Q: What is the best way to determine the line of credit need for a growing C&I business?
A: In a two-part webinar that we offer, we address the issue of projections - Projections and Repayment Sources: Parts I and II - which comes down to projecting the performance ratios for the Business Drivers. The Business Drivers set both the cash and accrual position of a borrower. They are as follows:
1. Sales Growth
2. The Gross Margin
3. SG&A% or Operating Expenses as % of Sales
4. The Owner Payout Rate
5. Accounts Receivable Days
6. Inventory Days
7. Accounts Payable Days
8. Fixed Asset Spending as % of Sales
The eight Business Drivers apply to some borrowers, such as a distributor or manufacturer, while far fewer would apply to a real estate investment company, e.g., Sales Growth in the form of a change in the Occupancy Rate, Operating Expenses as % of Sales or Effective Gross Income, and Rents and Deposits Due relative to Effective Gross Income.
The attached Credit Refresher on Forecast Assumptions and Cash Flow provides more detail. Note that the starting point for projections is always the last actual values for the Business Driver Performance Ratios. We change them only if there is a compelling reason to do so.
Looking for compelling reasons brings management into the picture to provide its input on likely changes. In addition, we assess the competitive forces at work in the borrower's market and determine if they are sufficiently strong to force change in one of more of the Performance Ratios. That issue is addressed in the other attached Credit Refresher on Competitive Forces and Cash Flow.
The projected credit line is then the existing line plus the cumulative cash impact of the changes in a) the Gross Margin, b) Operating Expenses as % of Sales, c) the Owner Payout Rate, d) Accounts Receivable Days, e) Inventory Days, and e) Accounts Payable Days. If this cumulative change is a cash outflow, the line increases by the amount of the change - and vice versa.
We emphasize, too, that this whole projection process is a very rough guess at best. But the process of thinking through all these issues can be very helpful to both the lender and the borrower.
All sessions, including these two, are available via 30-day recording.
Course overview: Projections and Repayment Sources