted to each persona.

In Sharp’s case, he knows that his “ideal customer” always revolves around the two M’s, moms and millennials, and his successful marketing efforts always take them into consideration. He says this helps him focus his business efforts, target the right people, and lower the cost of acquiring new customers.

The 5 C's of Credit and How They Impact Business Financing Decisions

The Five C’s of Credit and How They Impact Business Financing Decisions

/in , /by

If you’ve heard of the five C’s of credit, you may assume that this phrase is only associated with personal credit; however, it’s also a tool used by lenders to evaluate businesses pursuing credit options.

Here’s why the five C’s of credit are important to your business; how lenders evaluate each of them; and how to best position your business when applying for financing.

What are the 5 C’s of Credit?

The term “five C’s of credit” refers to one way in which lenders evaluate the credit-worthiness of an applicant. It can be used for individuals and couples applying for personal credit such as a loan, credit card or a mortgage. But, it’s also used to help assess the “worthiness” of business credit applicants.

Lenders review how well a business meets each of the five C’s, and then use their findings to help make a lending decision.

1. Character

Character refers to the likelihood that a business will pay back borrowed money. Information for the Character portion of the five C’s of credit often comes from the history noted on a business’ credit reports. It will also include the business credit score generated from these reports. Business credit reports come from business credit reporting agencies such as Dun & Bradstreet, Equifax, and Experian.

These detailed reports contain particulars of previous borrowing arrangements – including total amounts borrowed and repaid, as well as delinquencies and late payments. The reports also include details of judgments, liens, and accounts in collections going back through seven years.

2. Capacity

Capacity is your ability to pay back the money borrowed from the proceeds of your business. Before a lender gives a borrower any money, they’ll want some evidence that the borrower (being the business), generates enough money to make payments on the loan. So Capacity is the proof that the business has the cash flow to not only make the payments, but to also cover all the business expenses, other debts and obligations, and pay the wages of its employees.

To evaluate a business’ capacity, lenders will review the financial statements and financial ratios of the business, including:

  • Debt-to-Income Ratio (DTI)
  • Debt-Service-Coverage Ratio (DSCR)
  • Current Ratio
  • Debt-to-Tangible-Net-Worth Ratio
  • Inventory Turnover Ratio
  • Accounts Receivable Turnover Ratio (ART)
  • Payables Turnover Ratio
  • Cash Flow Statement
  • Income Statement

When it comes to evaluating business capacity, a lender may also consider your managerial capacity. This is your business knowledge and professional experience.

3. Collateral

Any lender faces the risk that borrowers won’t return the money they borrowed. So lenders look for ways to reduce that risk and secure their loan, which brings us to the third C of Credit: Collateral.

Collateral is any asset used as security for the lender. Lenders could seize secured business assets of value such as real estate, equipment, and machinery to sell and recoup some or all of the unpaid loan if the borrower can’t pay it off. For example, a business may get a loan secured against vehicles or a commercial building.

4. Capital

Another factor that influences lenders’ willingness to loan money to a business is the owner’s equity. How much of your own money have you invested in your business? Your “skin in the game” indicates your financial commitment to the business. This equity, referred to as capital, gives lenders an idea of just how risky the owners consider their own business. Generally, the more of your own money invested, the better it is in the eyes of a lender.

5. Conditions

The fifth C of credit is one that you have little control over, yet it also influences business lending decisions. The current macroeconomic and microeconomic conditions could impact a business’ ability to pay back a loan. So lenders carefully consider the economic environment as part of a lending decision.

Demonstrate that you have a good understanding of current (and forecasted) economic conditions, and how they’ll potentially impact your business by referencing them in your discussions and correspondence with your lender. This shows lenders you’re a forward-thinking and responsible business owner who is committed to growing your business through changing economic conditions.

Once you know about each of the 5 C’s of credit, you can better understand how lenders use them to make lending decisions for businesses. And you’ll have a better idea of what to watch out for, and what to work on when making financial decisions for your own business.

No margin for error: Calculating your profit margins

No margin for error: Calculating your profit margins

/in , /by

Krystal Stubbendeck comes from a family of seven, but it wasn’t until her friends started having children that she noticed the challenges of staying in style as bodies changed from day to day. She launched Borrow For Your Bump, an e-commerce platform that lets women borrow maternity and nursing clothing during pregnancy and shortly after they give birth.

