It matters because if your business can meet traditional lender requirements, your interest charges will be a WHOLE LOT LESS.
You want this because it’s a better use to cash to find new customers, invest in new products, not subsidize a lender because you’re paying too much in interest.
This entrepreneurs business sales are over half a million dollars (wow) and she wants to scale it quickly.
It will help you too if you’re thinking about applying for a credit line from the bank.
I put on my “banker’s hat” and here’s what I suggested she do.
Here’s How to Tell If Your Financials Are Strong Enough to Get a Credit Line From a Bank
Banks care more about the Balance Sheet than just revenue levels.
This is discussed at length in the chapter “How to Win Friends and Influence Bankers” in Accounting for the Numberphobic.
Before you apply for a loan, make sure you read it.
Lenders Care About Your Balance Sheet
The bank cares most about three things;
How much working capital you have;
How well you’re translating revenues into cash flow
And how much debt you have versus liquid assets (the cash to pay it back).
Go to your Balance Sheet. Ask your accountant to pull it for you.
The first screen for commercial lender uses is figuring out if working capital is greater than 1.
Current Assets- Current Liabilities= Working Capital
Figure out your working capital this way:
Total your year end current assets. Deduct current liabilities.
If it’s greater than 1, you’re doing well. Go to the next step.
If it’s not, you need to reduce liabilities or grow assets before you qualify for a loan. If working capital is below 1, your company will be viewed as high risk.
The second screen is called a quick ratio which also gets to how easily your company could pay back the loan in a pinch.
Figure out your quick ratio this way:
Deduct inventory value from current assets. This gives you liquid current assets.
Divide by current liabilities(due within next twelve months). Is the ratio >1?
Current Assets-Inventory= Current Liquid Assets (cash or easily converted to cash)
Current Liquid Assets/ Current Liabilities= Quick Ratio (it should be >1)
If your Quick Ratio is greater than 1, good deal.
You’re in great shape. If not, you need to liquidate inventory and pay down current debt to bring the ratio into alignment.
How much of a credit line are you looking for? Make sure you’re super clear on how you’ll be using the line. For every dollar you borrow, you should have a plan to get 10 back.That’s what we used to look for at Citi when I was a VP there.
Again, read the chapter on How to Win Friends and Influence Bankers in my award-winning book Accounting for the Numberphobic.
You’ll be thinking like a banker and getting that credit line in a snap.