It has been said that entrepreneurship is like jumping off a cliff and building an airplane on the way down. You have to have nerves of steel, steadfast conviction, and the ability to quickly react and adapt to any situation. This adaptability has been on display for all the world to see since the beginning of 2020. No one could have guessed how businesses would have to shift, pivot, and recreate themselves. Entrepreneurs have proven that they can be operational flexible. But what about financial flexibility? Have you considered the disciple of maximizing your financial flexibility?
Financial flexibility means that your company has the ability to financially adapt to any circumstance by using every asset and liability to your advantage. Here are 6 key principals of financial flexibility.
1. Cash is king. There is nothing that provides more financial flexibility than cash. Let’s face it, being an entrepreneur is full of unknowns and calculated risks. Having an appropriate amount of cash can help reduce the impacts if those unknowns and risks go against you.
2. Debt is like fire – it can cook your steak, or it can burn your house down. Debt of any kind (not just bank debt) can be a useful tool that allows you to grow and generate increased profits. However, whenever you have debt – you have someone other than the owners telling the business where, how, and when to spend (at least some of) its cash.
3. Match how you obtain an asset with the useful life of the asset. A wise client of mine once told me that he was never going to use short term cash to purchase long term assets. If you were to purchase a piece of equipment that will generate profit for your company over the next 10 years – then you should consider financing that acquisition. Don’t take working capital cash (the oil that keeps the cash generating engine going) to buy that asset. Instead, let the profits that the equipment generates over the years pay for it. A word of warning though, don’t finance the asset for longer than its useful life (even if the bank will let you). You wouldn’t finance a car for 30 years, would you? Of course not. Because in 7 years, when the wheels are falling off the car and it is not worth anything, you will still owe over 60% of what the car cost.
4. Get the longest amortization possible (as long as it is not beyond the useful life of the asset) in order to reduce your monthly payment. While this will give you the lowest monthly payment (thereby increasing your financial flexibility), it will cost you more in interest, and you will probably be charged a higher interest rate. You counter-act these negative side effects by aggressively paying debt off. For example, I have a client that purchases 5 vehicles every year. The vehicles last for about 5 years. She finances the vehicles for 5 years, but makes monthly payments as if they were 3-year loans. When COVID impacted her business and cash got a little tight, she simply told me that she wanted to go back to paying the required (lower) payment. Then after a few months, stable cashflow returned and she went back to aggressively paying the loan off. All she had to do in order to adjust to an unknown that was impacting her business was simply call me.
5. Structure your loans with the future in mind. I once had a large real estate deal blow up in my face because on one of my visits to my client’s office, he told me about how he wanted to build another building on his land in 5 to 7 years. The problem was that for the deal we were working on, the part of his land that he wanted to build on would be pledged as collateral. So in 5 to 7 years, he was going to face the frustrating choice of either refinancing the deal in order to get more cash (who knows what the rates will be like in the future), going through the process of getting part of the real estate released, or paying cash for the expansion (see point 3). Instead, he put the existing deal on hold so that he could have his property surveyed and the expansion land was excluded from the current deal. It took a little bit more time, but in the end, the entrepreneur increased his financial flexibility and strategically structured his loans.
Another point is that you should pledge only the amount of collateral required. Of course, any lender wants to decrease their risk. A loan that has a 50% loan to value is less risky than one that has a 90% loan to value. Sometimes this cannot be avoided (after all, you can’t pledge half a piece of equipment); but have an honest discussion and push your banker to secure your loan with the least amount of collateral possible.
6. Find financial flexibility in your suppliers and customers. Cash is king, so the longer you can hold on to it, the better you are. Push your suppliers for the longest terms that they will allow, then pay promptly on that day (don’t be one of their worst customers). At the same time, negotiate hard with your customers to have them pay you as quickly as possible. Sometimes this may mean that you give a slight discount for incentive; just make sure that you have that discount built into your price to prevent you giving away your profit.
This is also someplace that operational flexibility and financial flexibility intersect. Having multiple suppliers and a diverse customer base ensures that you are not held hostage to events beyond your control. Events such as a fire at your main supplier’s warehouse, the bankruptcy of your top customer, or a geopolitical issue that results in 15% tariffs on your raw goods. All of these situations not only impact your operational flexibility, but will end up costing you more, as you are going to have to place rush orders, scramble to find new customers, or pay higher inventory costs.
Many entrepreneurs focus on increasing their operational flexibility, but few are obsessed about their financial flexibility. This is not an extremely difficult concept to master. With a little bit of work, some input from your Fab 5 advisors, and a little help from your banker you will increase the financial flexibility of your company to adjust to whatever you are going to face next.
Being an entrepreneur is one of the most difficult and demanding things you can do. The good news is that entrepreneurship today is a team sport. Hit the connect button on LinkedIn or Facebook NOW and together we will work towards hitting your 10-year target. Along the way we will increase your profit, strengthen your leadership skills and transform your banking relationship into a strategic partnership. This will lead to confidence in your path, freedom to dream up bigger targets and a business that is enjoyable to own. When we connect, tell me how financially flexible your company is.
Greg Martin is an entrepreneur’s insider to the banking industry and passionately believes that every person was uniquely designed for a higher purpose and calling. Greg guides entrepreneurs in defining and achieving their purpose and calling. His deepest passion is living life with his wife and their wonderful son.
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