Over the last 10 or so years, business banking has changed, unfortunately, for small business in Canada, not for the better. In this article I outline the role that banks play in a small business owner's world, and how they should be picked and then managed.
In all the many years that I've been giving banking advice to small and mid-sized businesses as a part time CFO, "access to capital" has been the #1 challenge facing their owners. See a very good article on the Top 3 business challenges by Catherine Clifford in Entrepreneur Magazine HERE . I will be addressing each of these challenges in a Canadian context in my next articles.
What does "banking" mean for Canadian small business?
For a Canadian small business, "banking" means:
- Access to capital;
- A place to store its cash; and
- A means by which to process its financial transactions.
Access to Capital
It has never been easy for SMB's to access capital. We quite often see a misalignment of expectations from the entrepreneur and any banker when it comes to their ability to provide loans to fund business endeavours. The fact is that, today, capital is available through loans from banks in one of only four circumstances:
Home equity loans:If the small business owner/manager has equity in her/his home, then, up to the limits established from time to time by the bank, a loan can be obtained personally to advance capital to the business secured by the owner's personal residence:
- This is quite effective, as loans of this nature are simple to process, and with today's interest rates on housing, at reasonable rates; however:
- This intermingles personal assets with personal ones, something small business owners should try hard to avoid;
- Banks, through their credit card providers, have provided reasonably ready access to capital for small businesses in Canada, and we've seen it used vey frequently as it becomes one of the only sources an owner can access for working capital;
- This obviously comes at a high cost of capital, however, quite often the only alternative.
Working capital loans:
- If a small business has built up assets such as inventory and/or accounts receivable, plus a history of profitability, the banks in Canada are receptive to providing lines of credit to help the business access cash sooner for these assets;
- Lines of credit are based on a percentage of the cost of these assets, most frequently 50% of inventory plus 75% of accounts receivable;
- In almost every situation, banks also require personal guarantees from the small business owner to cover any shortfall should the loan be required to be repaid.
Government backed loans:
- The CSBFP (Canadian Small Business Funding Program) offers financial support to banks for small businesses to obtain loans to finance capital assets (buildings, leaseholds, and equipment):
- This program works quite well in the specific circumstances that it applies to, however does not apply in many capital requirement situations that Canadian small businesses face in today's business environment.
Simply and bluntly put, banks are the warehouses for all small, mid-sized and large businesses to store their cash assets. In turn however, when we give them our cash to store, we agree to allow them to use it in their business to earn returns, pay their bills, and generate income for themselves.
Having experienced the recent issues that banks around the world have experienced, the "debt crisis", even though Canadian banks have thus far avoided this issue, one must be mindful of the arrangements we have in place and ensure that our hard earned cash is safe. This doesn't mean keeping it in a sock or under the bed, as banks do provide very user friendly means by which we can access our cash for processing of business transactions. It does mean, however, that when a small business is in an enviable position of owning cash balances, formal processes need to be in place to ensure it is secure. These processes include:
All deposits should be held in bank accounts that have the maximum Canada Deposit Insurance Corp. (CDIC) protection. This amount currently is $100,000 per CDIC member financial institution. To see a list of CDIC members see HERE.
Purchase Government Issued Securities
Standing orders should always be placed to purchase Canadian government issued investments such as Treasury Bills for excess capital, so that exposure to bank failure is minimized. Guaranteed Investment Certificates (GIC) are interest bearing deposits offered by banks. They are not guaranteed by the Canadian government, but are insured by the CDIC, subject to the $100,000 per bank limits referred to above.
It goes without saying, in today's sophisticated financial world, and the freedom that banks, even Canadian ones, have in putting our hard-earned cash to work for them to earn income, it's very important to be dealing with the safest of banks. At a minimum, only deal with CDIC member banks. Of those banks, one should always revert to the strongest of those. Currently we have 4 Canadian banks in the Top 10 list. I'm sure that, of those 4, all the services that a Canadian small business needs can be found. However, be cautioned, that ratings are just that, someone's opinion, and we all know how well Moody's and Standard and Poor's did rating global banks in 2008. There's a very good Wikipedia entry on this HERE.
Monitor Financial News, Get Professional Advice
Last but not least, always have a sense of the stability of the banking system both globally and in Canada by monitoring the financial news, and having ready access to professionals who are experienced and trained at recognizing early indicators of potential issues. Listen to their advice, so that, in the worst case scenario, you will be first to a chair in the musical chair game that Canadian banks are playing with our money.
Financial Transaction Processing
This has been a growth area for banks, and not just for revenue, but as well in marketing. They have capitalized on the internet, digital and the Cloud like no other, making our small business lives that much more convenient. The magic of something as simple as an email transfer takes a lot away from the head-aches of processing the ins and outs of our daily small business lives.
There are competitive systems available that, in all cases should be considered, for their ease of use, cost, applicability, and connectibility to your other small business systems like accounting, etc.
At InHouseCFO, we also subscribe to a "don't put all your eggs in one basket" philosophy when it comes to dealing with Canadian banks. I discuss this more fully in the next section of the article.
Don't Put All Your Eggs in One Basket
The last piece of wisdom I'd like to note in managing your banking relationships is to "spread it around".
The banks make it very tempting to do everything with them, and with de-regulation of the '90's this goes way beyond banking itself into areas like investments, insurance, non-traditional transaction processing, estate and trust services, even income tax planning.
Small business owners in Canada, for some hopefiul reason, as a rule hold to the lost notion that having a personal relationship with an account manager adds real value to what they can gain in any of the above areas from its banking needs. Unfortunately "relationship banking" left the building more than 10 years ago.
Your account manageer has no meaningful say in how the bank provides solutions and services to the Canadian SMB. Don't get me wrong, get to know your assigned manager, a personal relationship will help you navigate through their system and deal with administrative issues as they arise more effectively, they might even be worthy of a friendship. That's where it all ends though, in reality they are powerless in overcoming the paternal view that all Canadian banks have over ther customers.This unfortunate view has evolved in the Canadian banks over the past 100 years and is the result of the oligopolistic nature of our banking industry.
it's bank brand first, customer second in the relationship equation, and bank brand is currently controlled by a group known as National Risk Management, a faceless group in the bank's head office that is using risk monitoring tools and algorithms to minimize brand risk. These tools unfortunately, while sophisticated scientifically, are in my opinion, much less mature in the non-numerical components for measuring risk and reward. We have entered a phase where I believe choices are and will be made with flawed data. So for this reason alone, I strongly recommend that every Canadian small business owner plan and manage his/her banking relationships with this at the forefront. The lure of one-stop shopping can be attractive, but lead to unsatisfactory, even surprising results. A few bullets of advice:
- Don't choose your banking relationship based on how well you get along with your account manager;
- Don't expect access to capital from your bank other than from the sources I've outlined above;
- Choose your banking relationship based on which ones that best fit the criteria I outline in Cash Storage and Transaction Processing above;
- In all cases, regardless of temptation, set up your personal and business banking relationships with separate banks; and
- Your business bank should be for core business banking services only:
- Investments, insurance, planning, and anything else non-core should be with another qualified service provider. There are many great ones to choose from;
- The same applies for personal.
Unlike most other professionals you pick to work with, no matter how hard you try or hope, you'll never be able to truly hire one that is truly "on your side", so make sure this is factored in at all times. That said, they are very good at processing transactions, storing your hard-earned cash, and providing access to capital under the limited circumstances outlined above.