Debt Matching

August 22, 2018

I recently sat down with a prospective client who wanted to do some cash flow forecasting, a pretty common request.  They had recently done some debt restructuring and now had some bank covenants they needed to hit by the end of the year.

As they spoke I must have been nodding my head while I was taking notes because at one point the client said “I take it you’ve seen this before, right?”  Then I proceeded to talk to them about how easy it can be when times are good to use both profits and short-term financing together to launch into the next new project or asset acquisition.  Then when profits slow down and your operating line is maxed out there are really only three options: sell something big, have ownership inject capital, or restructure your long-term debt to pay-down the short term debt.

Here’s the thing to remember when using financing in your business: finding a good match is important.  If you’re needing an operating line of credit for normal working capital, fine.  If you’re using your operating line to acquire long-term assets then you’ve mismatched short-term debt with a long-term asset and you’re likely headed towards a debt restructuring or capital call at some point – at the very least you just bought yourself several meetings with your banker!

Instead use long-term debt when acquiring long-term assets.  Get a loan that has slightly shorter amortization than the asset’s estimated useful life.  Short-term interest rates can be attractive, but be careful, they are also variable.  In a time of rising rates you could get caught with high debt service costs.  Instead look at fixing your long-term rates and get loans with a low (or no) pre-payment penalty to give yourself options later if you need them.

If you currently find yourself in a tight spot with a maxed out operating line, but have good equity in your long-term assets you can probably restructure your debt, pull capital out of your long-term assets and pay down your operating line.  This is fairly common “get-out-of-jail” maneuver, but it’s not “free”; expect to receive a good kicking when it comes to paying loan fees on the new debt. Doing this more than once in a relatively short period of time and you might as well rent the office next to your banker, you’ll be seeing a lot of each other.

Speaking of working with bankers, if you’re getting calls from banks you’re not working with – good, take those lunch meetings.  Simply having bankers call on you is a good sign, doesn’t mean you have to take a loan from every banker that stops by, but having a relationship with more than just your current bank may prove valuable down the line. 

About the Author

+Geoff Chinnock is managing principal with Morrison & Company, providing business planning (including budgeting, cash flow forecasting, and strategic planning), special projects, and has greatest expertise in interim/outsource financial services and special projects that don't fit into any conventional category.  You can contact Geoff directly at gchinnock@morrisonco.net or via telephone at (530) 893-4764 Ext. 204

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