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2013

When businesses need a short-term cash infusion, the first option to come to mind is often a traditional bank loan with repayment terms ranging several years or more. However, short-term financing, with repayment terms of less than a year—often as little as 90 or 120 days—can be a smart tool to help build your business and fill cash flow gaps without committing to several years of repayment.

 

Short-term financing has a wide range of applications, says business consultant Dave Lavinsky, co-founder of Growthink in Los Angeles, California. Seasonal businesses may need short-term funds to sustain them during slow periods. Other companies might need to purchase inventory or materials for sales or orders that won’t be paid for months. In some cases, the business investment necessary to sustain growth may leave a business temporarily cash-strapped, says Lavinsky. Short-term financing can also provide the immediate funds necessary for an acquisition or expansion that will lead to additional sales, revenue, or access to capital to meet the repayment terms.

 

There are several types of short-term financing options. Businesses may use credit cards to finance smaller expenses over a short period of time, says Lavinsky. That can be effective, but it’s important to track the cost of interest on this type of financing, which can be high. Small business credit cards in particular are not subject to the regulations passed in the Credit Card Accountability, Responsibility and Disclosure Act of 2009, which restricted arbitrary interest rate increases and standardized payment dates and also provided other protections. However, some issuers have opted to extend these policies on their small business cards regardless of the requirement, so it’s important to read the fine print. These cards are also often issued based on the business owner’s personal credit, so late payments or high balances could damage the individual’s credit profile.

 

Traditional bank loans with shorter repayment terms and lines of credit are usually the most attractive option for many businesses seeking short-term financing. They may have slightly higher interest rates than longer-term loans, but cost less in the long run because the interest isn’t being paid over a longer period of time. In addition, they’re much less expensive than options like factoring, where businesses are paid a portion of their accounts receivable and hand over collection activities to the factoring firm at rates that are often “just short of loan sharks,” says Lavinsky. However, they do offer a way to get revenue in-house quickly, he says.

 

Qualifying for bank loans requires a track record in business of at least a couple of years, as well as demonstrated ability to repay, says Lavinsky. Be prepared to provide financial documents like profit and loss statements for the past two or more years, cash flow analyses, and others, as well as documentation of assets, inventory, cash on hand, or other assets the business owns that might be used as collateral. If you have contracts with or orders from large clients that show an ongoing relationship, that might be useful, as well. Depending on the amount of the loan and your business track record, you might be asked for a personal guarantee, where you pledge your personal assets as collateral to satisfy the loan.

 

To avoid needless delays in the decision-making process, discuss your loan package with your bank representative to ensure it’s complete before submitting it. And while credit markets have been tighter in recent years, the 2012 Federal Reserve Bank of New York Small Business Borrowers Poll found that 63 percent of loan applicants in 2011 were able to get at least part of the credit they sought, although only 13 percent were approved for the full amount of the loan or line of credit they sought.

 

“I’ve always been of the mindset that a company that commits itself to raising capital will raise the capital,” Lavinsky says. “Don’t give up.”

 

 

What your company needs to know about credit, collections, and their impact on small business growth.


Understanding Risks and Rewards

  

Attractive credit terms can spark an increase in sales to consumers and business customers, support upselling initiatives by allowing them to budget for bigger purchases, and strengthen customer relations. Before small business owners extend credit to customers, however, they need to understand the risks relative to the potential benefits. That’s especially true in challenging economic times—but in any economic climate, credit extension and oversight require a commitment of time and attention that some small business owners may not be able to divert from running their companies.

 

To assess the net benefits that credit extension may offer to your business, begin by learning what credit terms are customary in your industry; terms vary from one industry to another. Trade associations are good resources for getting a grounding in the basics.

 

Once you know how credit extension will need to be structured for your business, the next step is to assess whether and how it will strengthen your value proposition and ability to compete in your market. A company that offers a unique product or service for which there is high demand won’t need to offer credit to attract customers or clients and achieve growth in market share. Conversely, a well-capitalized company that’s selling a commodity in a competitive industry may find that credit extension can generate an increase in market share.

