As we wrote in a recent blog, it’s not only businesses with major problems that require help. It’s also important to note that significant problems aren’t always obvious, but they certainly can ruin your small business’s profitability.
Look no further than a Connecticut retail business run by a hard-working owner with far more stress than he needed. He also was making far less money than he should have.
Why was a successful business having such a hard time turning a profit?
Assessing His Business Like A Doctor Diagnoses A Patient
Despite the success of his small business and the revenue he was raking in, the retail owner was consistently short on cash. To the small business’s consultant, something didn’t add up.
The advisor looked into the company’s revenue and bank statements: Revenues and bank balances did not add up. The bank statements showed less money than the business should have had earned.
As the owner’s partner first thought, this is typically a sign that an owner is taking money out of the business for himself, without recording this money as income. In discussing the issue with the owner, the stress on the owner’s face led the advisor to believe this wasn’t the case. Why would someone taking unreported income from a successful business be so stressed?
The consultant knew he needed to dive deeper. Soon, he uncovered the critical cash flow problem and diagnosed the small business with excessively expensive borrowing costs.
Pinpointing The Cause Of The Cash Flow Problem
It took plenty of hard work and great attention to detail, but in time the business advisor found that the owner was funding his company’s growth and day-to-day operations with a merchant card loan. Far more common today than in years past, these loans from merchant processing companies are more expensive than almost any other kind of debt.
The issue wasn’t obvious to the consultant at first because the merchant processing company was deducting the owner’s debt from its sales deposits into the business’s bank accounts.
Companies that work with such vendors pay 2-3% of their sales to receive funds from the merchant processing company while the latter waits to pull money from customers’ checking accounts or credit cards. In this case, the small business’s merchant processing vendor was deducting both its 3% charge and loan charges before sending customer payments.
Merchant Card Loans: Where Small Business Cash Flow Goes To Die
For nearly a year and a half, the retailer borrowed $30,000 in merchant card loans every three months or so. He would pay $40,000 back over three months, meaning he was paying $10,000 in interest and an annual rate of 100%!
Unlike typical loans, with merchant card loans interest rates are the same regardless of your credit history. It is one of the most expensive means of borrowing and should always be your last resort.
The owner had no idea how these loans were cutting into his business’s bottom line. As it turned out, his interest expense was eating 75% of his potential profit. It made the difference between an owner being proud and wealthy from his success and one suffering from oppressive anxiety.
Securing Loans And Maximizing Your Profit
The retail owner’s small business advisor always encourages his clients to plan ahead to secure lines of credit and backup funds before there’s a need for them.
You never want to have to jump through hoops to get the funding you need, and there’s never a quick and easy fix that won’t cost you dearly. A typical small business loan or line of credit is your most affordable option (read: lowest interest rates), but getting approved can take two months.
Should you need cash in a short amount of time, there is no easy solution. However, you’re better off securing a home equity loan, which is far less expensive than a merchant card loan and may take only 30 days for approval.
The retail business was not a struggling company by any means. Its sales had grown 15-20% annually over the previous four years, and its profitability had increased. But its bottom line was being strangled by the 100% interest loan.
Now in line to secure a bank loan, the small business owner will quadruple his profitability. He won’t struggle to pay the bills he once stressed over.
Sometimes, critical and painful problems aren’t obvious, even to the small business expert. But if you have a detail-oriented partner who works hard to uncover your problems, there is always advice and a solution to get you back on track.