Financing strategies for troubled times
Every day brings more bad news in the credit markets affecting virtually every sector of the economy, including healthcare. Even the aging of the baby boomer generation is not enough to guarantee that healthcare expenditures will continue to trend upward. Political and budgetary pressures are bound to squeeze revenues, particularly for elective procedures and services.
So what’s a long-term care facility to do to ensure its long-term survival? Make money and conserve cash! Those businesses that keep a cash cushion are more likely to make it through the tough times than those that take cash out of the business. Keeping cash on hand ensures the flexibility to meet unexpected contingencies, such as the ups and downs of business cycles, slowdowns in government payments, and work stoppages caused by natural disasters and other unforeseen events.
Conserving cash should be a fundamental financial strategy, but it is clear that many private business owners make the same financial mistake. Once an entity becomes profitable, the owners tend to take most of the money out of the business in the form of management fees and bonuses. Sometimes this practice results in a negative tangible net worth. Even if these funds are reinvested in real estate or other assets and regardless of the seeming strength of the revenue stream, a business with little cash on hand can find itself in a precarious position. As a result, lenders frequently charge higher rates on financing to entities with low cash reserves. Or, in current tight markets, lenders may decline to finance at all. After all, given today’s shaky markets, confidence is critical. Lenders look askance at businesses with a small net worth, let alone a negative position, seeing it as a sign of poor management. The largest lenders are usually saying no to exceptions to their credit criteria, because no one wants to take on the risk of making a mistake. Smaller or local lenders, who might be more willing to lend to a known entity in the community, may have limited capacity to handle sizable transactions. And any lender forced to ration funds is likely to request a significant account relationship in order to extend credit. As a result, long-term care facilities would do well to find alternative sources of funds to ensure access to adequate cash.
In view of the credit crunch, business managers should take a strategic approach to conserving cash and maximizing their debt financing resources. The alternative-raising equity-is particularly costly in times like these. The following financial strategies will enable long-term care and other specialized healthcare firms to build a solid financial foundation.
1. Conserve cash. Retain a minimum of 25% (preferably 50% or more) of annual earnings in the business to build liquidity and maintain access to lenders. Cash on hand is better than borrowing from a bank. Moreover, the old adage that “Banks lend first to those who need it least,” is true. Any business will have a true economic advantage, particularly during times of financial uncertainty or duress, by maintaining a strong cash position.
2. Manage for the long term. Set a one-year plan with budgets and business priorities and stick to it. Lenders want to see evidence that a business is being managed properly. Of course, the best evidence is to make a profit and exceed plan targets. In difficult times, try to limit investments in illiquid assets such as real estate, especially those involving long-term equity commitments or unpredictable cash requirements.
3. Aim for conservative growth. Growth rates of 20% or more may be looked upon as risky, because such high growth may require that expenses be geared up in advance of projected revenues. It is better to forecast conservative growth and beat the plan. Risk, whether perceived or real, drives up borrowing rates. Building up equity and paying down debt reduces financing costs.
4. Balance the balance sheet. Keep an eye on the ratio of current assets to current liabilities (current ratio). Ensure a good Coverage of Fixed Charges, which is the ratio of funds generated by the business in a given year relative to the interest and principal due within the year. Of equal importance is to spread out debt obligations evenly over a period of time. Lenders will evaluate whether a business has too much debt coming due at any given year, because concentrated debt obligations can spell trouble. It is important to generate a surplus of cash flow in relation to debt service, ideally at a ratio of two to one or above in the current market.
5. Complete financial statements in a timely fashion. Lenders are looking for businesses that measure their own financial performance carefully and frequently and can provide up-to-date financial statements in a timely manner. Invest in preparing an accrual financial statement, preferably audited, rather than just a tax statement. The drawback of a tax statement is that it does not include accounts receivable but instead reports only cash collections as sales. As a result, net income and shareholders’ equity tend to be understated, especially in a growth situation.
6. Treat lenders as clients. Respect lenders, take their calls, and build relationships based on trust and open communication. Top lenders should be kept informed of any changes in the business-whenever possible, in advance of the event.
7. Choose a mix of lenders and lessors. Don’t rely on a single financing source. Develop relationships with several large and small lenders and lessors who can be depended upon. Many businesses only have enough account activity to maintain relationships with one or two banks-perhaps one for the receivables line and another for a mortgage. It makes sense to identify an independent lessor or two, who can augment direct bank financing but do not require anything like a full banking relationship. Also, the time may well come when a bank will reach its lending limit or, worse yet, reduce the credit line or refuse to renew it.
8. Match financing terms to the life of the asset. Try to avoid using short-term financing, such as a receivables line, for long-term assets or those that require extended earning power to support. Instead, use short-term financing for short-term needs. Consider leasing as a cost-effective form of medium-term debt to finance assets that will retain their value longer than the lease term. Equipment leases are usually written for a period of three to five years, but can be longer if the asset life and the company history support extended terms. This allows a business to accurately match revenues to costs. If a firm has recently acquired a large amount of equipment and would like to improve liquidity, a sale-leaseback may be a good option, allowing the transfer of title to the equipment while keeping it in service and paying back the debt over the economic life of the asset.
Veteran venture capitalist Fred Adler said it best: “Happiness is positive cash flow.” But I am sure that he really meant positive enough for long-term growth. Crossing over to positive cash flow is the first step. But maintaining healthy growth over time is the only way to realize the full value of the business. Whatever the year ahead holds for the U.S. economy, those businesses that have been maximizing their cash position and building reserves for the long term are likely to move ahead of the competition and enhance their long-term prospects.
Martin E. Zimmerman is president and CEO of LFC Capital, Chicago. He earned his MBA in finance from Columbia Business School, where he was a McKinsey Scholar and Kennecott Copper Fellow. He is a member of the business school’s Board of Overseers and its advisory Board for Entrepreneurship. He can be reached at (312) 228-6000.
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Eight tips to build a solid financial foundation
Manage for the long term
Aim for conservative growth
Balance the balance sheet
Complete financial statements in a timely fashion
Treat lenders as clients
Choose a mix of lenders and lessors
Match financing terms to the life of the asset
Long-Term Living 2009 April;58(4):35-36
Topics: Articles , Facility management , Finance