Ask Bernard (part 1)

Ask Bernard – Is there a business issue that has you tearing your hair — or tearing up your business plan? Then ask Bernard, chief operating officer of the Local Business Banking team at the Commonwealth Bank.

Q1. Why did my bank knock me back?

My business has great growth prospects, with some fantastic opportunities starting to open up. Yet I still got knocked back for a business loan. So, have the banks simply stopped lending to small businesses? What can I do to get the money I need?

A: While I know some people have been saying banks have stopped lending to small businesses, for the most part, lending standards for small businesses have remained materially unchanged – and despite the recent ups and downs in global credit markets, there is more than enough money available to meet demand. So it’s simply not true that banks have been rationing credit.

Unfortunately, that doesn’t mean everyone who asks will be successful in obtaining a loan, or that every business owner can borrow as much as they’d like. But having a loan application turned down isn’t a judgment about whether your business will succeed. Nor does it mean you won’t get a loan next time you apply. It simply means you don’t meet the bank’s risk standards right now.

Be sure to discuss with your banker the reasons why your loan application has been unsuccessful so that you can be better prepared next time. You may also be able to revisit your application with greater details, sometimes within a matter of days, which may well satisfy the bank’s risk standards.

Remember, your banker has a responsibility to keep depositors’ money safe. They also have a responsibility to make sure you don’t take on more debt than you can handle. That means they have to look at your business a little differently from the way you do, or the way a potential investor would.

Certainly, it’s important to have a well-run business with good prospects, and it sounds like you definitely measure up on that score. But your banker also needs to see two more things:

• First, they need to know you have enough cash flow to keep up with loan repayments after covering your other costs. This is one area where some businesses could have been having difficulties lately, with tougher trading conditions putting cash flow under pressure.
• Second, they want to see that you can offer enough security to cover your debt if you get into problems. It’s all about reducing risk – the risk to our depositors’ money, and the risk to you if things go pear shaped. Generally, physical security is preferred, but is not an absolute requirement in every circumstance, particularly if your business has sufficiently strong cash flow.  

So how do you maximize your chances of getting a loan? Here are some tips:

• Be prepared. When you’re putting your loan application together, it makes a big difference if you can demonstrate that your business has, or will have, strong cash flow. That means putting together detailed projections showing how the extra investment is going to boost your revenue.
• Show your true profitability. It’s worth casting a critical eye over your accounts and stripping out any optional extras (business owners’ cars are a common example), letting your true profitability shine through.
• Be realistic. At the same time, you need to be realistic – in the amount you want to borrow, the assumptions you use for your projections, and your growth expectations. Sometimes it’s better to take things step by step rather than trying to do too much, too soon.
• Consider all the options. Is a traditional business loan your only option? What about asset finance, where the asset you’re buying secures your borrowings? Or a personally guaranteed loan? Your business banker can help you explore the options.
• Talk to your business banker. Try involving your banker in the process as early as possible. Tell them about your situation and your aspirations. They spend every day working with businesses just like yours, so the likelihood is that they’ll have plenty of ideas to help you make the most of your resources.

Above all, don’t be discouraged. Many business owners find that when they return to the bank after a year or two they have no trouble getting the money they want. Often it’s just a matter of timing.

Q2. Is this the right time to launch a business?

I’ve got a great idea for a new online business, but I need to put in some serious cash to get it up and running. Now I’m concerned that things are still slow out there. Is this a bad time to launch a new business?

A: Here are just some of the reasons we have to be reasonably optimistic about 2010:

• In early October, the Reserve Bank dramatically upgraded its outlook for 2010, forecasting growth of 3.25%, rather than the 2.25% it had previously expected.
• Employment rose by 40,600 in September, the biggest one month increase in nearly two years.
• House prices soared to record highs in August, as measured by the RP Data-Rismark Hedonic Australian Home Value Index. Meanwhile, construction loans climbed to seven-year highs.
• Retail sales rose by 0.9% in August to a level 5.8% higher than a year earlier.

The outlook is brighter than it’s been for some time. By setting up your business now, you could be just in time to take advantage of the improved economic conditions. But that doesn’t mean it’s going to be easy.

Plenty of fantastic ideas never translate into successful businesses. That’s why the preparation you do now before you launch, is absolutely crucial.

Here are some of the things you need to think about doing:

• Thoroughly research your target market and your competitors. How large is the market, both in terms of the number of customers and in dollar terms? How much of that market do you need to capture to be financially viable?
• Develop and test your unique value proposition. What will set you apart from your competitors? Why would customers buy from you?
• Create a detailed business plan, describing the market, your products, your marketing plan, your business goals, your structure – everything about your business, in fact. 
• Include a detailed financial plan, with a cash flow forecast and a profit and loss forecast, as well as an analysis of your start up costs. (If you need a helping hand, you can find a business plan toolkit and financial plan template here.)

At every point, be prepared to redesign your initial concept to make it work. The effort you spend getting your business model right in the beginning will be repaid many times over once you’re up and running.

You should also consider starting small and building up gradually, before sinking in too much capital. Remember, one of the biggest risks new businesses face is that of being undercapitalized. If you invest too much of your precious seed capital at the beginning, you may find yourself short of cash to keep your business afloat from day today.

If it all sounds like hard work – it is. But don’t be daunted. It’s worth it, for the satisfaction of building something from scratch and seeing your vision become a reality. So good luck with your new venture!

Q3. How do I fight a discounting competitor?

My problem is the competitor down the street. They sell similar products (sometimes the same) at a price I know can’t cover their costs. How do I fight back?

A: Recognising and confronting your pricing issue is the first step in finding a solution.

If your competitor really is selling at an uneconomic price, then all you need to do is wait – after all, they’ll soon go out of business. But have you considered that their pricing may not be as crazy as it seems?

Higher sales volumes can make it possible to sell profitably with a lower mark-up. That’s because, after paying the unit cost of each sale, you have more sales to cover the fixed costs of your business.

You can think of it this way. The price you charge for every item you sell is made up of three parts: the cost of the item; an amount to cover your fixed costs (rent, wages, and so on); and some profit. If you can increase sales by selling at a lower price, you can reduce the amount from each sale that goes to cover your fixed costs.

For example, imagine your fixed costs are $500,000 a year and you’re selling items with a unit cost of $10. How many units do you need to sell to break even? (See table below.)

When you halve your mark-up, you need to generate double the sales. If you more than double your sales, you can actually increase your profits by discounting.

So what do you need to do? Essentially, you have two choices:

• You can follow their lead and drop your prices. Re-examine your fixed costs, then think carefully about your pricing. Do some calculations to see how many more sales you’d need to make to operate profitably while selling at a lower price. Then start by discounting selected product lines and carefully measure the results. When you’re ready to relaunch your business at a new, lower price point, print out some flyers, hang up some banners and do it with a splash.
• Alternatively, you can find a way to compete on something other than price – service, range, quality or convenience, for example. You could look at varying your product range with some higher priced items and positioning yourself as the more exclusive, quality provider. After all, the flipside of your competitor’s approach is to sell fewer units at a higher mark-up. Sometimes it just doesn’t make sense to be the lowest-cost provider.

Whichever path you choose, be prepared to try out multiple approaches to see what works.

Don’t be afraid to change your strategy if it isn’t working. And don’t lose hope – I’m sure the answer is out there.