At first she focused on clothing that provided the most value to customers, like casual clothing they could wear daily. However, those pieces came back so worn they couldn’t be rented again. After careful analysis, she realized the most profitable items were formal wear and focused more on clothing that turned over more quickly. This change allowed her to boost her profit margins, and ultimately keep her business running.

Not All Sales Equal

Most small businesses strive to increase revenues, but they often fail to take into account their profit margins. “Not all sales are equal; you want to increase those sales that maximize profit without a significant or equal increase in costs,” says Michael Gallagher, an official with the Small Business Administration.

Profit margins come in two forms:

Gross profit margin: Typically, this equation is used to determine the profit margin of a single product or service, allowing you to figure out the profitability of each of your offerings and determine if you’re mispricing a product or service. The calculation is made by taking all the costs associated with producing a good or service, subtracting that from the revenues that are generated from the good or service, and then dividing by the revenue. If you sell a product for $50, and it costs $40 to make, your gross profit margin is 20%.

Net profit margin: This equation, which determines an entire organization’s profit margin, requires you to subtract total expenses from total revenues over a given period, and then divide that figure by total revenue.

Determining profit margins requires exactitude. You need to keep track of everything including expenses like payroll, utilities, and shipping and every source of revenue, even smaller items such as transaction fees.

Ways to Boost Margins

Profit margins vary by industry. According to Investopedia, farmers make about a 3% profit, while the alcohol industry has a net profit of 19.13%. Because of the variance, it’s important to benchmark your profit margins against companies in your industry to determine if you’re doing well or need to make adjustments. There are a variety of ways to boost your profit margins, including trimming expenses, eliminating services and products that aren’t pulling their weight, or adding more products and services that don’t increase your overhead.

Profit margins can indicate whether a company is in solid enough shape to weather a rough patch. “Many analysts and investors take profit margin so seriously because it can contain an enormous amount of information about a company into one efficient, easy-to-understand number,” says Brian Beers, a writer for Investopedia.

 

Accounts Receivable Turnover: What You Don't Know and How It Could Hurt Your Business

Accounts Receivable Turnover: What You Don’t Know and How It Could Hurt Your Business

/in , /by

As a small business owner, you know about accounts receivable because they’re critical to your cash flow. But what about accounts receivable turnover?

If you’re unfamiliar with this phrase, you could be overlooking an important indicator of your business’ financial health — one that banks and investors may look at closely.

Here’s what you need to know about the accounts receivable turnover ratio and how it impacts your business.

What is Accounts Receivable Turnover?

The accounts receivable turnover (ART) calculation quantifies a business’ activity in the form of a ratio. It measures efficiency, and represents how quickly a business collects the money owed by customers.

Other names for the accounts receivable turnover ratio include:

  • Receivable turnover ratio
  • Accounts receivable turnover
  • Debtors turnover ratio
Why Lenders and Investors Want to Know About Yours

When investors and financial institutions consider financing a business, they review the 5 C’s of Credit for Business, including capacity — how your business cash flow operates, and that includes ART.

Investors and financiers look at this ratio because it shows how efficiently your business collects on outstanding accounts. A business that is slow to collect outstanding accounts receivables could have cash flow struggles, resulting in difficulties meeting accounts payable (and debt) obligations.

Therefore, a poor ART could negatively impact investor opportunities and credit applications. And that, in turn, could stifle expansion plans and opportunities to grow a business.

How to Calculate Accounts Receivable Turnover

To calculate the accounts receivable turnover ratio, divide the net value of a company’s sales during a specified period by the average accounts receivable during the same period. Usually, the ART gets calculated annually, though it may also be calculated quarterly or even monthly to note any changes in trends.

It is easy to calculate the average receivables during a period. Simply take the receivables at the start date, and add the receivables at the end date. Then using the total, divide by two.

So the formula for ART looks like:

ART = Net Credit Sales/ Average Accounts Receivable

For example, say a company has $1.5 million in net credit sales for a period. It has accounts receivable of $100,000 at the start of the period, and $120,000 at the end. The ART is $1.5 million/ (($100,000 + $120,000)/2) = 13.64. This means that the company’s accounts receivable get collected or “turned over” 13.64 times during the year.

Bigger is Better

When it comes to the ART ratio, the bigger the number, the better. It’s easiest to see with an example.

