At Meridian, we are getting a record number of phone calls from folks who have maxed out their credit lines yet still need more working capital. If you have yourself in a tight money bind, here’s what to do plus how to prevent that situation from happening again in the future.
Get prepared to fess up your sins to your banker. You likely bought a bunch of fixed assets on your line. So, to solve your problem, you now need to term out that portion of your line that was inadvertently used for this purpose. First, dig up receipts to find out exactly how much you spent on equipment, trucks, building improvements, tanks, land, etc. that was not directly financed. You’ll be showing them to your banker. Start with one year, and then work back to as many as three years until you have a meaningful dollar total. Remember most bankers will only want to fund about 75% of the cost, especially since a year or two may have gone by since your purchases.
Determine the amount of free working capital you will need. To determine the correct line amount, you will need to consider what is the highest amount of receivables you will have during the year, plus the highest amount of inventory, less the smallest amount of trade payables. This dollar amount should then be rounded up to the nearest $100,000 increment. This will be the amount of line you need after getting rid of the asset purchase portion. Let’s use an example so you can work through the numbers:
Current Line $1,500,000
Used for Assets $900,000
Est. Max. A/R $2,200,000
Est. Max. Inv. $400,000
Est. Min. A/P $1,400,000
Assume that your line is fully drawn at $1,500,000 actually outstanding. The bank agrees to term out 75% of the $900,000 or $675,000.
Based upon the forecast of $2.2 million in maximum receivables plus $400,000 inventory, less $1,400,000 trade payables, we find the needed line amount to be $1,200,000. Since you already have $825,000 borrowed, this will give your company $375,000 in new borrowing capacity.
Estimate your capital asset purchases for the year. Your final step before going to see your banker is to estimate your capital asset purchase needs and request a separate line of credit for those needs. This line will prevent you from tapping out your working capital line again, preserving the original line for its intended function. In addition, structure your capital asset line so that shortly before your fiscal year-end, any balance on that line converts automatically to a term loan, helping to keep your current ratio up. So, for instance, you might request a $400,000 line based upon your upcoming needs. At FYE December 31, your balance of let’s say $376,000 actually borrowed, is converted to a five-year term loan. On your year-end financials, only one-fifth of the loan amount is a current liability rather than 100% if you’d used your working capital bank line for the purpose.
Go to your banker with your request. So, now you are prepared to actually ask your banker to restructure your debt. You will:
- Term out $675,000 on a five-year note supported by invoices of purchases totaling $900,000.
- Adjust your working capital line to $1,200,000.
- Open a new capital asset purchase line of $400,000 with assets pre-approved for 75% funding. (You fax an invoice; the bank immediately advances 75% of the invoice into your checking account same day.)
To support your request, you also bring up to date financial statements and volume reports to show your company is growing profitably. If you are in a non-profitable period, you also bring projections that show how you will become profitable again. If there is a personal guarantee involved with the company’s debt, also bring along an updated personal financial statement. It also doesn’t hurt to be the bearer of other good news. Pictures of new sites, grand openings, employee functions, new web sites, etc. are also confidence building for bankers.
With this new debt structure and strategy, the bank’s financial commitment totals $2,275,000, a $775,000 increase over their prior $1,500,000 commitment. If you find your bank is reluctant to restructure your debt, it may be time to look for another lender. Fortunately, the lending environment is still very competitive, and you will likely find plenty of folks wanting your business.
As you work on the details of your new loan structure, keep two guidelines in mind. First, the capital asset line and revolving line of credit should be at the exact same variable interest rate. (You may want a fixed rate for the asset term out loan and have the option for a fixed rate when the asset purchase line becomes a term loan.) Next, if your company has a strong balance sheet and profits, you may lower your borrowing rates by pegging your interest to LIBOR (London Interbank Rate) rather than Prime.
If you use your lines correctly and structure your lines and loans this way year after year, you should never again find your company with a tapped-out credit line.