 

Gaining Business—and Obligations

 

How many additional customers, and how much additional business, can the company gain by offering credit extension—and what business will the company forgo without it?

 

“You make that evaluation, and you determine whether you have to offer credit or not,” says Bob Seiwert, senior vice president of the American Bankers Association. “If so, are you going to offer it on the normal terms of the industry, or are you going to use it as a competitive tool and gather more customers and offer looser terms?”

 

He cautions business owners to recognize the real cost in the latter approach, which will make the company more attractive to slow-pay clients. “So you’d better be pretty good at evaluating credits, which most small business people are not. They’re so busy running their business. They don’t have time to focus on the creditworthiness—or know how to evaluate the creditworthiness—of customers. So you’ve got to figure out how this fits in the game plan.”

 

Setting Limits, Mitigating Risk


Another policy question is how much credit your company will extend to any one customer or to customers within a particular industry. The answer to that question depends on risk assessment: how much the company can afford to lose. Among the questions Seiwert encourages business owners to consider: “How much do I have to extend credit to be competitive? How much exposure can I have? And if I take a hit, will my business survive?”

 

One strategy for mitigating risk is establishing a payment schedule. However, in some circumstances, you may agree to extend terms in line with a customer’s seasonal business. In that scenario, Seiwert advises that your company must make sure it is paid when the customer is paid.

“Any time you wait longer than that, you’re really putting yourself at risk, because there are lots of demands for that money,” he says. “If you’re going to offer dating terms, you want to time the extension of credit and the payment of credit to when that customer is going to be receiving the cash from their customers. That’s critical.”

 

Another challenge, particularly for small businesses with limited staff resources, is monitoring the financial health of the customers to which they’ve extended credit. “One way you limit your exposure is by limiting the amount of credit you extend,” Seiwert says. “But you better keep your ear to the ground by joining trade associations, the chamber of commerce—the rumor mill can be very beneficial. You’ve got to be attuned to the grapevine.”

 

Know Your Legal Obligations

 

“You definitely need a lawyer to write up your sales contracts,” Seiwert stresses. Your trade association, accountant, and business banker can direct you to additional resources. It’s also essential to familiarize yourself with Federal Trade Commission (FTC) regulations and consumer and business lending laws.

 

The FTC’s Bureau of Consumer Protection Business Center (Bureau of Credit Consumer Protection Business Center) provides business owners with advice regarding credit and loans, payments and billing, and debt and debt collection. Resources on its website also include the Complying with the Credit Practices Rule guide and advice regarding the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act.

 

Timely Payment Strategies


Debt collection presents an ongoing challenge for small business owners who extend credit to their clients and customers. Some of those challenges arise owing to inefficiencies on the creditor side. Short of staff and in the middle of a marketing push, small companies can fall behind on invoicing, which can lengthen the pay cycle or create a billing pile-up that leaves the customer with a charge that’s too big to dispatch in a single payment. Competing priorities can also lead to delays and deficiencies in following up on delinquent accounts.

 

Many of these problem can be averted by establishing good invoicing and debt collection practices in advance.

 

“We make sure that we’re using all of our tools and all of our strategies in order to do what’s necessary to recover and enforce the debt. A lot of people don’t enforce the debt. They do collections somewhat—maybe a letter, maybe certified mail, maybe a few phone calls—and then they give up,” says Stephanie Williams, vice president of collection operations at Freedom Stores Inc., and a former member of the board of directors of ACA International, the Association of Credit and Collection Professionals. “If you have certain standards and tools in place, and you’re enforcing the debt and also counseling the consumer, I think you would be a little bit more successful.”

 

Credit and collections experts agree that if you haven’t established a bill payment expectation before the bill is due, you’re already a step behind. Best practice calls for stating terms at every step of the transaction. Include the payment terms on the prices quote. Restate the price and terms on the confirmation of receipt of the purchase order. Include the payment due date on the invoice. Offer the option, positioned as a convenience to the client or customer, of sending a reminder by email or text five days before the due date.