With an annual ART of 13.64, we can calculate the average accounts receivable collection period as 26.76 days – (365/13.64). However, if the ART increases by just 1, to 14.64 ,the average accounts collection period gets reduced to 24.93 days. So a bigger ART means a more efficient, or shorter, collection period, which is good for cash flow.

What to Watch for When Comparing Account Receivable Turnover Ratios

If you’re reviewing or comparing ARTs, keep these three things in mind.

  1. Some companies use “total sales” instead of “net sales” in the ART calculation. And this may result in a higher number because it includes cash sales, which of course shortens the collection period because collection is immediate.
  2. The accounts receivable balances used at the start date and the end date of the period show the balances for two specific points in time. And they may differ significantly from the average accounts receivable balance for the period. That’s why it’s also considered acceptable to use an alternate method of calculating the average accounts receivable balance for the ART ratio, such as taking an average of 12 months of ending accounts receivable balances.
  3. Sometimes, a lower ART may result from areas of a business other than the credit and collections policies, such as if there’s a product or service quality issue resulting in customers who refuse to pay.
5 Ways to Increase Your Business’ Accounts Receivable Turnover

If you’re looking to boost your business’s ART, here are five methods to consider:

  1. Screen customers more carefully before working out credit terms. Researching a company and its previous credit history can help uncover poor payment activity.
  2. Shorten the time between product/service delivery and billing. The sooner the customer gets the bill, the sooner they can pay.
  3. Offer a discount as an incentive to customers who pay immediately or within a shorter period.
  4. Send reminder notices out sooner, such as right at the thirty-day mark instead of waiting until the bill is 40 or 45 days past due.
  5. Introduce a more aggressive late payment and collections policy. This may include taking action on late payments sooner, and introducing a small late payment penalty for overdue accounts.1

Understanding what ART represents and how to increase it not can help business owners make wiser decisions that may improve cash flow. This in turn could have a positive impact on your business’ overall financial health.

  1. “A Company’s Vital Signs—Accounts Receivable” Financial Accounting, University of Minnesota Press.

 

Growth Hack: Run a Lean Operation

Growth Hack: Run a Lean Operation

/in , /by

Though the idea of minimalism was not widely practiced, it has made its way to the spotlight over recent years. People have found that simplifying their lives leads to a greater peace of mind and a more efficient use of their resources.

This applies to business as well.

Lean management means cutting anything from a business process that does not provide value. Where some stick to how they’ve always done things, you make changes to improve. This may seem risky. However, when done properly, streamlining processes will save you time, labor, and money.

Even small adjustments can make a big difference. Toyota pioneered this concept in manufacturing during the 1980’s. When they realized building vehicles to meet specific sales projections led to wasting parts, they adjusted and began to manufacture vehicles as orders were placed.

When evaluating your own business processes, make sure to take the following steps.

Define what value you are creating.

The first step to creating a lean process is deciding which output to focus on. This value can be a product created to sell to customers or a service offered to clients. Once this is defined, you can identify all of the steps taken in its creation.

Identify the steps used to create this value.

Follow the process of creating this value from start to finish. Clearly lay out each step involved in each part of the process. Then, determine which contribute and which do not. Find processes that lead to unnecessary stalls or create waste. Then, decide how to get rid of them.

Create a strategy to streamline.

Once you find what can be removed, get rid of it. Have a clear, step-by-step plan. This should include all useful steps from how things used to be done adjusted to remove waste. Once this is established, run the process and analyze the results.

Implement your strategy and see what results you get.

Measure the effectiveness of your new processes and see if your value is being created with less waste. Make sure it is actually an improvement over what you did before. Evaluate your results and see how you are already saving resources.

Repeat this process as necessary.

Things are rarely perfect on the first try. Like you have to practice your golf swing to get the best shot, you’ll have to adjust your processes more than once to reach peak efficiency. This should not be a discouragement, but an opportunity to continue learning and really become an expert in your industry.

Never become complacent and always look at how to become more efficient.

Small Businesses Mismanage Sales Tax

Small Businesses Mismanage Sales Tax

/in , /by

When Strategic Funding was in its early days we began to look for bank lines of credit so that we could expand our business of financing small businesses across America.  The banks liked the idea of working with an alternative lender as it gave them a way to indirectly serve that market without the direct risk of lending to Main Street businesses. Strategic became the borrower and, in turn, provided working capital directly to the individual small business.  This was necessary because so many small businesses lacked the financial management skills to provide adequate financial statements and cash management disciplines to qualify for bank loans.

