It Figures

How to determine how much of a line of credit you need for your growing business
Magazine Contributor
2 min read

This story appears in the December 2000 issue of . Subscribe »

Q: How do we figure the line-of-credit needs for our growing board games distributorship?

A: Figuring how to finance your trade cycle is not a trivial pursuit. As sales grow, so will inventory and accounts receivable. You finance this growth with increased accounts payable, after-tax profits, and a business line of credit.

Here's a cash-cycle equation to help you figure out what you need in terms of a line of credit: According to your financial statements, your customers pay you in 60 days. You carry 25 days of cost-of-goods in inventory. You pay your suppliers in 45 days. Profits, after taxes, are 6 percent of sales.

Sixty accounts receivable days1 plus 25 inventory days 2 less 45 accounts payable days3 equals a 40-day cash cycle. Each $1 million in annual sales is $2,740 in daily sales. Multiply daily sales times the 40-day cash cycle for line-of-credit financing needs of $109,600 for each $1 million in sales. But wait a minute: That $1 million in sales produces $60,000 in profits, so the actual line-of-credit need is only $49,600.

If your business is seasonal, refigure this equation using receivables, inventory and payables from your peak season. Plan ahead. Get your credit line set up well before you really need it.

Remember that banks aren't your only option. Factoring companies provide lines of credit, too.

Using the cash-cycle equation isn't as accurate as a computer-based, 12-month cash-flow projection program, which can help you fine-tune assumptions and test various combinations of days payable, receivables, inventory and profits.

1 Divide receivables by annual sales; multiply by 365.
2 Divide inventory by annual cost of goods sold; multiply by 365.
3 Divide payables by annual cost of goods sold; multiply by 365.


George M. Dawson is author of Borrowing to Build Your Business: Getting Your Banker to Say "Yes" (Upstart Publishing). Send your financing questions to bsumag@entrepreneur.com.

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