Borrowing money is often the smart (and necessary) way to go if you want to grow your business. In this third, and final, part of my conversations with Andy Pletz, Vice President and Commercial Relationship Manager at Umpqua Bank in Bellevue, Washington, we talk about how to make the best use of your best bank (and banker), how to use bank financial resources correctly and use key drivers to keep your business on track.
Here are the earlier interviews: Part I: How to Find the Best Bank (and Banker for Your Business) and Part II: You’ve Found the Best Banker (and Bank).
Credit Lines: Get One When You Don’t Need It
Lauren: Credit lines. I’m a big believer in having one before you need one; if you never use it, great; but you can’t get it usually when you need it. What’s your philosophy?
Andy Pletz: I totally agree with you. To me, a line of credit is a safety net, and hopefully it will be just a safety net. But typically, a credit line is a gap financing, it funds the gap. You need to pay your people every two weeks, you need to pay your rent every month and your customers are supposed to pay you every 30 days. And some of your customers aren’t paying you in 30 days, they’re paying you in 45 and 60 days. Or maybe you’ve got great customers and they’re paying you but then they change accounting systems. And for a short period of time what you had counted on like clockwork every 30 days, you now have to wait for 90 days because the system got all screwed up. That’s when the safety net, a line of credit, is there for you. So I would agree 100% it’s a great thing to have and I encourage all my clients to have a line of credit, whether they use it or not.
And what’s your philosophy on paying it down even if it’s not a covenant? I sure like to see my clients to be in a position where they can at least pay it down to zero if they’re using it, that there is some period of time during the year where they pay it down to zero because it’s just a good discipline.
You could be a banker! I heartily encourage that. Again, it’s a sign of strength and discipline; it’s a sign of strength that the company has the wherewithal to be able to operate without that capital from the bank. Lines of credit are intended to be short-term in nature. And so, as the money comes in from their clients, they should be paying back that obligation. We call them revolving lines of credit for a reason. They are meant to be revolving. You borrow, you pay it back; you borrow, you pay it back. I do have one client that does not revolve his line of credit. He has a couple hundred dollars on his line of credit. He’s had that on his line of credit I swear, for about five years. I asked him, “Why do you leave such a small amount on your line of credit?” His point was, “I don’t want you to forget about me,” which I thought was very interesting.
It was actually, a very valid point, because when you have a zero on your report in a banking world, reporting is not an issue.. But when you have money outstanding and there’s a deadline, you’re required to communicate. I thought that was really an interesting viewpoint that my client. Clearly, he doesn’t need it. He can pay it off at any time.
And why that amount?
It was a very odd, small dollar amount and clearly can be paid off with his deposits anytime. But some clients just don’t think about it and leave a balance on there, and they end up paying interest on that. Why would you want to pay interest on that if you don’t need it?
It’s all part of paying attention to things.
Right, as much as I’d like my clients to borrow, because that’s what we banks do. We like to loan money and get interest on that. But if they don’t need it, my advice to my client is pay down that line of credit and borrow only when you need it.
Match the Life of the Loan to the Life of the Asset
And pay attention to how you’re using it. Match the life of the asset to the life of the obligation. Another scenario is where a company is growing. As they’ve grown and expanded maybe they haven’t been working with a knowledgeable banker. They’ve ended up using their credit line to buy permanent assets. They’ve gotten themselves “upside down” in the loan structure. How often do you see that situation?
Occasionally, but not often. I’d take a look at that and ask: is it appropriate to pay off the line of credit and term out the loan over a period of time? You reset it so you have the ability to pay it off and revolve it the way you’re supposed to do. For example, you bought a piece of equipment with a line of credit. Let’s do a term loan on that equipment, however long the asset is going to live, say a three to five-year term loan on that and put it where it belongs. I don’t see that all that often, but occasionally it does happen. We sit down, we talk about it: why is the credit line not revolving? Is it because of growth and that capital growth requires? Ok, that’s an understandable need. Is it because they’re losing money? If they are losing money, that’s going to be harder to sell, because you don’t really have the capacity to pay it back. I haven’t seen it recently but during tougher times, we probably saw a little more frequently.
Cash Flow is King (and a Key Driver to Success)
Profit and Loss (P & L) or Balance Sheet, what’s your favorite statement? Or, Cash Flow?
With banking, it’s always cash flow! Cash flow is king, absolutely! I could look at the balance sheet and I would know what the P & L is because I can look at the equity.. But I always start with a P & L, because that’s where my clients start, too. They start with their P & L because they know it. They know where their revenue is coming from, what their costs are, where their people’s time is invested. I always start there. Then I move over to the balance sheet and see how or what has happened over the year. I can see from the cash flow statement how they’ve been using cash and I can see if their liquidity is down. It does all tie together. A lot of clients don’t necessarily know that. Smaller clients still focus on the P & L. They’ve got that part, but they can grow out of business and not realize it. I help them understand that there is a connection to that balance sheet and that it does balance for a reason.
That connection between the two can be a mysterious thing to owners.
And helping them understand how they can manage their balance sheet, what levers they can push and pull on their balance sheet to generate cash is very important.
And the difference it makes in their cash flow, turning that cycle faster, collecting faster.
