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Effective cash management strategies are key to the success of any business. Here is the third of three excerpts from Cash Management Toolkit for Small & Medium Businesses, written by Jeffrey D. Sherman and published by The Canadian Institute of Chartered Accountants.

A variety of products are available to borrowers, distinguished by their term, nature of security required, size, availability, and source.

Most businesses need a variety of borrowing products. A start-up or particularly risky business may have no capacity to borrow at all. Other businesses need to consider a variety of borrowing products. They can be thought of as differing layers ("tranches") of loans. The number and nature of the tranches will depend upon the circumstances, and may include:

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  • Credit cards
  • Overdraft or line of credit for short-term needs
  • Loans for medium-term needs
  • Mortgages, longer-term loans and mezzanine financing for medium or long-term needs
  • Leases

These are discussed below. This chapter provides a concise overview of borrowing and credit in the context of cash management. A great deal of additional information is available and there are many other types of products in the market.

Credit cards

Credit cards can be used as a source of financing as well as a convenient way to purchase items. However, they should only be used as a source of financing as a last resort. The interest charges are invariably much higher than for alternative ways of borrowing, and the amounts available are relatively low. It is far better to arrange for an overdraft or loan, if possible. Note that if your business is a start-up, or for any other reason cannot obtain an overdraft or loan from a bank, it will be required to provide cash or equivalent as collateral (or a personal guarantee from the owner) in order to obtain a business credit card, thus eliminating its usefulness as a means of financing the business.

On the other hand, if you use a credit card and pay off the total amount due each month, no interest charges are incurred. So, provided you are able to do that consistently, credit cards offer a source of cheap funding.

Overdraft or lines of credit

Overdraft facilities and lines of credit offer a convenient and easy-to-administer way of borrowing for short periods of time. Usually they are "evergreen" or "revolving" arrangements, which means that the loans must be paid back from time to time to demonstrate that the overdraft or line of credit is only required for a short period of time, and is not being used as permanent financing. Both overdrafts and lines of credit are efficient and easy to use because they are drawn-down automatically as funds are needed, and are repaid automatically as cash becomes available.

An overdraft is intended to be very short-term, and often carries relatively high interest rates. A line of credit is intended to provide short-term financing and carries a more competitive interest rate. Some banks charge fees whether or not the facility is used; others only charge fees when the account goes into overdraft or the line of credit is drawn. In other cases, the only charge is interest expense. The arrangements are somewhat negotiable depending upon how much the bank wants your business.

The large banks offer many different products - with many different names - that provide lines of credit and overdraft facilities. When reviewing your financing needs with your banker, ask whether other types of products should be considered. While the bank may state that they cannot reduce the service charges for one product, there may be another product with a pricing structure that would provide cost savings - but you may have to ask. This is a good example of the need to involve your bank's cash management and credit specialists to ensure that you are aware of, and have considered, the complete spectrum of products.

The overdraft or line of credit may be unsecured, secured by a general assignment or secured by specific assets of the business. If the bank offers you a choice as to whether the facility is secured, keep in mind that a secured facility normally has a lower interest rate.


As with lines of credit, there is a variety of loan products available. They vary by term, amortization (speed of principal repayment, if any, during the term), nature of security required, and the amount of reporting and covenants required. Ideally, you want flexible terms, the ability to repay at your option, minimal reporting and few restrictive covenants. The extent to which you achieve those goals will depend upon the business risk that the bank perceives in your operations, the existing financial leverage in your business (debt to equity ratio), and how much the bank wants your business.

This latter point should not be underestimated. In the recession of 2008-2009, many quite good and stable businesses in Canada found that their borrowing capacity was reduced, not as a result of any action on their part or any change to their operations, but because their lender made a strategic decision to reduce its exposure to a particular geographic region or industry segment.

What can you do to reduce the risk if the bank reduces its loan availability? Try to make sure you have other options: other lenders or investors that you can approach if necessary, and leave a buffer of equity in the business, greater than the minimum that lenders require.

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Mortgages and long-term loans

Loans for longer terms are more complex because, from the perspective of the bank, the risk increases as the term lengthens. For small and medium-sized businesses with otherwise unencumbered assets, banks may suggest using

mortgages as financing vehicles (loans secured by real estate) since these are products that banks understand and market - sometimes quite aggressively. Of course, mortgages are also available from many other sources: if you search the Internet for "commercial mortgages," you'll find not only the chartered banks well represented, but also many other firms. Business associates and advisers may also be able to recommend sources.

Larger businesses have access to the bond markets, but medium-sized businesses with longer-term borrowing needs (other than mortgages) will require other sources of financing. Some of the banks have affiliates that specialize in such products.

If you need longer-term financing, consider something that straddles the debt and equity categories: for example, the lender may require a "sweetener" such as common shares, options on common shares, or an ability to convert part of its loan to common shares. Such debt is called "mezzanine" financing - since its characteristics are between those of debt and equity. This is discussed below.

Mezzanine, venture capital and other alternatives

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Sometimes what a business really needs is financing closer in nature to equity than pure debt. The primary return to a lender is based upon the interest and fees charged. The interest rate may range from a few per cent to as high as the teens (or perhaps even greater), depending upon the circumstances.

For that to make sense, the risk of default (from the perspective of the lender) must be very low. For businesses that cannot provide that level of assurance because of their level of financial risk (debt-equity ratio or leverage), or because their business risk appears to be relatively high (losses, fluctuating results, or limited history), what is really needed is something other than just debt. The lender then needs an "upside:" the chance of receiving an equity-like return on the investment.

Mezzanine financing achieves this by being a hybrid of debt and equity. The lender has the security position of a lender (and claim on the assets of the business in the event of default) but also the possibility of a very high return by acquiring shares of the company (or a lot of cash in lieu of shares) if everything goes according to plan.

Ask your banker, advisers and peer companies to recommend sources of mezzanine financing.

There are many providers of mezzanine financing in Canada. When the financing is aimed at riskier situations such as start-ups, it is called "venture capital." As a start, a good place to source this type of financing is through industry colleagues, professional advisers, and your banker. To make the process efficient, you should conduct preliminary due diligence on any firm with which you are thinking of doing business. Ask peer companies or advisers to recommend firms to avoid investing a great deal of time with a firm you do not know.


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Leases are often used as a convenient way of acquiring machinery and equipment. Most leases are a form of borrowing: rather than borrow and use the funds to acquire an asset, another party finances and purchases the asset and then rents it to you. Your lease commitment is a fixed amount, usually monthly, for a certain number of years, so your financial commitment is similar to that of a loan. The party leasing you the asset is really financing your acquisition of it, so when another lender assesses your company's financial leverage, most leases will be treated as loans (because, in essence, they are loans).

Assess the merits of leasing rather than buying an asset.

Because the lender legally owns the asset, it is easier for them to get it back if you stop paying rent. Therefore, it may be easier to lease than to borrow to buy the asset.

Special to The Globe and Mail

Excerpted from Cash Management Toolkit for Small & Medium Businesses, by Jeffrey D. Sherman, published by The Canadian Institute of Chartered Accountants and sponsored by Canadian Imperial Bank of Commerce. Copyright 2010 The Canadian Institute of Chartered Accountants.

For more information on the book, please click here.

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For the French version, click here.

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