Even companies in the fortunate position of rarely needing to borrow, know it is prudent to have a working line ready and at their disposal in the event of that unexpected cash crunch.
Smart line management isn’t always easy. Here are the common mistakes we see and how to cure them:
Mistake #1 – Use the line to buy fixed assets or finance acquisitions. Besides wreaking havoc on the current ratio, this practice can leave a company without any borrowing availability when they need it most. Set up capital equipment and acquisition lines at the beginning of each year that are specifically for this purpose, where the balance will automatically convert to a fully amortizing term loan just shortly before the company’s fiscal year-end.
Mistake #2 – Infrequent pay downs. Making a payment on the line only when you have a big chunk of cash available costs you extra interest expense on all those days when you could have paid down at least a little bit. With today’s technology, most banks are able to automatically pay down your balance each night with any spare funds in your checking account. Ask for this service.
Mistake #3 – Unnecessary draws. The key to success is to not borrow unless you absolutely must. Again, with today’s technology, draw requests should be a thing of the past. With your line linked to your checking account, the only time there should be a draw on the line is when the checking account is out of money.
Mistake #4 – Incorrect line limit. When a line limit is set too low, a company may run out of money and have to juggle vendor payments. If a line limit is set too high, and in the event the bank is charging any kind of fee linked to the line limit, there is unnecessary expense. Use projections to accurately forecast line needs each year.
Mistake #5 – No interest rate negotiation. Complacence translates to unnecessary interest expense. Especially after a year of nice profits, you should be negotiating lower interest rates. And remember that Prime is not the only rate benchmark. Many marketers with million dollar or higher lines are obtaining LIBOR-based rates which puts their borrowing below the prime rate. You get what you negotiate.
So, in summary, avoid these common mistakes by setting an appropriate limit, negotiating your interest rate, and then having your bank do automatic draws and pay downs through a checking account link.