Home' Trinidad and Tobago Guardian : January 10th 2015 Contents The caseFrancis, 49, has been running a
very profitable equipment rental
company for the past eight
years. The business afforded
him a comfortable lifestyle, two
homes, three vehicles and a
healthy bank account.
Recently, a large player in the industry has
been gobbling up market share with high-
tech equipment and cheaper prices. This com-
petitor has been courting one of Francis top
clients whose has a contract for four out of
the company s 10 pieces of equipment. This
expires in two months.
The business monthly commitments
include: office building rent: $20,000, salaries
for six employees: $40,000; miscellaneous
expenses: $27,500 and five bank loans totaling
$38,000---used to finance one property, two
vehicles and the four pieces of equipment cur-
rently in the client s possession.
The total debt is $4.2 million while the
assets include: cash at bank: $200,000, vehi-
cles: $450,000, fixed assets: $100,000, rental
equipment valued at $2.5 million and the two
properties valued at $1.8 million and $1.5 mil-
One piece of equipment is usually rented
out for $500 per day. Francis has been con-
sidering accepting an overdraft from his bank
for $250,000 to be secured by the existing
mortgage. He believes this will be a good back
up plan if things take a turn for the worse.
Nick's assessment and advice
Any seasoned entrepreneur will admit that
stability could breed complacency and a change
in fortunes can happen at any point in time.
As such, some feel more comfortable holding
on to as much cash as possible.
The question of how much cash to keep on
hand is difficult to answer as too much cash
could be unproductive from a return-on-
As far as Francis is concerned, the long peri-
od of income stability has not warranted more
than $200,000 in cash reserves. Whether this
is a good decision or not will be discussed
Cash as a cushion is really only a temporary
measure to business success. If a business is
not sustainable, reserves will eventually be
depleted. Francis is considering adding an
overdraft of $250,000 to his working capital.
However, if he doesn t sit up an take a note
of the changes in his industry and adapt
accordingly, he could find himself out of busi-
ness sooner rather than later.
What could make things worse is having
too much debt when things are about to
decline. A great temptation of any successful
business is to borrow more than is necessary
when things are going well, and when things
get worse, borrow some more.
Taking on too much debt to finance unpro-
ductive assets---even if there are tax benefits---
can put a drain on a business resources.
We have not been given the breakdown of
Francis debts but, from our calculations, his
debt-to-asset ratio is 64 per cent ($4.2 mil-
lion:$6.5 million). This means for every $100
of asset he owns; he also owes $64 in debt.
This may not seem too bad if we consider his
current monthly debt to income ratio of only
25 per cent ($38,000:$150,000) assuming full
capacity ($500 x 30 days x 10 pieces of equip-
ment = $150,000).
If we were to factor the impact of his top
client leaving, then this ratio will jump to 42
per cent ($38,000:$90,000) assuming ($500
x 30 Days x 4 pieces = $60,000) and ($150,000
- $60,000 = $90,000). This may not seem
too glaring if we consider the lenders standard
debt service ratio of 40 per cent of income.
However, if we look at his numbers from the
standpoint of profitability, the picture would
be much different.
Expense ratio and profits:
Francis expenses are currently 84 per cent
of his income ($125,000 : $150,000). If he
loses $60,000 in revenue, at this level of
expenditure the ratio will jump to 139 per cent
($1,255,000 : $90,000).
What this means is from making a monthly
profit (or positive cash flow) of $24,500
($150,000 -- $125,500) Francis would now be
making a loss (negative cash flow) of -$35,500
($90,000 -- $125,500).
If this continues unabated, Francis "healthy
bank balance" of $200,000 will be exhausted
in less than six months ($200,000 / $35,500).
If the overdraft of $250,000 were in place, he
would have another seven months of working
capital to tide him over. But then what?
If Francis does not have a sustainable plan,
he will simply be digging one hole (the over-
draft) to cover another (the monthly loan pay-
ment). When the overdraft is maxed out, the
loan payments will fall behind and lenders
could move against collateral items such as:
property, vehicles and equipment.
The above scenario might appear a bit pes-
simistic, however, it is important to give it
some attention because many businesses delay
addressing a financial problem only until a
crisis is upon them.
There is also false hope---some entrepreneurs
have---that things will always get better. Some
entrepreneurs get so comfortable with the
levels of expenditure---or lifestyle---they enjoy
and erroneously finance it with more debt
simply to maintain the status quo.
Trim the fat: When faced with an uncertain
future, it is always a good idea to get lean.
Times of plenty could cause businesses to be
a bit more liberal with expenses and satisfy
wants instead of needs.
Francis would need to enlist the support of
his team to economise as much as possible in
order to guarantee their employment moving
forward. He must be very careful, however,
not to create panic among the ranks. Instead,
he must tactfully use the situation as an oppor-
tunity to increase productivity.
Damage control: When business is good,
it is not difficult to take customers for granted
and treat them with indifference. A customer
will not leave a business that consistently sat-
isfies its needs in an efficient, friendly and
economical way. When done right a client will
sometimes remain loyal regardless of a com-
petitor s offerings of cheaper, faster, better
goods and services. An audit of customer sat-
isfaction should not be left as a last resort. If
done, then measures should be introduced to
fix broken relationships immediately and retain
the business on the books.
The market mix (price, place, promo-
tion, packaging, product): Identifying the
market s needs and providing innovative solu-
tions are key pillars in business success.
Francis may have to rethink his product or
service offerings. He may need to sell off aging
or outdated equipment and replace them with
newer models or simply upgrade to remain
relevant. He could consider new applications
for the same equipment and open up markets
that didn t exist before. He can adjust any of
the five Ps of the marketing mix to stay afloat.
Address debt: Francis is considering an
overdraft facility---a finite resource which only
buys him time---so he must devise a plan that
is geared towards eliminating this and other
debts so there is less burden on his cash flows.
He might be able to consolidate or restructure
short-term debts---vehicle and equipment
loans---by attaching them to the mortgage for
a longer period, reducing monthly payments.
Timing is very important because, if his
financial position deteriorates, Francis ability
to negotiate facilities will also diminish. Taking
steps to dispose of non-essential assets to liq-
uidate debt is another strategy to avert possible
foreclosure when values shrink.
While there may not be one perfect solution
to Francis problem, a combination of those
mentioned above could help him prepare and
adapt to the changes in income if he loses his
D C F
.F C C .
JANUARY 10 • 2016 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
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