Managing cash flow and loan facilities during difficult economic times

Managing cash flow can be challenging for many business owners in the current economic climate.  It’s critical to understand how managing your accounts receivable (“A/R”), for example, can impact your cash flow and your available credit and lending costs with your lender.

Even if you’re paying your loan payments on time, your lender may send you a default notice because your company has violated certain financial covenants in your loan agreement.  There are several different financial covenants and tests that your lender may use in your loan agreement.  A common financial covenant is the Fixed Charge Coverage Ratio (“FCCR”).  This covenant requires that your earnings or cash flow exceed your fixed charges by some ratio, usually starting from 1.15 to 1, to 2 to 1. If you are lax in managing and enforcing your A/R, you may drift into default because of the FCCR.

Once you default on a financial covenant, your lender normally has the right to impose all sorts of new costs and requirements on your business that will make cash flow even tighter.  For example, your lender could increase the interest rate to the default rate, usually several percentage points higher than the normal rate.  The lender could also require monthly inventory checks by an outside party, more frequent and reviewed or audited financial reports, outside valuations of equipment and assets, and even require you to hire an outside CFO.  Your company will be required to pay for all of these additional services and inspections, potentially putting great strain on your cash.

Failing to manage your A/R can also reduce the available credit you have from your lender.  Some banks loan money based on a percentage of the value of a company’s assets pledged as collateral, which can include a company’s A/R.  This borrowing base typically sets the maximum credit available to a company.

However, letting A/R get beyond 60 days or more may make those assets ineligible for borrowing base purposes. You may be surprised to find out that A/R you thought was included as an asset in your borrowing base, is actually excluded under the bank’s formula.

Not receiving A/R from the customer timely, plus not having the A/R count towards your borrowing base can have a double-negative impact to cash flow.   

Some best practices to help manage cash flow include:

• Staying on top of A/R and receiving timely payments from your customers.
• Reconsidering selling to slower paying accounts, or moving to cash-on-delivery payment terms.
• Performing your own due diligence on customers who appear to have trouble paying on time. 
• Obtaining credit reports and other background information on potential customers before extending any credit.
• Avoid using your line of credit to buy capital assets, and either delay the purchase until you have the cash or obtain a term loan instead.

Managing your A/R and familiarizing yourself with the scope of the financial covenants in your loan documents may help avoid a default which can further strain your company’s cash flow in this challenging economic environment.