Because many of us were once small business owners we understood our typical small business customer better than the banks. Cash flow determined how sound their businesses were, but certain traits were common amongst our applicants.  Many of the applicants had tax delinquencies, liens and judgments against them.  This was unfathomable to bankers who assumed that paying your sales tax was a priority – not understanding that keeping the lights on, meeting payroll and inventory took precedence. We also know that how the business owner managed their tax payments and general cash flow was as important as how much it was. We understood these customers well and could help many of them through education and often an injection of working capital to get them on the right path.

When I owned my first restaurant a hundred years ago, I experienced the wrath of the taxing authorities when I missed successive tax payments as I was trying to survive my maiden voyage in this business.  I was so busy managing, cooking, covering vendors, paying utilities and keeping the place clean and well staffed that I didn’t pay much attention to the mounting taxes. I thought it could wait and thought the state would offer me an easy and manageable payment plan. I’d be happy to pay reasonable fees and interest since I hadn’t put the funds aside. I looked at it as a loan from the government. That was just delusional on my part.

One day just before Christmas, I got a call from my bank telling me that revenue officers had come to the bank and levied my accounts. They grabbed everything in them and everything I had just deposited from the previous business day – including the revenue from that big fat holiday party I did.  I had never even heard the word “levy” until that day.  Now I was in real trouble as I had no money for my vendors, landlord or payroll. I was dead in the water. All my credit card receipts were being processed and were going directly to pay the taxes. By this time I woke up – the judgment amount had doubled my outstanding balance as penalties, interest and fees surpassed the liability.  As a new business owner I was in trouble and realized I had made a dumb move that I vowed would never happen again.

Over the years, I opened up more businesses in a variety of industries. Each state I operated in had it’s own system for collecting sales tax and, of course, you always had the Feds to deal with on payroll taxes.  Regardless of the state or the payment schedules, I put procedures in place to prevent this costly error from ever happening again.

RULE #1 – SALES TAX COLLECTED IS NOT YOUR MONEY!!  You need to realize that you are just holding this money for someone else – as if a customer left her purse at your business. It’s not yours and you will return it to them.  Many small businesses charge and collect sales taxes as they are required to do. The real mistake comes when owners use the sales tax revenue as part of their operating capital.  They float their operations with sales taxes money to keep them from going negative. They do this until taxes are due and hope the funds will be available when they have to file. Well, guess what?  Very often they can’t scrape together everything they owe and end up either not filing the return (really bad) or filing the return and sending a partial payment (better – but still bad).

If you need to use this money to steady your financial boat then you really need to evaluate the health of your business.  Without using tax money, is your revenue enough to cover your expenses, payroll and direct operating costs while yielding you a profit? If you are using tax money you aren’t making it and need to take a hard look at your business and figure out how to fix it.

I recommend that you immediately separate and impound the sale tax funds in a dedicated “tax account” – every single day.  That means when you close out your register for the day – identify the sales tax charged to customers and collected by your staff and separate it.  That amount includes any taxes charged to a credit card even if you have to write a check to cover it. Impound those funds and deposit them directly into the separate dedicated tax account.  Get it out of your cash flow. This makes it available and easier to track, audit and account for.

Resist temptation. Do not raid this account if your operating account is short.  Set up a relationship with your bank or an alternative lender to provide working capital  when needed. It’s easier and less costly to work it out with them and pay their fees then risk being short on tax payment day.  The other dark truth is that liability from tax delinquency will also follow you personally even if your business fails and you have to file bankruptcy.  Tax obligations are not discharged in bankruptcy so you are on the hook forever. They will never go away and will compound at an astronomical rate. A very expensive mistake.

A good tax policy and strategy will help your business stay healthy and grow.  If you want to discuss your business questions, you can email me at [email protected]

That cheap business finance rate could cost you a bundle: interest and your business

That “Cheap” Business Finance Rate Could Cost You a Bundle: Interest and Your Business

/in , /by

The last decade has been an era of cheap money for businesses, with interest rates at historical lows. But those days may be ending. How you look at financing — in particular choosing between fixed and adjustable rates — may have to change.

These are the good old days.

