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Coming Up Short

Short-term financing could help your company overcome temporary setbacks or cash-flow issues.
December 1, 2004
URL: http://www.entrepreneur.com/article/73708

For Idaho entrepreneur Leo A. Geis, running his commercial aerial photography business is somewhat akin to working without a net. Inconsistent customer demand, changing technology, and the need to rapidly expand into new geographic markets all make for an unpredictable commercial existence. "There is no cookbook for a company like this, so we're guessing a lot," says Geis, 46, whose Idaho Airships Inc. also specializes in forensic imaging for use in litigation. "Because of that, we [need] buffers financially that you don't [need] in established or more predictable markets."

One of those safeguards has been short-term financing. Not long after launching the Boise company in 1997, Geis had to upgrade his photography equipment to get better aerial images. To fund the unanticipated purchase, the half-million-dollar company borrowed $80,000, most of which was financed for just one year. The interest rate was about 4 percent higher than for a longer-term arrangement, but the flexibility was well worth the cost, in Geis' view. "We don't know what we're making next week or four weeks from now," he says. "It allows us to make a minimum payment if necessary or to load the payment without penalty."

Though the company could have used its own capital to fund the transaction, Geis thought there were more productive ways to use the cash. "We used financing instead of cash to remain prepared for a variety of competitive potentials, such as media campaigns," he says. The ease with which he could obtain short-term funds also allowed the company to capitalize quickly on geographic expansion opportunities, which are imperative in his industry. "We might have to make major decisions, like opening up a new market, in four days," says Geis, who now operates nationally. "There is no way to go out and acquire equity capital or long-term high-dollar financing."

Filling a Temporary Void

For a quick-moving company like Geis', a primary benefit of short-term financing is its flexibility; with it, a business can adapt swiftly to changing market conditions while conserving working capital. Short-term financing can also serve as a lifeline, helping sustain a shaky business operation until it gains commercial footing.

In reality, too little capital can quickly derail a developing company, yet many entrepreneurs don't appreciate the important role that short-term financing-usually a loan or line of credit of up to one year-plays in cash-flow management. Indeed, an interim funding arrangement not only allows businesses to take on bigger deals and increase sales, but also helps ensure they won't run out of operating capital before securing more permanent financing. Rapidly growing companies are often the most vulnerable to capital shortages, despite their sometimes-spectacular sales records. "Often, the businesses that are growing have a need for cash that's just as great as a business in decline or in temporary trouble," stresses Houston accountant Calvin Martin. "Growth requires additional accounts receivable, and they do not generate cash until they're collected. At the same time, you're paying for rent, for labor, for all your expenses that require cash."

Whether a business is growing at breakneck speed or developing at a more controlled pace, winning the cash-flow battle requires vigilant monitoring of sales activity, expenses and customer payment patterns. This allows owners to pinpoint and deal with a cash-flow deficiency before it evolves into a full-scale crisis. "If sales are declining, you need to find out why," Martin advises. "You may need short-term financing to pump up those sales through advertising and promotion."

Spend Wisely

Bear in mind that short-term financing isn't ideal for all kinds of capital shortfalls. As a general rule, short-term debt should fund business activities that will generate cash flow to repay the loan. Businesspeople need to distinguish between a temporary investment in current assets and a permanent investment, says consultant John Barrickman, president of New Horizons Financial Group in Roswell, Georgia. "With a temporary investment, you finance the purchase of the asset with the intent of liquidating the asset in the normal course of business." An example is a retailer who builds up inventory in the fall in anticipation of the holidays: "They'll sell the inventory during the Christmas season and pay the loan back in January, and not have another need until the subsequent fall," Barrickman says.

On the other hand, a company that has to constantly replenish its inventory may have difficulty managing short-term debt. "A lot of times, the lender will finance it with a line of credit," he says. "But every time that line matures, the borrower better be sure the lender is prepared to renew it or [convert the debt to a term loan], because, if they don't, the borrower is going to have to find another institution to loan them the money." Short-term financing is also risky if a business suffers a temporary setback but its lender refuses to extend the loan period. "It's a shame to see a company with positive sales growth and positive earnings [lose] its ability to obtain supplies to build their products or to deliver their services," says Rick Vycital, regional director of the Idaho Small Business Development Center in Boise.

While entrepreneurs sometimes have only themselves to blame for cash-flow difficulties, external market forces, such as labor shortages or oil prices, can wreak havoc on even well-run companies. In Geis' case, soaring gas prices generate uncertainty. "If gas goes to $3.50 a gallon, using an airplane is going to go right down the tubes," he declares. But rather than sit back and hope that rising fuel costs won't limit operations, he has used interim financing to help fund the purchase of energy-efficient gear. "[Without short-term financing], I'd be stuck with a particular business model for two or three more years every time I did something," Geis adds. "And two or three years is two generations right now in terms of business cycles in my industry."

No Surprises

When short-term financing is necessary to "bridge a problem," an entrepreneur should demonstrate that the funds aren't merely a temporary resolution to a permanent predicament, says Rick Vycital, regional director of the Idaho Small Business Development Center in Boise.

According to Vycital, financial backers are more likely to lend their support when the business owner has genuinely sought solutions to a crisis. "Just to keep borrowing and not change the source of the problem is not the type of loan that a bank or investment company would be willing to, or should be asked to, entertain," he says. "You'd better show how you're going to support the loan with changes, improvements and increased profits."

The good news is that lenders and investors are often receptive to short-term funding interventions because they have a vested interest in an entrepreneur's success; in many instances, they have contributed more funding to the developing business than the owner. What they expect in return is an open line of communication. "Your job as the owner is to communicate the status of your company," Vycital stresses. "Getting to the point where you have a calamity and surprising them-why would you do that?"