Friday, March 20, 2009

Credit -- Use it or You May Lose it

News Flash: Banks, credit card companies and other lenders are reducing "dormant" lines of credit. Why might that be a problem? We'll explain later -- first, some background.

Credit is a topic that's surfaced regularly in recent meetings of Chief Executive Boards International. Granted, most business owners are borderline allergic to debt. That emotional bias aside, debt is one of the tools in the business owner's toolbox, and it's there for a reason.

Simply stated, debt is a good thing whenever you can

  • Be confident of available cash to service the debt (from within the business or elsewhere)

  • Get a far better return on the capital from investing in something than the interest rate on the debt

  • Have a fallback strategy by which to retire the debt if you absolutely had to (with cash from within the business or other sources)

  • Get over your debt allergy

"Cash is King" -- seen almost daily in the business press, has rarely been more true. A more financially sophisticated view might expand that to "Available Cash is King." In fact, your existing credit lines qualify as available cash. And CEBI members are making good use of available cash right now, for things like:

  • Buying durable inventory at distressed prices (from suppliers or competitors)

  • Buying equipment and machinery at distressed prices (from almost anyone)

  • Buying real estate at distressed prices

  • Investing in people, promotion, training, maintenance, etc. to ensure the company's market strength in a recovering economy

  • Pulling cash out of the business and investing it personally in good opportunities (distressed equities, real estate, etc.)

Let's agree, then, that keeping your credit lines open and available is an essential strategy -- in case of a short-term need for cash for almost any reason. And at current interest rates, almost any use of capital will return 2x - 10x (or more) the cost of renting the money (interest).

The news flash you should be aware of is that banks and other lenders are reducing lines of credit that aren't being used. Credit card companies are reducing limits or cancelling credit cards that aren't being used.

So, what's with this lender behavior? Simply stated, it's the way bankers think. They see a credit line as a potential need for cash, of which they might have short supply. And in some arguably circular logic, comprehended only by bankers, they see taking an unused line down from $250,000 to $100,000 as somehow making themselves $150,000 better off -- despite the fact it wasn't being used anyway. Oh well.

How might you keep this from happening? I may be a good practice to just exercise each or most of your credit lines on occasion. You fire up your standby generator every month or so, right? It doesn't take much diesel fuel, and you don't run your plant on the generator all day, do you? Wouldn't make sense. You do this to be sure the generator will be there when you need it.

Likewise, you can exercise your credit. How much available credit do you have in your wallet? For many of us, it's over $100,000. And if one of those credit cards goes away, it's correspondingly less. Fact is, your credit score is based on your current outstanding balances as a ratio of your total available credit limits. Why not use each of those cards regularly to keep the issuer interested (even if you pay it off every month and don't pay a dime in interest)? They're happy as clams with a 2%-3% merchant fee for an average of 20 days' float. It's easy to see, also, that getting limits raised on your credit cards works in your favor -- just make the phone call.

At today's interest rates, exercising a $100,000 hit on your revolving LOC for a week costs you maybe $100 in interest. Do it every 90 days or so -- good insurance. You might want to do the same with your home equity line. If you don't use it, you may lose it.

The premise of this article is that you're a savvy business owner who sees (or is watching for) opportunities to invest available cash in high-return strategies, and that your credit lines can provide that cash quickly when those opportunities come up. It further assumes that you shouldn't be the source of that cash. Instead of keeping $100,000 on hand in the business for a "rainy day", pull it out of the business, out of reach of creditors and lawsuits, and use $100,000 from the bank. Don't spend it -- invest it in an asset for your own balance sheet.

Think about it -- would you rather have an additional $100,000 on your personal balance sheet and $100,000 of debt on the company's, or zero on both?

The idea that debt isn't intrinsically bad and that available credit is an essential business strategy is provocative, and not a widely held view among business owners. Whether you agree or disagree, please click on "Comments" below and let us know.

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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