Access to capital can often make or break a business. Each year, fifty-three percent of business owners kick in additional funding, according to the Small Business Administration. Almost a quarter add more than $50,000.

The adage that it takes money to make money is fine — if you have the cash on hand. If you don’t, it’s time to look at outside financing. But that may take some unlearning of recent lessons.

The global economic collapse beginning in 2008 was brutal, but it did have one benefit for some businesses: Because the U.S. Federal Reserve and other regulators slashed interest rates to stimulate buying, over the last decade the cost of money has been incredibly low.

Businesses who were approved for traditional forms of financing had enviable choices, including taking adjustable rates over fixed ones to keep borrowing costs down.

The Two Types of Interest Rates

A quick refresher: whether talking consumer or business financing, there are two general types of interest rates: fixed or variable.

A fixed rate is just that; the borrower pays a set interest percentage of the principal. Monthly payments don’t change.

Variable rates start at one rate. After some time, they shift to an amount based on any one of several common benchmark rates.

The Fed’s federal funds rate is one example of a benchmark rate. So is the prime rate, which is based on the federal funds rate, and is often what a bank’s best customers get. Another benchmark is the London Interbank Overnight Rate (Libor) — the rates banks charge one another on short-term borrowing.

The variable financing rate will be some number of percentage points over a benchmark rate. When the benchmark goes up, so will the variable rate. If the benchmark drops, the variable rate does as well.

Most people are familiar with variable rates from mortgages and credit cards. They are common in small business financing as well.

Variable Rates Have Been Low

In the past, business owners chose variable rates that were initially low. The idea was that when the rate increased, either revenues would have grown enough to more than offset it or refinancing at a lower rate would eliminate the extra costs.

For the last decade, however, variable rates have acted strangely. Because benchmarks were so low, you could effectively get a great rate for the life of the financing. There was always the gamble that the rate would climb, but in hindsight, for years you could win the game. Variable became almost the same as fixed.

No longer. By June 2018, the Fed had increased the federal funds rate seven times in three years.

As job growth remains brisk and the economy improves, regulators could keep increasing their rates, making all the benchmarks increase. Variable rates will follow, making the era of super-cheap money over. Opting for a variable rate instead of a fixed rate could now cost you.

Create a Financing Strategy

If you’re looking for financing, you’re best off doing some calculations in advance to see how a variable and a fixed rate might compare. Consider that a variable rate loan might increase a couple of times during the life of the financing:

  1. Look at how much the Fed has raised the key interest rate over the previous 12 months and assume for a moment that the increases will continue in the near future, given how low rates have been.
  2. Calculate the full principal, the length of the loan, and the initial rate. Then use an amortization schedule to calculate how much you pay in the first year.
  3. For the second year, calculate with an increased interest rate (initial rate plus the last 12-month increased in a benchmark) and the remaining financing time. Use an amortization schedule to calculate how much is paid in the second year.
  4. Keep doing this for at least one or two more years with benchmark increases.
  5. Finally, calculate the remaining principle, time left on financing, and the “final” interest rate. (Remember that this is an estimate and there might be additional rate increases.)
  6. Add the payments over all the years and compare that to what you’d pay with available fixed rates.

You might choose to run estimates for different numbers and amounts of rate increases. This modeling can help you manage risk and choose an option that works for your business.

Searching for the best business bank account? Consider your unique needs first

Searching for the Best Business Bank Account? Consider Your Unique Needs First

/in , /by

There may be several financial institutions in your area that offer business bank accounts, but you cannot determine the “best choice” based on the bank’s age, size, or advertising claims. Ultimately, finding the best business bank account for your business starts with identifying specifically what you want to achieve with your banking relationship — now and in the future.

The questions below may help determine which bank can best support both the financial needs of your business, along with your longer term business goals.

Does the bank specialize in businesses like yours?

Not all business bank accounts are the right fit for every type of business. Your business may share commonalities with others in size, region, years in business, and annual revenue, but the challenges and opportunities that come with your business are unique. As you consider different banks, explore what types of businesses they serve. Do they offer solutions geared toward your industry? How familiar are they with your local market? Are they well-versed in SBA loans? The business relationship you have with your bank can influence your ability to reach profitability, maintain adequate cash flow and expand to establish a unique point of differentiation from competitors.

