Understanding banking in the '90s. (The CPA in Industry)by Blumenthal, James E.
With interest rates relatively low, a growing economy, and many problem loans now behind them, bankers are again aggressively marketing loans to small and medium-sized businesses. Banking, like most industries, has undergone tremendous changes in its competitive environment. Commercial banks are faced with competition similar to that of full-line retailers: category killers. Just as superstores in office supplies, building materials, books, pet supplies, and sporting goods are gaining market share at the expense of conventional retailers, money market funds, mutual fund families, specialty credit card companies, and a variety of asset-based lenders are invading the territory of commercial banks. In addition to the competitive advantages these specialists have developed in product offerings, marketing techniques, and operating efficiencies, they also face fewer regulatory and geographic constraints than commercial banks offering the same services.
Banks are responding to this challenge by offering a wide range of fee- based services. Although bankers still talk of "relationships," their services have been unbundled. Each service must stand alone as a profit center. This fee frenzy results in higher costs for banking services formerly provided as either part of the relationship or subsidized by other high-margin services. Only businesses that aggressively seek out the best vendor for each service and negotiate a deal to meet their requirements, will benefit from the competition. As a result of the banking industry's intense competition, rapid rate of product development, evolving technology, and continuing consolidation, most businesses will benefit by dealing with several financial service vendors. The dynamics of the banking industry, fluctuating interest rates, and a changing economy, dictate that businesses and other borrowers of capital regularly review all of their financial service arrangements. For example, in most commercial accounts an interest credit is earned based on account balance. This credit is used to offset fees incurred in the account. Since banks do not pay interest on checking accounts, any amount of this earned credit in excess of fees in a checking account is lost. The bank will, of course, charge for the amount that the fees exceed the interest credit (heads they win--tails we tie). This situation may be corrected by having the bank analyze the account annually instead of monthly. This will net the winning and losing months. The amount saved can be substantial, particularly if the business is seasonal.
Cash-management accounts, which invest excess funds overnight, generate interest income while keeping the balance free for use in the business. While the interest rate paid varies daily, the fee is usually fixed. When interest rates decline, the earnings may not cover the fee. Assuming a $100 per month fee and three percent interest rate, it would take an average collected balance of $40,000 to break-even.
For a Rainy Day
Managers and businesses will want to create a banking umbrella that will be available in the rainy season. The key will be an open line of communication and a history of supplying reliable information. Bankers love consistency and hate surprises. Financial statements should be supplied on a timely basis as specified in the loan documents. Company management should create a covering letter explaining any significant variances from prior periods or projections. The presentation in the letter to the lender should cover both the problem areas and the solutions. It is also important to point out any positive surprises resulting from management's ability to capitalize on a specific opportunity. This will make period-to-period comparisons easier to understand. These explanations should relate to the balance sheet as well as the income statement. The letter should also address deviations expected to occur in the future. The best lead-in to a discussion of a problem is "As we anticipated...." The letter should include an update concerning the progress of the on-going effort to control expenses and manage working capital.
The presentation of interim financial information is a valuable tool for getting a message across. Managers should select an accounting package with a flexible account numbering system and a good report writer. If necessary, the company chart of accounts should be redesigned to meet the information needs of the banker. Multiple account levels can easily generate statements with varying levels of detail. Expense accounts should be selected that are standard for your industry. Trade associations can probably provide guidance this area. Trade associations may also be able to provide typical financial ratios for the industry.
In addition to helping the banker cover himself or herself with superiors, not to mention the bank's regulators, a periodic, comprehensive, documented review of the business will focus management's attention on challenges and opportunities they might otherwise miss. An in-depth understanding of the impact that operational decisions have on the income statement, balance sheet, and cash flows is not only helpful in impressing the banker, but it can dramatically improve the company's business.
Establishing relationships with several banks will help keep financing options open. Institutions with non-lending financial products are prime candidates. A package to distribute to these vendors should be developed. The package should include background information about the operation, a description of the business, where it stands in its industry, competitive advantages, management background, and ownership structure.
While personal relationships are still crucial for securing financing, presentation and documentation are becoming increasingly important. Decisions are often made by people not directly in the relationship. While the banker may live and work in the neighborhood, access to financing is probably controlled by someone in a far away place practicing global asset allocation. In other words, you could have your umbrella taken away due to someone else's rain storm.
James E. Blumenthal, CPA, is controller of Metro Feeds, Ltd., a distribution company located in Columbia, Maryland.
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