CHAPTER 20

The Bank Manager Is Not Your Friend

(Do Not Go to the Bank with a Problem)

Vignette: The Bank Letter

One morning, while sifting through my daily mail, I noticed a letter from my favorite bank manager. As the chief financial officer of a medium-sized business, my first reaction was that of surprise. Why would my bank, with which my company was doing business for quite some time, send me a letter? I opened the letter. To my further astonishment, my friendly bank manager with whom I had lunch just last week informed me that my company’s line of credit was reduced from $750,000 to $400,000. I had 2 weeks to comply, or I would lose my entire line of credit.

Why was this happening to me?

Of course, I knew that lately my company had quite often taken full advantage of the available line of credit at considerable financial cost. I justified this expense by the growth of the company as well as some major contracts with the federal government, who was always late in paying its invoices. Otherwise, the business was steady, revenues were flowing in, and the company was in the black. With no red flags on the horizon, I assumed that everything was going well.

Nonetheless, my business case was different. I knew my bank manager. We had lunch from time to time. We phoned each other, mostly dealing with logistics or menial issues. I sent him monthly financial reports. I checked my business balances online. He was doing the same. I had good cash flow estimates. I could predict next week’s account balances quite accurately. I felt confident. Most of all, I trusted my banker. And now this letter.

What was wrong with this picture?

Have more than one option when financing is involved.

Erroneous Assumptions

My first error was to believe that my bank manager was my friend and would support my company (i.e., me) in times of need. I based this belief on my relationship with my banker. I was always upfront with him. I always informed him when financial clouds were present on the horizon—for example, when a big client was late with the invoice payment (which happened regularly on some federal or provincial contracts), when an accident occurred (manufacturing can be dangerous in the best of circumstances), when I had to deal with fraud (another human behavior companies face from time to time), and, of course, when vendors were not meeting their shipment deadlines.

Obviously this was not enough.

Naturally, my first reaction was to call my banker. Why the letter? Why now? What happened?

Although polite, the answer was vague: “Head office has decided to modify its risk management structure. There is nothing I can do.”

I should have known better. The bank manager is not my friend.

What is then the role of the bank? Based on my experience, as a former banker and an entrepreneur myself, a bank is of great help in supporting the daily financial transactional needs of a viable business. In the North American business milieu and that of most developed countries, business-related financial transactions often involve some form of credit line, some form of delayed payments, and some form of funds transfer. Very seldom businesses use hard cash for their daily operations. This is the realm of banks.

Does one need to be a banker to know that banks, at least most of the Canadian banks, are not in the risk-taking business?

Seed money comes from sources ready to take a gamble, sometimes a big gamble involving serious risk. Seed capital for start-up ventures, or small business owners, generally comes from family, relatives, and friends, followed by (if the business shows some success) angel investors or even venture capitalists. Successful businesses are able to raise funds on the market (various stock exchanges) through an IPO. But this is the exception rather than the rule.

When discussing my experience with other business executives, it quickly became apparent that I was not alone in facing this type of banking situation. Others had similar experiences with their banks (and bank managers).

Some of the advice in the form of decision rules of thumb that emerged from these discussions included the following: If I do not believe in my business, why would anybody else?

The aforementioned was contradicted by the rule of thumb stating, “Do not go outside of your risk or comfort zone, based on your gut feeling” because the comfort zone may vary for every individual. Not a clear message.

Some colleagues stated, “When decisions affect others, those others must have a voice in the decision.”

I believed that I should also discuss this situation with my business partners and even some of my major shareholders to discover what they thought could be the most efficient response to the bank.

Following this approach implies a distinctly cooperative management style, one that involves others in the decision-making process, an approach not necessarily generalizable, albeit reasonable here.

Keep the debt at a manageable level was another wise advice.

Although a prudent suggestion, statistics shows that a large number of small businesses still have a short life span, usually fewer than 5 years.⁸⁸

Keep personal assets out of business.

This rule of thumb contradicts the ongoing policy applied by banks. Banks often require personal guarantees from business owners, making the aforementioned rule of thumb sometimes difficult to apply.

Every problem has a solution.

This rule of thumb sounds more like “wishful thinking” than reality. Executives need to remain optimistic and seek solutions, again, sometimes difficult to find.

In for a penny, in for a pound.

Here, the rule of thumb implies “risk is worth taking.” It contradicts some of the other proposed rules of thumb, making the generalization of this one less plausible. Risk is a “personal” and “emotional” element, and as a result, risk taking is also personal and emotional.

Anticipate the worst.

This rule of thumb suggests that, when taking risks, one should look at the worst-case scenario and evaluate if the outcome is within the decision maker’s comfort zone. Worst-case scenarios are often associated with life-and-death situations. In business, this may relate to staying in business (staying alive) or going bankrupt (dying). No decision is suggested here, just a “gut feel.”

What was I to do?

I needed to reduce my workload or commit more working capital to the business to meet my new banking constraints.

I did both.

Lessons Learned: The Solution

As with most business situations, one rarely finds a formula that solves all financial challenges. The most common approaches start with a proper understanding of the problem, followed by the analysis and identification of several options, ending with the least risky decision. Obvious, isn’t it?

I started by looking at some obvious sources of dormant funds. Not really obvious, because I did not use them beforehand.

The first source of funds was my customers’ A/R.

As a service company delivering repair work worth tens of thousands of dollars, I followed the industry standard—bill at the end of the job. This approach required a higher working capital because I had to purchase the various materials needed for the job at the start of the project and cover project-related expenses (like the cost of material and payroll) as the project progressed, sometimes over several weeks, even months.

I decided to modify the A/R process, against the advice of my accounting department, some first-line managers, and salespeople. I asked my customers to make a deposit covering the raw material requirements at the start of the project. In return, the operational mark-up of the raw material was limited to 25 percent.

Instead of invoicing at the end of the project, all time and material projects were invoiced weekly. In return, the customer would receive a detailed daily report of the work performed for approval and review.

Fixed-rate projects had a payment structure similar to the one mentioned earlier. Invoicing was performed based on work in progress and deliverables according to a prenegotiated fee schedule.

To everyone’s surprise (mine too), most of my customers understood the need for a stable cash flow, acknowledged the reduced risk both for their project and for my company, and accepted the new policy. The salespeople were happy. They could use this new approach of selling to the customers the benefit of a higher level of confidence that the job would be done on time and within budget. The results supported this claim.

This first method generated a more stable cash flow and decreased the working capital needs.

The second source of funds was in my account payables.

Because I had enough funds to pay for the raw materials up front, I negotiated better rates with my suppliers. I succeeded (in most cases) to either reduce the cost of the raw material or extend the payment due dates, generating another source of funds and reducing my working capital needs.

The third action, the most difficult to sell both inside and outside the company, was an increase in labor rates. The Canadian–U.S. exchange (at the time) was very favorable for my U.S. customers. I could raise my hourly rate to the equivalent of my U.S. competitors’ hourly rate and still offer a high-quality cost-effective service.

Finally, the shareholders had to use only a limited amount of their portfolio leverage to cover the remainder.

Fortunately, the above-combined approach reduced the company’s working capital requirements to the bank’s limits.

Ultimately, I changed banks.

Every problem has a solution.