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How Can You Borrow the Right Way in Order to Make Your Dream Cool Store a Reality?

How much you want isn’t the bank’s main concern. It’s how the debt is structured, says Laurie Owen.<




Cool Debt

You’ve drooled over the “Cool Stores” featured in this magazine for years. You’ve dreamed and schemed, found the perfect site and formulated a cutting-edge look. You’re confident that your sales forecast will more than cover the costs of the project. You’re ready to pull the trigger. But unless you’ve got a rich uncle or a stash of cash, chances are you’re going to have to bring in a bank to help make your own cool store a reality.

When borrowing money, you have to be ready to do more than answer the question “How much?”. You’ll have to answer “How?” But in normal borrowing situations, almost every business owner we know focuses on the issue of “How much?” as the primary concern.

Perhaps it will surprise you to learn that the question, “How?” is equally important. In fact, a wrong answer to this question is the most frequent cause of banker-business owner friction.

“Borrowing wrong? Is that possible?” you ask. Our answer is that it’s not only possible, it’s likely unless both customer and lender approach each borrowing situation armed with a firm understanding of the basic financing patterns — and the lending requirements for a proper structuring of the liabilities.

Fortunately, this complex combination of factors can be simplified by using the diagram below. The “snake-on-the-ramp” (see graphic below) will allow us to focus on the issue of patterns of asset growth.



Finance 101

Current assets are those that will be used up within a year. Typically, inventory, receivables, and cash are current assets. Fixed assets are those assets whose life-span extends over a year. Examples would be store cases, fixtures and buildings. Equity is what you own in a business, and debt, of course, is what you owe. SHORT-TERM DEBT is debt that is required to be paid back within a year. An example would be a line of credit. Bankers typically expect a line to be paid down to zero for a specific period of time, say 30 days, at least once a year. LONG-TERM DEBT, or a “term loan”, is paid off over a longer period of time.

Net profits are what’s left after you pay all your expenses, and cash is what you have in your bank account at the end of the day. And as we will see shortly, profits do not always equal cash, especially in a growing company!

Financing Patterns

Growing businesses often require an increased investment in both current and fixed assets. Inventories grow, receivables expand, and stores get upgraded. Even in a profitable company, cash needs can often outstrip profits. (My ex-banker partners call this the “Hoover Effect”.) If improperly managed, growth can cause a shortage of cash; therefore, the business owner must carefully assess future asset investments and plan for their financing.


In evaluating increases in assets, it is critical to understand the pattern of growth. First, carefully examine the relationships between sales increases and asset growth. The “snake” graph illustrates this relationship for the three essential types of assets: fixed assets, permanent current assets, and fluctuating current assets. Let’s look at each one individually.

Fixed Assets

Fixed assets are those that tend to be of a more permanent nature and are usually capitalized and depreciated over time. Note that the pattern tends to be a “stair-step” one. Fixed assets normally relate to fixed costs — those that don’t change relative to sales. However, increases in fixed assets over time generally relate to “capacity” considerations — thus, increases occur in lumps, such as store upgrades, equipment additions, or store expansions. If you will own your building, your loan structure likely will resemble a home mortgage, with the rate fixed for five to 20 years. The longer the term, the higher the interest rate banks will charge. This loan should be separate from the loan for other fixed assets such as showcases, lighting, etc., which have a shorter useful life (and loan term) than a building.

Permanent Current Assets

Permanent current assets are defined as base levels of cash, accounts receivable, and supply inventory. By base level, we mean that level below which — even in a seasonal business — these assets never drop. For example, if an inventory level of $1 million is required to support a revenue level of $2 million, then you can expect an inventory level of $1.5 million will be required to support revenue of $3 million — assuming inventory turnover remains constant. If this sales increase reflects long-term growth and not a seasonal fluctuation, then the company will experience a permanent increase in base level inventory.

Fluctuating Current Assets


Jewelers experience a seasonal pattern in their sales. Consequently, there is an accompanying increase in inventory and/or accounts receivable during these peak seasons that drops off during the rest of the year. These seasonal peaks and valleys in sales result in a portion of current assets that go up and down, and are therefore known as fluctuating current assets.

Structuring Liabilities

Yes, it’s back to that “How?” question. All assets require some source of funds to acquire them in the first place. When the source of the money is borrowed funds, it is absolutely critical that you match the length of the debt with the purchased asset’s ability to generate cash flow or net profits and thus repay the debt.

As our graph shows, fixed assets are generally financed by equity and long-term debt and — if long-term debt is used — are repaid out of net profits over the life of the assets.

Fluctuating current assets — or seasonal assets — represent short-term investments; thus, they are financed with short-term debt, such as a line of credit, and are repaid out of the cash flow generated by the liquidation of the assets that aren’t replaced at the end of the season.

Perhaps the most difficult concept to grasp is the idea of permanent, base-level increases in current assets when a company incurs real (vs. seasonal) growth. Since these increases represent permanent increases, they behave more like a fixed asset. Therefore, they should be financed with equity, permanent current liabilities (expanded credit from suppliers), and intermediate-term debt.

Ignoring these principles — and incorrectly financing the business — is the most frequent cause of trouble between owners and lenders. We can’t tell you how many business owners we’ve encountered who have used their lines of credit to pay for store expansions. When they can’t pay off the line at the end of the year, their bankers tend to get a little worried and the business owners a lot stressed.

It is essential that you do not use short-term debt for permanent-type assets (When this is done, the ensuing flail is often termed “restructuring.” What this frequently means is that the financing was done wrong the first time and now needs to be fixed).

What our snake diagram points out is that “How” is just as important as “How much” when it comes to financing. Structuring your debt properly is a key task that can only be done as a part of the total planning process. With proper planning, many lending problems and bad feelings can be avoided — if each business owner and banker would understand, remember, and apply “snake-on-the-ramp” analysis.

Go for that cool store but make sure you’ve got an equally cool and correct financing plan in place.


• Get advice if you’re not comfortable with the balance-sheet side of your statements.
• Find a knowledgeable, experienced banker and get their input.
• Ask your CPA to help you develop cash-flow forecasts for your new project.
• Use financial analysis software to do some “what-if” scenarios based on different sales levels and financing options.
• Talk to other business owners who’ve successfully grown their businesses. What did they do right? What do they wished they’d done differently?

Laurie Owen is senior vice president at Business Resource Services.



This Third-Generation Jeweler Was Ready for Retirement. He Called Wilkerson

Retirement is never easy, especially when it means the end to a business that was founded in 1884. But for Laura and Sam Sipe, it was time to put their own needs first. They decided to close J.C. Sipe Jewelers, one of Indianapolis’ most trusted names in fine jewelry, and call Wilkerson. “Laura and I decided the conditions were right,” says Sam. Wilkerson handled every detail in their going-out-of-business sale, from marketing to manning the sales floor. “The main goal was to sell our existing inventory that’s all paid for and turn that into cash for our retirement,” says Sam. “It’s been very, very productive.” Would they recommend Wilkerson to other jewelers who want to enjoy their golden years? Absolutely! “Call Wilkerson,” says Laura. “They can help you achieve your goals so you’ll be able to move into retirement comfortably.”

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