Why Banks Won"t Lend to You!
For a quick review of history, in September 2008 the US faced the largest financial crisis since the Great Depression.
Financial institutions such as banks stopped lending monies.
The secondary markets for lending quickly dried up as well.
The US Government and US Federal Reserve became the majority lending source and provided capital to financial institutions to keep them solvent.
Large institutions recovered in the spring of 2009 and began lending monies to large corporations.
Smaller institutions have not been able to recover and the amount of bank failures has continued to soar (106 failures per Yahoo! Finance as of October 24, 2009 and 122 accounting to The Atlanta Journal-Constitution on October 25, 2009).
Large banks will not lend to small businesses due to risk and small banks will not lend any business because they lack the capacity to do so.
In retrospect, Washington saved Wall Street instead of Main Street.
Many would say this is the exact opposite of campaign promises.
So why are large institutions lending to large corporations and not small businesses? First, large corporations have reacted quicker than small businesses for cost cutting.
Large corporations began major cost cutting initiatives in the fall of 2008 and continued to do so until the summer of 2009.
Second, large corporations have investments as an asset on their balance sheet.
Over time, large corporations begin keeping higher cash balances and begin building investments (usually conservative in US government and other bonds).
These investments act as collateral for loans.
Third, large corporations had different cash flow management of the major cash outflow items.
Large corporations pay interest and principle payments, then income taxes and then dividends (equity distributions).
The priority for large corporations cash outflow is first its obligations to the bank and government and then to its shareholders.
How is this different than small business behavior? Small businesses were slow to cut expenses.
Additionally, small business owners were slow to adjust their life-style.
Not changing their life style placed additional cash flow pressure on their small business.
Generally speaking, large corporations cut costs a level or two of management above the operation of the cut.
This allowed for a business decision with no or little emotional interference.
Small business owners have a more direct connection with the employees they lay off and waited to long to do so due to this relationship.
Small business cash flow began to slow and then quickly dry up early in 2009.
When they realized cash flow was a problem their financial situation was already up side down (cash, inventory and accounts receivable were less than accounts payable and other current liability).
Small business stopped spending all together in their panic.
Small businesses usually do not have any investments on their balance sheet.
Usually, the small business is the investment! Small businesses usually have no items to use as collateral (except for personal assets).
Small business cash flow management is dividends (equity distributions), interest and principle payments and then tax payments.
This is the exact opposite of large corporations.
Due to tax code opportunities small businesses have raided their equity over the years and usually distribute the entire equity amount to the owners (s-corporations and partnerships).
The prevailing message can be interpreted as small businesses pay themselves first, banks second and the government last.
They could get away with this cash flow formula in good times, but with a hiccup or more the cash flow nightmare quickly became reality.
So what can small businesses do amount it? The answer is to repair their balance sheet! First, build cash and collectible receivables.
Second, manage inventory more efficiently.
Third, reduce accounts payables and other current liabilities.
Fourth, build equity (make sure it is positive).
Fifth, review long-term debt and decide if it is necessary to reduce.
Sixth, begin a conservatively run investment account you can use as collateral (in the business or individually).
With investments as collateral you should not have to personally guarantee the debt.
Financial institutions such as banks stopped lending monies.
The secondary markets for lending quickly dried up as well.
The US Government and US Federal Reserve became the majority lending source and provided capital to financial institutions to keep them solvent.
Large institutions recovered in the spring of 2009 and began lending monies to large corporations.
Smaller institutions have not been able to recover and the amount of bank failures has continued to soar (106 failures per Yahoo! Finance as of October 24, 2009 and 122 accounting to The Atlanta Journal-Constitution on October 25, 2009).
Large banks will not lend to small businesses due to risk and small banks will not lend any business because they lack the capacity to do so.
In retrospect, Washington saved Wall Street instead of Main Street.
Many would say this is the exact opposite of campaign promises.
So why are large institutions lending to large corporations and not small businesses? First, large corporations have reacted quicker than small businesses for cost cutting.
Large corporations began major cost cutting initiatives in the fall of 2008 and continued to do so until the summer of 2009.
Second, large corporations have investments as an asset on their balance sheet.
Over time, large corporations begin keeping higher cash balances and begin building investments (usually conservative in US government and other bonds).
These investments act as collateral for loans.
Third, large corporations had different cash flow management of the major cash outflow items.
Large corporations pay interest and principle payments, then income taxes and then dividends (equity distributions).
The priority for large corporations cash outflow is first its obligations to the bank and government and then to its shareholders.
How is this different than small business behavior? Small businesses were slow to cut expenses.
Additionally, small business owners were slow to adjust their life-style.
Not changing their life style placed additional cash flow pressure on their small business.
Generally speaking, large corporations cut costs a level or two of management above the operation of the cut.
This allowed for a business decision with no or little emotional interference.
Small business owners have a more direct connection with the employees they lay off and waited to long to do so due to this relationship.
Small business cash flow began to slow and then quickly dry up early in 2009.
When they realized cash flow was a problem their financial situation was already up side down (cash, inventory and accounts receivable were less than accounts payable and other current liability).
Small business stopped spending all together in their panic.
Small businesses usually do not have any investments on their balance sheet.
Usually, the small business is the investment! Small businesses usually have no items to use as collateral (except for personal assets).
Small business cash flow management is dividends (equity distributions), interest and principle payments and then tax payments.
This is the exact opposite of large corporations.
Due to tax code opportunities small businesses have raided their equity over the years and usually distribute the entire equity amount to the owners (s-corporations and partnerships).
The prevailing message can be interpreted as small businesses pay themselves first, banks second and the government last.
They could get away with this cash flow formula in good times, but with a hiccup or more the cash flow nightmare quickly became reality.
So what can small businesses do amount it? The answer is to repair their balance sheet! First, build cash and collectible receivables.
Second, manage inventory more efficiently.
Third, reduce accounts payables and other current liabilities.
Fourth, build equity (make sure it is positive).
Fifth, review long-term debt and decide if it is necessary to reduce.
Sixth, begin a conservatively run investment account you can use as collateral (in the business or individually).
With investments as collateral you should not have to personally guarantee the debt.
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