From a banking standpoint, that’s what pays the loans back. Cash flow pays loans back and so that’s one of the things we focus on. But we always have a “Plan B”, what if cash flow changes or something else happens? Is there equipment you can sell, is there something else that can happen? But cash flow is what pays the loans back, so we focus on that.
We talked about balance sheet being sort of mysterious item to business owners and the relationship between two statements. Most people kind of know their Profit and Loss, I think most business owners sort of know their break-even, they just know that number. They maybe do not know how they could use that effectively to make decisions. What do you see most lacking in their ability to make good financial decisions? Is it the balance sheet issue, is it knowing where they stand relative to their industry?
It just varies with the company. Sometimes the person who founded a smaller company was good with what they themselves do or make, but they don’t have the acumen on the financial side of things. You might talk about a financial covenant, a current ratio, or a debt-to-worth covenant with them and they kind of glaze over a little bit because it’s not their thing.
They may know the working capital implication: “I’ve got to have enough coming in to pay my bills.” But they don’t care about the percentage or the trends. They kind of know it, but they don’t always translate it. Certainly, larger companies generally have more of a control over that or their accountant or CFO do.
I often ask my clients, “What do you measure? What’s important to your industry? What factors do you look at on a monthly basis to make sure that you’re doing A-ok?” That is usually a better measurement. Then by customizing a covenant, we would track their progress. It’s a better way to go rather than me just arbitrarily saying, “Well, let’s pick one or three.”
If there’s a term loan, generally, we’ll always have a cash flow covenant. We just want to make sure there’s enough cash flow to pay back the loan. But businesses vary, so what’s important to the client is what we will look at. We can customize the right covenant so we’re measuring the right things. Occasionally we measuring the wrong things and they could be out of compliance but the company is doing fine. In that case, we have to determine what the right covenant to measure really is.
Looking at the Dashboard: Creating Key Drivers
One of the things that I work with my clients on is putting together what I call a “Vital Drivers”, or Key Drivers, dashboard. It’s like a ratio sheet but it’s more like a very selective measurement or snapshot. You still measure everything; you’ve got to do that. But if you’re performing down here and you need to be performing up at a higher level by the end of the year, what are those vital things you have to achieve to get there? What do you and your management team need to set goals for, measure and attend to, every month. Typically, there’s some key financial revenue or gross margin targets, but there are also usually other non-financial statement type of goals, or marketing metrics, or customer satisfaction goals.
You’ve got to have something that you’re tracking and measuring to get to where you want to get to go.
And doing something about it when they’re not on target. But generally, I find once they’re looking at the right things regularly, and they’re using this information to set the right goals and hold each other accountable, it can’t hurt.
It helps them stay on track and to stay focused, because it’s very easy in a closely-held business to get distracted. It’s easy to get buried. I think those kinds of vital drivers help the business owners step back from that and focus on strategically on what they need to do for the company.
It also gives your management team some context around what’s happening. It’s not enough for me as an individual or my department to be knocking it out in the park. I like to see as a team that knows, first of all, what the key drivers are – their vital drivers -and then they are invested in each other’s success and kicking butt. There’s a feeling of, “We’re for each other and not getting off track.” Because otherwise, you are just a bunch of individual silos, lurching around and bumping up against each other, or you’re that owner trying to do everything.
You can go a lot faster if you’re paddling in the same direction.
Anything that I should have asked and I didn’t, or anything that you want to share from your point of view?
At one time you asked about how do the clients use the best products and services in a bank. I thought that was a good question because it changes. It kind of goes back to the communication process. Part of my job is to make sure my clients are aware of what banks can do to help them. I bank companies in different stages of their life spans, so if you’re just starting out now, you may not need something. But, as you grow, you may just not realize that it’s available or that now makes a lot of economic sense to do.
An example would be you’re a small company and your bookkeeper, administrator, secretary or whoever it is takes your deposits to a branch nearby where they live So on their way home they make a deposit. It’s great, easy, convenient.
Well, the company grows and that bookkeeper (or whoever) is no longer there, or the branch is no longer there, or whatever, and all of a sudden they’re spending more money to have this person get up in the middle of the day, fight traffic across town, get into the branch, chitchat with the branch people, come back an hour or a half later. How much did it cost them to have that person make a bank deposit? I’ll ask them, did you know that we have a remote deposit capture? It sits right in your desk, you go ahead and scan the check right in, and make your deposit even extending banking hours a bit. I definitely want to have annual conversations with my clients, not just about what their credit needs are but kind of about, “Did you know we can help you with this?” Also, fraud is such a big issue.
It leads us back to the questions: Do they have the right person and processes in place? Do they pay attention to things? You’re absolutely right about the fraud.
Besides internal fraud, we see tremendous number of bad guys out there stealing, phishing, gathering. It’s just is amazing, and just when you have a new set of criteria to block somebody, they figure out how to swipe and steal and do something different.
So use your banker as a help against these evil forces.
Use your banker as resource. A lot of my clients call me and while I may not know the answer right away, I’m able to connect them to good resources to help them..
It’s always about looking from the other person’s point of view. That desk between the banker and their customer can be very pretty wide and it doesn’t have to be.
I want a client that does well and their business grows. Growth is good for me because I can help them with that growth; that’s a win-win situation. This has been a great conversation! Thank you so much…
Thank you Andy!