The question of how do credit and cash reserves affect your company is a great question. And it’s one the majority of business owners don’t consider properly. There are a number of factors that this answer affects, such as how it affects the line of credit a bank will extend, the line of credit vendors will extend your company, and your companies survival rate.
Let’s begin by discussing your bank or banks.
How do they decide how large a line of credit they will extend your company?
Different banks have different criteria. And their criteria can change at any time without any notice. Every bank looks at your lowest daily bank balance. Generally, they will go back between three and six months and sometimes further. They want to see how well you manage your cash flow.
Next, they will look at your average daily bank balance. Again, they will look back three to six months or longer. This will be followed by looking at your highest daily bank balance.
If you have bank accounts with multiple banks they will want to see these factors for all your bank accounts. They do all this before looking at your business credit scores. One area many business owners don’t think about is how increasing their lines of business credit will help them increase their cash reserves. It is often easier to increase your line of credit with a vendor. When you pay your vendors as agreed and the orders you are placing with them are growing, they perceive your business is growing too. This will generally motivate them to increase your line of credit to ensure they get the majority of your business. Your vendor may check your business credit when making a decision to increase your line of credit.
However, most vendors are motivated by payment history and the potential of increasing their business. Cash reserves are also critical when regional, national or global economics affect your business. Here are a few items many business owners don’t consider.
I saw twenty percent interest rates for real estate First mortgages and much higher rates for other forms of debt instruments during the late nineteen seventies global recession. Then the Savings and Loan Crisis in the nineteen-eighties where over seven hundred savings and loan associations in the USA went bust. Then Black Monday on October nineteenth, nineteen eighty-seven, when the stock market lost over twenty-three percent of its value in one day. Followed by the nineteen eighty-nine Junk Bond crash. Then the Dot.com bust in two thousand. And most recently the two thousand eight Global financial crisis that took over six years for businesses to dig their way out of. Recently the world has experienced Covid-19 and the massive economic damage it has created. All of these events dramatically affected businesses of all sizes.
Because I was inexperienced I suffered unnecessary losses during some of these events when I was starting out. Since then I have learned how to be prepared for anything that affects the domestic and or the global economy. I didn’t understand how these events could affect my business in my early years in business.
Today, I am much wiser. I coach all my clients to keep a minimum of one hundred eighty days of operating cash reserves. Not necessarily in their primary bank account with whom they have their line of credit. Every bank loan has covenants in it that you must comply with. When a bank changes its loan criteria it often has ways of calling or reducing your line of credit which can deplete your cash reserves. With one hundred eighty days of liquid cash, you should be able to survive any financial crisis that happens, providing you act wisely. When the markets have crashed in the past, the companies with cash reserves have weathered the storm.
Remember, business kept going, it was just not as much business as before the event. Revenue dropped and when they do you need to reduce costs too. Cost-cutting combined with current revenue and your cash reserves have the ability to stretch a company’s life to a year or two until business picks up again. I know businesses that are now dominant players in their market years after a crash because their competitors failed or shrunk during a financial crisis, while the business with sufficient cash reserves had the resources to grab market share.
How much cash reserves does your business have?
Until next time,