 

It’s all part of what Williams calls “enforcing the debt,” and it begins by qualifying clients and customers and making sure they understand the credit terms and repercussions of non-payment before the company extends credit.

 

Tim Collins, an ACA International attorney member who has worked in the debt collection industry since 1993, underscores this point. He is director of compliance at Hyundai Capital America, which sends a welcome package to new customers—a tactic whose benefits extend beyond building goodwill. Mail that’s returned as undeliverable gives the company an early opportunity to update its records so that billing can be sent to a correct and current address—and raises an early red flag about customers who may be a bad debt risk. The company also makes follow-up phone calls to new customers in the higher risk account pool, such as people with lower credit scores. The conversation offers a friendly welcome and asks if there’s anything the customer needs—but it also provides an opportunity to collect additional phone and other contact details that may be useful should a collections need arise.

 

Rely on Relationships

 

That’s one illustration of the extent to which good credit collection practices go hand-in-hand with relationship building. That can be true even when it becomes necessary to initiate collection calls to a customer who is having trouble making payments on time. Small businesses, in particular, are likely to have personal relationships with their clients and customers, and Williams advocates trying to work with late payers to set up payment plans.

 

“We can offer a payment plan, but we can also refinance them or offer them a lower payment for a little bit longer term. So there are different ways that you can do it, but you have to educate, you have to listen, and you have to make them understand that ‘we’re helping you, and in order for us to help you, we’re going to take a little bit of a loss in the beginning, but we’re going to make it work out,’” she says. “From that point, you always communicate. I always tell our customers, don’t ever not call us.”

 

That outward show of support can also be turned on its head to pressure customers to meet their obligations. Small business owners can express sympathy for the personal or business problems that have caused the payment delay and then remind customers that they don’t want to compound those problems by having their credit ratings damaged. At that point, a friendly demand for payment is couched in terms of concern. “That’s perfect,” Collins says. “It puts you on the same side as that customer.”

 

Above all, don’t delay in acting on delinquent payments. “You have to start right away. The older the debt gets, the harder it is to collect, and that’s true for anyone,” Williams says. The same is true, she adds, of selecting a collections agency to pursue accounts from which your business has failed to receive payment. It takes time to do background research on agencies, ensure that they’re properly licensed for the states in which you need them to operate, and know which techniques they use in their collection process. Here, again, your company needs to complete that groundwork before it needs those services.

 

Credit extension is a complicated business that can place heavy demands on small companies—but in the right circumstances, and with proper management of these concerns, it can serve as a tool for sales growth.

 

 

FiscalCliff_Body.jpgby Jen Hickey.

 

Many small business owners exhaled a collective sigh of relief after the 11th-hour passage of the American Taxpayer Relief Act of 2012. While most of the Bush era tax cuts have been extended or made permanent, uncertainty lingers around the potential impact of higher payroll taxes and surtaxes related to the Affordable Care Act (often referred to as ObamaCare). Small businesses owners are now scrambling to adjust their returns for 2012 to take advantage of retroactive deductions and implement tax strategies for 2013. And those that fall into the new higher income marginal rate will likely see their taxes rise this year and beyond.

 

While some provisions were made permanent, like marginal tax rates and alternative minimum tax (AMT) exemption amounts, estate and gift tax exemption levels, other deductions and credits have only been extended through this year. “I have a greater sense of certainty when it comes to tax planning for 2013,” notes Andrew Schrage, co-owner of Money Crashers Personal Finance. “I no longer have to guess, which makes for a more streamlined roadmap as I plan my finances throughout the year.”

