by Mark J. O'Donnell
The published timing, direction, and magnitude of the U.S. economic impacts seem to change monthly. This environment dictates that we stay nimble and prepared for the rest of 2024. This month, consider your current financing structure and gather information to prepare for either positive or negative economic changes over the next twelve months.
The debt environment and interest rates:
- The Federal Reserve currently indicates interest rates will be “higher for longer.” For small businesses, this means that debt interest will remain expensive compared to recent years and is not likely to drop significantly before the end of 2024. We recommend changing your expectations for this year accordingly.
- The current economy is impacting our banks. Economic conditions influence them, and according to a recent Federal Reserve survey, some banks are tightening their lending policies. That may impact your ability to borrow, or even renew existing debt.
Three recommended steps:
First, get a clear picture of your current interest-bearing debt.
1. Summarize your line of credit, its terms, the current borrowing base available, and a recent history of the line of credit balance as a percent of the borrowing base.
2. Review your installment debt, and its collateral, and schedule your future payments by month.
3. Your personal guarantees. Some or all of these debts may include personal guarantees.
Second, visit with your accountant. Become well-versed in these ratios and concepts critical to evaluating debt, which may come up in discussion with your banker. Pay particular attention to any debt covenants contained in your loan documents, which probably include one or more of these ratios:
- Working capital
- Current ratio
- Debt to equity ratio
- Debt service coverage
- EBITDA
Finally, visit with your banker. Your objective is to get information and advice from your banker and understand how the banker evaluates your company. Here are a few items you can cover:
A. The bank’s analysis of your recent financial statements. Listen carefully for opinions about your financial strengths and weaknesses.
B. Your ability to borrow additional funds. You may need a loan to finance an asset purchase or to fund an unexpected short-term decline in business (recession, customer loss, etc.).
C. Your collateral for the loans. Bank loans require collateral in unencumbered company-owned property and your personal guarantee. You must understand the terms of the collateral agreements; some may be unexpected. In addition, it will be valuable to know what assets you have that may be available as collateral on a new loan,
Armed with this information, you want to revisit your overall strategy and financial projections for the rest of the year. For example, if you determine that, based on your forecasts, you will need more money than the bank seems comfortable lending, it’s a good sign that you have bumped into a guardrail and cannot execute your projections without additional action on your part. You then need to look for other sources financing, internal and external.
In summary, your debt structure can protect you in tough times and allow you to accomplish business goals faster than if you self-finance. However, too much debt relative to your business can eliminate opportunities to accelerate growth and may cause serious business financial problems. In this environment, we recommend that you carefully consider and manage your debt and, if possible, stay well below what may be regarded as ‘too much debt’ by your bank and other financing sources.
Mark O’Donnell, CPA, is Partner at Schmersahl Treloar & Co. He can be reached at 314.966.2727.