Harold Thought He Knew His Banker

It was early spring; the temperatures were much warmer than normal as the banker walked down the sidewalk to see his customer.  Harold knew his banker was coming, he just could not figure out why.  His line of credit was in good shape and he had not missed a loan payment in years.  Harold thought the banker was making a courtesy call – Harold couldn’t have been more WRONG.

Harold soon found out that this was going to be one of the worst days of his life. His banker had come to tell him that his line of credit of $250,000 and the $325,000 equipment loan was being called.  Harold had 30 days to find other financing.   If you haven’t had the opportunity to experience this, it is like being hit (unexpectedly) by a truck, it is a demoralizing experience.

What Harold did not realize is that the banker had been reviewing the profit performance of Harold’s business for the last 18 months. And there wasn’t any (profit).   The banker had been looking at the monthly financial statements each month, whereas Harold didn’t give them much thought.  The company was paying their vendors (although a little slower than normal), making payroll and keeping their loan payments current.  Harold didn’t think there was anything to worry about.  Don’t let this happen to you. 

Here is an easy way to tell if your company is making enough money to keep your banker happy (and if your banker is happy, you can relax).  For the last 12 months:

  1. Add up the interest expense on your line of credit,
  2. Add up all of your payments on term debt (principal and interest)
  3. Add: a) net profit, b) deprecation expense, c) amortization expense and d) all interest expense (including your line of credit)
  4. Add 1 and 2 together and divide that into 3, that numbers should be 1.25 or higher.

Example – for the last 12 months:

Debt Service requirements:

  • Interest on line of credit – $20,000
  • Payment on trucks (P&I) – $36,500
  • Payments on Equipment Loan (P&I) – $37,500
  • Total – $94,000

Cash Flow Generated by Company:

  • Profit – $50,000
  • Depreciation – $32,500
  • Interest – $43,400
  • Amortization – $0
  • Total – $125,900

Calculation $125,900/114,000 = 1.33

In this example, the company has cash flow of $1.33 to service $1.00 in debt (principle and interest) for the last 12 months.  Lenders will typically look at this annually.  If your bankers are looking at this, so should you.

Have a Great Week,

Dan Lacy

The Prophet of Profit