 

Kent Reed, owner of franchised brokerage services company Murphy Business & Financial Corp. in Atlanta, Georgia, was disappointed with the final deal. He had hoped for more comprehensive tax reform, as Reed and the small and medium-sized businesses he consults regard the tax code as an obstacle when it comes to strategizing. “Before we can even adjust, they change it,” notes Reed. “It makes it very difficult to plan long term.” Reed decided to postpone filing for 2012 to see if there are any deductions he can take.

 

“For small business owners looking to put new assets into service or build out their space, it’s a good year to do it,” notes Claudia Lazzarato, tax manager at Pleasanton, California-based tax and accounting firm Sensiba San Filippo. Deductions set to expire or be reduced significantly were extended for 2013. Scheduled to drop to $25,000 before the fiscal cliff deal, limits for Section 179, which allows small businesses to deduct qualified equipment purchases, were increased from $125,000 in 2012 to $500,000 for companies with less than $2 million in qualified capital expenditures for 2013 and 2012, retroactively. Set to expire at the end of 2012, the deduction for 50-percent bonus depreciation was extended through the end of 2013 (2014 for certain types of property).

 

Alternative minimum tax exemption amounts have been permanently increased from $33,750 to $50,600 for single filers and from $45,000 to $78,750 for married couples filing jointly. “Now that these amounts are set, we know how hard our clients will be hit by AMT and whether there’s a way to avoid it,” Lazzarato points out.

 

Certain tax credits also remain in place through this year. The research and development (R&D) credit, which expired at the end of 2011, was extended through 2013 and made retroactive through 2012, as was the work opportunity credit for employers that hire veterans or those from groups that have faced barriers to employment.

 

FiscalCliff_PQ.jpgAmong the Bush era tax provisions made permanent are the six federal income tax brackets (10-35 percent), with the addition of a top bracket (39.6 percent) for higher income taxpayers ($400,000 individuals/$450,000 married couples filing jointly), and the 15-percent tax on capital gains and dividends (increased to 20 percent for income at or above that top bracket). “As most small businesses are structured so revenues flow through to their personal income, it’s an especially important planning point to try to stay below that higher income threshold,” explains Lazzarato. Scheduled to drop to $1 million, the estate and gift tax exemption has been made permanent at $5 million (indexed for inflation), along with the exclusion amount "portable" between spouses. “This is good news for family-owned businesses and small business owners gifting business stock,” notes Lazzarato.

 

Even those small business owners that remain below the higher income threshold, their taxes will rise to some extent, as Social Security payroll taxes have returned to their pre-2011 rate of 6.2 percent (up from 4.2 percent). “It makes it all the more important for small business owners to decide how to invest money coming in as a means of managing their taxable income,” explains Lazzarato. And the fiscal cliff deal did not postpone the implementation of the Affordable Care Act surtax of 0.9 percent on earned income above certain threshold ($200,000 for single filers; $250,000 married) and 3.8 percent on the lesser of net investment income or modified gross income over these amounts. For this reason, Reed has postponed adding new staff through at least the first quarter until the effects of these higher taxes can be measured. 

 

To complicate matters, personal and dependency exemptions have been phased out for those in the higher income brackets (adjusted gross income $300,000 married filing jointly; $250,000 single), who may also be subject to limits on itemized deductions. Schrage has decided to hire an accountant for the first time. “Up until now, I’ve always used Turbo Tax,” notes Schrage. “But I just don’t feel comfortable filing my own returns this year.” 

 

Reed expects to pay $4,000-$6,000 in additional taxes this year, depending on where the AMT hits. His accountant has recommended changing the structure of his business from an LLC to an S Corp, allowing profits to be split between salary and S corporation distributions. “Rather than being on a cash basis from year to year, we’d accrue and have some stock,” explains Reed. While his salary would be subject to payroll taxes, dividend distributions are not. “You want to put more money into goodwill and capital gains because you’re taxed at a lower rate.”