  • If your business is small with little-to-no plans to grow, in start-up mode, or is seasonal in nature, you may not know the average monthly balance you’ll be able to maintain, or the payment tools you’ll need to purchase goods from vendors, and accept payments from customers. Narrow your search to banks that offer business checking accounts with a low (or no) monthly minimum balances and fees, debit cards, online banking, fee-free wire transfers and unlimited incoming deposits.
  • If your business is well-established, in growth mode or operates internationally, consider banks that have an extensive footprint (around the country or world), offer cash management solutions like lockbox, remote deposit capture and fraud prevention for checks and payments, and/or specialize in high-value or cross-border transactions.

Does the bank offer tools beyond traditional accounts?

Javelin Strategy & Research reports that digital solutions and payments services for small businesses have “…lagged significantly behind consumer and commercial banking.” As a result, many small business owners may be hindered by a lack of access to the technology they need to effectively run their business. A bank that offers additional business tools may provide you turnkey solutions to run your business — including the ability to process card payments, offer gift cards, or manage loyalty programs and inventory. Know that having digital and mobile access to your business bank account is a top priority? Narrow your search for a bank only to those brands who are equipped to deliver all of your needs virtually. If you’ll rely on your bank for more than traditional financial services, limit your search to those that offer value-added tools.

Does the bank offer the ability to build credit?

Building a formal business credit history can document your businesses financial responsibility, and could work to your advantage if you intend to bring in business investors, partners, or want to sell your business. Not all banks offer credit cards or similar products for business clients; those that do may be more willing to issue credit to a business customer who has an established relationship with it.

Does the bank assign a relationship manager?

The best business bank accounts establish relationships, much like a consultative relationship between the client and a bank representative. If a personal touch is important to you, look for a business bank account that provides a relationship manager who is vested in understanding your business, and how the bank can help support it. If you’d prefer to handle most of your businesses’ financials online, however, a relationship-based model may not be necessary.

If you do opt for a bank that assigns a relationship manager to your account, consider the level of authority and expertise the person who will support your business holds, and whether the business bank relationship will suit your need for a minimum of 18 months. Meet with relationship managers at a few banks to gain a sense of how they interact with business clients, and to gauge whether their approach aligns with your expectations.

Is the bank preparing for the future?

Technology is changing business payments at a rapid pace, and banking is increasingly moving to a digital environment, allowing for faster processing times. Not all banks are equally invested in keeping up with the technology changes, particularly when it comes to meeting the demands of small business clients. While many banks now offer digital conveniences like person to person payments for consumers, not all have the capability to offer a similar services to business customers. Smaller banks or credit unions may be more flexible with fees, compared to larger banks, but not all have the resources to support the latest banking technology.

Research the business banking solutions that a variety of banks offer; compare what is available in the broader market, and from each specific bank. The bank you choose should offer the benefits most important to you, support the financial needs of your business, and be investing in technology and infrastructure enabling them to be your business banking provider for the long haul.

Borrowing and Business: What You Don't Know Can Hurt Your Finances

Borrowing and Business: What You Don’t Know Can Hurt Your Finances

/in , /by

So, you’re feeling confident enough about your business to go shopping for a loan. Congratulations! But before you start looking you should understand these five important areas impacting loans, beginning with the difference between interest rates and APR.

What is APR?

APR is the annualized percentage rate, which measures the cost of borrowing money. It includes the total cost for the loan including covering all fees that the lender might charge.

By looking at the APR, you can objectively compare the costs of loans from different banks. That’s entirely different from looking at the headline interest rates that sometimes get advertised. Such headline rates frequently don’t include all the fees that you must pay to get the loan.

In short, if you looked only at the headline interest rates, then you might think you got a good deal when in reality you didn’t.

Always ask the loan officer for the APR in any loan. If they won’t provide it, then choose another bank.

LIBOR and interest rates.

The cost of a lot of business credit moves up and down in line with something called LIBOR, the London Interbank Offered Rate, which is an interest rate charged by banks to lend to other banks.

When the banks see little risk of lending to each other, then the LIBOR will be lower than it would be otherwise. When they see heightened risk of lending to each other, then the LIBOR typically rises as it did during the financial crisis.

Commercial businesses typically pay a fixed amount above the LIBOR for the duration of the loan, see the Small Business Administration website for examples. The prime rate, which is a common benchmark lending rate for both commercial and consumer loans, is usually between 2.5 and 3.5 percentage points higher than the LIBOR rate, according to the FinAid website.

