Credit: The Double-Edged Sword

A problem that takes many small businesses by surprise is also the second major cause of companies going out of business. Without the proper planning, businesses take on cash flow problems from which many can’t recover.

Companies find they can open a line of credit and use it as a safety net when there are cash flow problems. But a line of credit can also be destructive to business – especially the way they’re taking shape in the current state of the economy.

Ideally, a company would use a line of credit for short-term borrowing against receivables, says Tom Grandy of Grandy & Associates, an Owensboro, Ky.-based firm that helps those in various trades learn how to make a profit. If a check that’s expected to come in ends up being late, a check can be written on the line of credit and paid back when the late check arrives.

But if a contractor needs to finance a new piece of equipment now, it’s tempting to use that line of credit. This dilemma likely arises often for the landscape and lawn care industry.

“Equipment spending represents the second highest cost of doing business,” Grandy says. “It just so happens that the landscape industry, of all the industries we deal with (including HVAC and other sectors) is by far the most equipment intense industry in the country.”

Using the line of credit for large purchases and not paying it off quickly can lead to problems if the bank begins taking a hard look at its borrowers. This is becoming more common as banks are changing ownership and the new owners review customers’ lines of credit. Those who haven’t gotten their balance below $40,000 in two years will draw the attention of the new owners, Grandy says.

“The new owners don’t know you,” Grandy says. “If they are really nice, they will call you on the phone and tell you your $40,000 balance has been converted to a 24-month note with a monthly payment of about $2,000 a month. That is if they are nice to you. If they want to get really sticky they can – and do – give you notice that the $40,000 balance will be due ‘in full’ the first of the next month. Think it can’t happen?  It does every day, and it has the ability to put you out of business.”

Grandy’s traveling Basic Business Boot camps address ways to build up cash flow so there is enough to pay for a new piece of equipment when purchases are scheduled. Grandy suggests looking at the 10 or 20 percent the government lets businesses write off for such purchases. Also, the Economic Stimulus Act of 2008 provides relief for equipment purchases (click here to read more about it).

“Think about how much it will cost to replace the equipment and when you will need to replace it,” Grandy says. “Divided by that many years, that’s how much per year you’ll need to save. When comes time for the replacement, you’ll have the cash to do it.”

The alternative – relying on a line of credit – can be a slippery slope, especially in an uncertain economy.