 

Another tax benefit for S Corps is the retroactive restoration of the shareholder basis rule for stock in S corporations that make charitable donations of appreciated assets for 2012 and 2013. “Under the temporary incentive, shareholders reduce their basis (or value) in the stock of the S corporation by their pro rata share of the adjusted basis (typically the smaller amount) of the contributed property, rather than by the fair market value (typically the larger amount) of the charitable contribution,” explains Lazzarato. “The lower basis reduction for charitable gifts benefits the shareholders because their value (basis) in the stock remains higher while reducing taxable income by the higher amount (fair market value).”

 

“You don’t want to base all your business decisions on taxes,” cautions Lazzarato. “But you should at least calculate them beforehand so you know what to expect at the end of the year.” While there seems to be less uncertainty now, many small business owners have a wait-and-see attitude about how the deal will affect their bottom line. Schrage would like to see all deductions/credits for small business made permanent, though he’s not holding his breath. “That would take a lot of the guesswork out of hiring.”

If cash is king in business, ensuring that you have access to it is just as important

 

Introduction: Liquidity Is Your Best Hedge Against Risk

   

As a small business owner, you have a handle on the cash flow required to keep your business operating under normal circumstances. But how accurately have you assessed your ability to liquefy assets quickly in response to unforeseen circumstances?

 

To get a reliable answer to that question, you need to master an accounting balancing act, says Paul Stahlin, CPA, CGMA, and former chair of the board of directors of the American Institute of Certified Public Accountants (AICPA). In one column is “how much liquidity you need to have on your balance sheet.” In the other, how much you have in “assets that are close to liquid, and how quickly you can get them.” Together, these elements constitute “a stress test that happens whenever you have a natural or unnatural disaster.”

 

Small businesses are being subjected to that stress test more often in an increasingly global economy, he says. The March 2011 tsunami in Japan sent shock waves through the supply chains of some markets and industries in the U.S. More recently, tens of thousands of small business owners in the greater New York metropolitan area found their companies brought to a standstill for weeks following Hurricane Sandy.

 

That “superstorm” also demonstrated the limitations of crisis planning. Companies in areas left largely untouched by the storm had to remain closed for days when employees had no way to get to work. Small business owners who had invested in generators to see them through extended power outages found themselves unable to get the gasoline necessary to keep those generators humming. “You can’t calculate the risks precisely of what’s going to happen into the future,” Stahlin says. “And that’s why you need to have some liquidity in your balance sheet. I’m all about risk management, and risk management does play into liquidity needs.”

 

Create a Liquidity Plan

 

“Think forward,” says Craig E. Aronoff, chairman and principal of The Family Business Consulting Group and co-author of Financing Transitions: Managing Capital and Liquidity in the Family Business. “To plan for liquidity means you have to plan, and the first element of business planning is having a budget. If you have a budget, then you can make a better projection relative to your cash flow and your cash flow needs. And if you can do that, then you can do a better job of managing your cash flow, which is a liquidity issue.”

 

Next, he says, small business owners must probe longer term questions. “Do we want our business to grow? Is it growing? What do we need to make it grow? What kinds of investments do we need to make to support our growth? That’s called capital budgeting, and it’s a process of planning out: here’s our goals, here’s what we want to do, here’s what it’s going to take in terms of money. What other resources are required, and how do we work this out? It’s a thoughtful approach to thinking out the future. That can be translated into a capital budget that says, “In six months, we’re going to need X dollars. And in twelve months, we’re going to need Y dollars. Or here’s the list of things we need money for, and then we need to go backward and plan for that.”

 

Those projections can relate to anticipated business or personal needs, experts say. They can involve anything from heightened disaster preparation to planning for market or product line expansion, construction of new facilities, or growth in payroll. But they can also spring from, for example, the knowledge that a senior partner plans to retire in ten years and will have to be bought out at roughly the same time that the remaining partners want to take some distributions as their children enter college.

 

Inheritance and estate taxes introduce further potential tests of liquidity. “Transferring ownership of the family business to a new generation is often more complicated than it sounds,” the U.S. Small Business Administration (SBA) warns. “Additional tax implications, such as estate and gift taxes, generally arise for both parties. Proactive succession planning can help provide business stability, prepare for tax obligations, and make the ownership transfer as smooth as possible.”

