What the Banker Found

Keep meticulous financial records from Day One, or pay the price later.
Magazine Contributor
4 min read

This story appears in the October 2010 issue of . Subscribe »

"Always dress for the job two levels above yours." That bit of advice came from my first real boss when I was a fresh-out-of-college newbie banker. She meant the advice literally. But over my corporate and entrepreneurial career, I've seen how important "dressing up" figuratively is, too, for a startup business.

If your goal is to qualify for a bank or SBA loan a year or two down the road, start dressing the part now. That means, among other things, having a good financial management system.

Back in my days as a bank lender, I was handed a credit file on a shoe store chain and asked to review the owner's latest loan request. On the surface, it looked like an entrepreneurial success story. Based on the performance of his first shoe store, the bank had loaned him money to expand. He used it during the following three years to add a dozen stores. This request was for an increase in his line of credit and a term loan to fund his continued expansion.

My first clue that this wasn't going to be an easy deal was that in two years, he hadn't "cleaned up" (banker-speak for reduced to zero) his line of credit. A line of credit is intended to fund a temporary mismatch of cash coming in and cash going out--but if it maxes out and stays that way, there's a problem.

The next red flag was that the company's income and profit margins were moving in opposite directions.

The third was the most troubling. The owner was either unaware of a problem or had no clue to its cause because he didn't keep good financial records.

Instead of considering his request for more money, the bank was now focused on recouping the money he already owed. Over the next several months, I worked with the owner to figure out what was going on. The fundamental problem, we found, was that about half of his stores weren't profitable. And among those that were, profit margins varied widely.

We found more problems as we dug deeper. A physical inventory told a much different story than the number on his balance sheet: The warehouse was full of unwanted high-tops, pumps and other fallen footwear. Apparently, what sold well in one store didn't in another, and there were no inventory controls in place to catch the shift. Poor purchasing played a role, too. And because of the difference in store-to-store cash flow, we suspected customer pilferage and employee theft. Unfortunately, we were proven right about the latter.

The owner couldn't clean up his line of credit, it turned out, because he'd used the money to fund new stores, not for smoothing cash-flow troughs as he should have. Technically, this put him in breach of his loan agreement.

Like many entrepreneurs, this cobbler turned shoe mogul was so mesmerized by growth that he was blind to everything else. As a result, the bank downgraded his credit, put him on a watch list and forced him to track his performance on a weekly basis. If he didn't close the unprofitable stores and get his financial controls in order, the bank would call the loan.

The lesson here, if it's not obvious, is that the banker is the last person you want to uncover a flaw in your business operations. Regular and effective financial reports as well as proper checks and balances would have prevented this boot baron from facing impending doom. An experienced business accountant would have spotted the trouble, too.

Having a good financial management system won't guarantee success with a lender, but the lack of one will guarantee failure. It's never too early to dress for success.

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