The LIBOR is also partly determined by decisions made by the Federal Reserve, which is a target interest rate for short-term overnight loans between banks. When that rate changes you can usually expect the LIBOR rate to change as well. In the simplest terms, if the Fed Funds rate rises then you should expect LIBOR to increase.

Recently, the Fed has been transparent about likely future changes in Fed Funds rates. If you regularly read the business press, you’ll be aware of most likely future changes in the costs of borrowing.

Fixed versus floating interest rates.

Not all business loans have interest rates which vary. Some have a fixed rate for the term of the loan. Such loans reduce the uncertainty about what would happen to the company’s profitability due to changes in short-term interest rates.

The cost of these loans is typically far higher than for variable rate loans. That’s because the bank takes on the risk of the interest rates changing over the term of the loan.

When a company purchases a long-lived asset, such as a factory building, it can make sense to seek out a fixed rate loan. That’s similar to seeking out a fixed rate home loan mortgage. Often, purchasing a building is a major expense and the predictability of the same monthly payment can help managers plan better for the future.

On the other hand, working capital typically gets funded through credit lines with variable rates of interest. That makes a lot of sense. When times are lean in business, then interest rates are lower and so are working capital needs. Conversely, when the economy is expanding, then although the cost of borrowing is usually higher, so is the demand for goods and services.

Sensitivity and the cost of borrowing.

Before you take out a loan, you need to understand what would happen to your profitability if the cost of borrowing increased.

For instance, if the cost of borrowing is $5,000 a month in interest and your company still would likely be profitable, then that is a good start. But then you also need to know if the business would remain in profit if the cost of borrowing increased. For instance, what would happen it the interest expense was half as much again, or $7,500 a month. Making theoretical changes and then calculating the likely outcomes is known assensitivity analysis. It is something that your Chief Financial Officer or accountant should be capable of doing.

If a change in interest rates of relatively small magnitude would vastly reduce profitability, then you might want to consider a smaller loan.

Likewise, when you conduct the interest rate sensitivity analysis, you may want to consider what would happen to the earnings if revenue fluctuated when the company also had a new loan. If even a small dip in sales would cause the company to lose money then perhaps it would make sense to be cautious by reducing the possible size of the loan.

Wall Street Prep has some useful tips on running sensitivity analysis.

Derivatives and interest rates.

Interest-rate derivatives exist to help companies guard against changes in the cost of borrowing. Rather like knives, when appropriately used, they can be a useful tool. However, when wielded incorrectly they can be harmful.

So-called interest rate swaps can be used to convert a variable rate loan to a fixed rate loan, and vice versa. These products can be useful, but the customers should have a high level of sophistication.

Unfortunately, in the United Kingdom, some banks inappropriately sold small businesses some of these products. That eventually led to losses by some buyers of these derivatives. Given that many of the people selling these swaps hold higher-level finance degrees it is frequently the case that the buyers are far less sophisticated than those selling the products.

Two things to take away from this episode. First, if you have any doubts that you truly understand the product then don’t buy it. Second, just because these problems occurred in the U.K. don’t think they couldn’t happen in the U.S.

Raising Capital Through Crowdfunding

/in , /by

When the JOBS Act (“Jumpstart Our Business Startups”) was signed back in 2012, the intent was to make access to capital easier and less restrictive for small businesses. This was one of the few bipartisan pieces of legislation passed by Congress and has had broad support for a number of years.

Under Title III of the JOBS Act, also referred to as the Crowdfund Act, small companies could issue securities (sell equity / shares) to the public in ways that were not previously permitted. The hope was that average Americans would be able to invest small amounts of capital in small business ventures through a web based platform without the cost and complexity associated with public securities exchanges. Hundreds or thousands of small investments would be pooled together to give the business the working capital it needed. The “crowd” makes it possible for good ideas and concepts to get launched, even when the business or concept doesn’t appeal to conventional investors and banks.  Now small business opportunities were open to thousands of non-accredited investors and potentially millions of individuals seeking investment opportunities.

A number of Crowdfunding platforms were launched, developing creative ways of raising capital.  But, not all of these platforms are created equal and each offers different financial options for both the business and the investor. Some offer campaigns to solicit donations in return for rewards or discounted goods and services, while others seek investors to purchase equity in the company or provide various forms of debt financing.

