www. stage2planning.com

Use your Capital Effectively

Many private business owners are intimidated-sometimes to the point of immobility--by their banks. When I look at their balance sheets, I scratch my head in wonder. Usually further conversation with the business owner uncovers the reason for their fear, that at some point in their past their business didn't perform well, and the bank was unhappy with them. Often the owner thought the bank was about to put them out of business. Even though the company financials have recovered, the owner has not.

Your bank is a supplier

I have to remind these business owners that the bank is just a supplier to the company. The relationship is important, sure, but you should work for the best deal that is in your best interest. You can be certain that a bank will work to make a deal that is in their best interest, just like every other supplier you deal with.

Just as you manage your other supplier relationships, you should manage your bank relationships. It's important to understand how the bank thinks as well as understanding the need for capital within our company.

If your company is strong, you are in a good position to set the terms of engagement with the bank. When this happens, you often have too much cash in your company or may not be using debt in an effective manner.

If your company is not as profitable as you like or your company is expanding very rapidly, the bank may be less cooperative. In this case, you must understand how bankers think and learn how to communicate with them in a manner that they understand.

Step One - Understand your balance sheet

Most of the companies we work with either have too much or too little debt in their company. Business owners often don't understand what the proper use of debt is. Those with too little debt will keep large amounts of cash in the company and pay for everything with cash. Emotionally this is a great way to live. However, when it comes to getting an adequate return on your business, it often leads to not having money in the right place when it's time to leave your business.

There are several formulas that are crucial for understanding the capitalization of your business. Two formulas that can deal with effective use of capital are return on assets and return on equity. A bank will be very interested in knowing what your debt to equity ratio as well as your cash flow coverage for loans that you have out.

Step Two - Understand the cost of capital

Leaving money in your business is very expensive. If you use an appropriate amount of debt, you will be able to remove money from your business and use this capital in other ways. If your business is well run, a bank will be more than happy to loan you the money that you took out of your business.

Capital invested in your company is very expensive. Capital that you can borrow from a bank is relatively inexpensive. The challenge is that many successful private business owners are debt averse. These owners could dramatically increase their business returns if they learned how to use debt appropriately in their business. For example, it is easy and inexepensive to borrow money for equipment, since equipment loans are secured by the equipment. So, in my opinion it is better to borrow for this purpose and keep your cash for another day.

Step 3 - Become financially literate

More often than not, the business owners we work with don't understand the financial ratios that drive their business. Because of this they don't know if they are using their business cash in a manner that helps them reach their goals.

Banks have guidelines for each business they deal with. Talk to bankers and find out what they are expecting from you.

Understanding how banks think about your business and knowing what range your business financial ratios can have a large effect in your business and the independence you might want in the future. We are always happy to have a conversation about your particular situation and help you learn not only what a banker is looking for, but also find the sweet spot for your own business.

Step 4 - Review your banking relationships

Finally, remember that a bank is a supplier, nothing more and nothing less. At least every few years, you should have a conversation with other banks that serve your industry and your community to find out what they have to offer. You may be surprised to learn that different banks have different priorities, and that their goals change over time, sometimes to your benefit.

Still, it is true that a good bank is as beneficial as any other good supplier. A strong relationship is worth a lot. Just don't let false claims of "relationship" keep you from seeing when it is time to make a change.

With warm regards,

Stage 2 Planning Partners

Josh Patrick © 2007

Securities and Investment Advisory Services offered through NFP Securities, Inc., a Broker/Dealer, Member NASD/SIPC and Federally Registered Investment Advisor.

Stage 2 Planning Partners is a member of PartnersFinancial, a division of NFP Insurance Services, Inc., which is a subsidiary of National Financial Partners Corp. (NFP), the parent company of NFP Securities, Inc. Representatives listed on this website are currently registered to conduct securities business in the following states: AZ, CO, CT, FL, IL, IN, MA, MT, NC, NH, NY, PA, RI, VA, VT, WA

NFP Securities is not affiliated with Harris- Murray

.