 

Any of these issues can put challenges to liquidity on the company’s horizons. Even with months or years of advance warning, business owners can be blindsided by those challenges if they don’t have an accurate grasp of the value of assets they can liquefy and the time it will take to convert them to cash.

 

Capital Calculations


“Cash is king. Capital is queen. That’s what people have to look at, and small businesses often underestimate. They’re trying to do something on the margin. They’re trying to make the best they can out of what little they have,” Stahlin says. “That’s not a criticism of them, because that’s why they’re in business. They’ve got the entrepreneurial spirit. If it was easy, everybody would do it. But that is why businesses fail often, because there’s just not enough capital, there’s not enough liquidity, and there’s not enough ability to repay if there’s a little blip.”

 

What are some of the most common mistakes that small business owners make in assessing their liquidity? Do they over-invest in inventory? Overestimate the value of the assets they have on hand? Underestimate the time it will take to convert those assets to cash?

 

“They’re doing all of those,” Stahlin says. “They’re underestimating the time it takes to make things liquid. They’re underestimating how much they need. I can look at a small business’s checking account, and I can see the velocity of what goes in and what goes out, and the average balance, and you can tell that they don’t necessarily need a loan; they need another source of revenue.”

 

Aronoff underscores that point. “When small businesses get into a liquidity crunch, it’s because they’re doing something else wrong, not because they haven’t watched their cash draining out of their checking account.” One example is a source of increased liquidity that some business owners overlook: their accounts receivable. “If you have a liquidity problem, and you need to be told that you need to be more aggressive in collecting your accounts receivable, then you’ve got a different problem, which is that you’re not collecting your accounts receivable,” he says. “But that is another source of liquidity, and of course it can be used for factoring and other ways of generating cash.”

 

Avoiding Collateral Damage

 

Rejected credit applications can serve as a wake-up call for small business owners who make some of these mistakes, Stahlin says. “Particularly when they’re real estate rich, they say, ‘I’ve got plenty of collateral. How could you be classifying my loan as substandard if I’ve got all this collateral?’ Well, collateral, unfortunately, in a quick sale, diminishes very quickly.” That’s especially true in the current environment when business owners are overconfident in their ability to convert real estate assets to cash. “People think, ‘I’ve got this piece of property; I could sell this in three months.’ Well, that’s not the case anymore. So they overvalue that collateral on the basis of the time that they have to disburse it, or liquefy it.”

 

An excess of caution can be equally harmful to the company’s health. “It can stifle growth,” Stahlin warns. “If you’re too conservative, you’re not reinvesting in the business. There’s got to be a formula that you develop within your business on how much you put back into the business. You can’t be shortsighted. One of the biggest issues if people are too conservative is that they’re not thinking out three to five years into the future on the vision for growth. Sometimes that will constrain growth in operations.”

 

Increasing Liquidity, Reducing Risk

 

Best practice for ensuring an accurate read on liquidity before there’s a need to tap the assets, calls for input from at least three parties. “You need the business owner, the banker—who you have to have a relationship with; it’s all based on relationships—and somebody with financial acumen. That’s usually where the CPA comes in,” he says. It’s usually advisable to include the company’s legal counsel in the discussions, too. 

 

The process is not a one-time exercise but one that requires attention at least monthly. “It depends on how fluid your business is and how much tie to high turnover there is. There’s a definite correlation to the velocity of money going in and out of the business. The correlation should be, the higher the velocity, the more often you should be looking at the liquidity balance,” Stahlin says. “Business owners have to balance out running the business and the back office operations. I ask them, ‘What is the most critical point to you in your business?’ To be a good businessman, you can’t just run your business. You’ve got to own a piece of that banking expertise, a piece of that CPA expertise, and the legal expertise, and it’s all got to be wrapped around, because that’s how you develop your risk tolerance.”

 

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