The most popular method of crowdfunding is referred to as “Reward Based” Crowdfunding, which solicits donations in return for incentives or rewards that the sponsor (or small business) provides. The leaders in this arena are Kickstarter.com and Indigogo.com. The business seeking money launches a campaign that has a stated goal for their capital raise. Typically, the reward is a discounted product or service of the business that is offered for redemption in the future in return for providing capital today.  Let’s say you are publishing a book that, when finished, will retail for $25.00.  As part of your capital raising campaign, you offer donors to your campaign the same book for $20.00. The hope is that the discount will be attractive enough to gain hundreds of donors. This method of fundraising has been done for years in places like PBS. Many entrepreneurs consider this to be “cheap money” because they are raising capital without selling off an equity stake in their company, or incurring debt that needs to be repaid.

In reality, this type of crowdfunding is not dissimilar to alternative finance options that factor your receivables, such as merchant cash advances or revenue based finance.  These companies purchase future receivables at a discount by providing working capital immediately against sales you will make in the future.  They may give the applicant $100,000 today for $125,000 worth of future sales over the following year.  The same principal is at work here that occurs with rewards crowdfunding – just without the work of creating marketing campaigns to enlist donors and the uncertainty that can come along with “all or nothing” crowdfunding.

The second group of crowdfunding platforms provides you with working capital in exchange for a piece of your company’s equity.  This is really an abbreviated micro public offering of your company’s stock.  One of the biggest benefits of equity crowdfunding is access to larger funding amounts of $500,000 and more.  While equity financing seems attractive to many business owners because it technically does not need to be repaid, it does come with many other costs and considerations.  First and foremost, is that you will be bringing on new partners with all the benefits and headaches that this entails. The downside is that you now have many partners and you have a new level of transparency and reporting that you didn’t have before.  Managing numerous investors can become time consuming. Even if the crowdfunding site combines the investor “crowd” into a single pool, you are still required to report results according to SEC requirements.

The most recent draft of SEC regulations requires founders to have their financials reviewed or formally audited by a CPA. Additionally, companies are legally required to publicize a detailed business plan, a list of all large shareholders in the company, a description of the financial condition of the company, as well as file an annual report with the SEC.  This is no small undertaking and many smaller business owners consider other options, particularly when raising smaller amounts of capital.

Equity crowdfunding platforms operate in different ways. Companies like CircleUp, act as intermediaries between investors and companies looking for funds. They typically hold investors’ funds in escrow until the round ends successfully, then transfer equity to the company and complete the transaction. Some platforms like Crowdfunder.com and Fundable.com are basically publicizing the individual fundraising campaigns to the investor public and do not act as an intermediary in the transaction. The company seeking funding contacts the individual investors and collect funds and deliver stock certificates on their own.

Check with various sites to see if they have had any successful placements with businesses in your sector. Not all platforms are suitable for various business types.  CircleUp and LocalStake perform well with consumer products, food & beverage, apparel, fitness and supporting technology.  While EquityNet and AngelList focus on higher tech, B2B and IT driven businesses.

Outwardly, crowdfunding looks like a simple process, but the reality is that it takes work and time for the company to create a compelling campaign and oft times produce the documentation necessary for a successful capital raise. This is particularly true if you are seeking equity or traditional debt financing. The obvious advantages include access to interested investors who regularly follow these sites as opposed to identifying and soliciting investments from individuals you may get introduced to.  This is the scalability of technology, but it also puts pressure on you to produce a story that will get an investor to write a check.

Even if your campaign is well crafted and up there on a popular platform, it will be up to you to drive interest through social media and your own savvy.  Many crowdfunding campaigns are heavily funded by people you already know and in fact some sites actively push you towards your family and friends to seed the round.  Frankly, if that’s the case there is really no reason for you to channel their investment through the Crowdfunding platform as they will charge you a fee for money they had no influence in raising.

The other factor is time.  These campaigns can consume a considerable amount of your time and attention and may result in an unfunded capital raise because you failed to hit your target (all or nothing financing).  You have your ideas and strategy out there for the public to see and scrutinize and while most agree the risk of someone copying your newest creative, disruptive idea is small – it can happen.

All things to consider before putting everything up on the web.

About Us

Products

Contact Us