2011 has arrived and is certain to be a dynamic year. We are in interesting times from weather to politics. This year has already seen major rain and snow in Southern California, snow and freezing weather in Phoenix and unseasonably warm weather in Toronto. Meanwhile Australia has been experiencing catastrophic flooding. In the middle of these unusual weather events the US political climate is in a state of change and many European countries in addition to the US are struggling with financial challenges. With these unusual circumstances it promises to be an interesting year.
If the start of the year is a precursor of things to come then I have some resolutions for your consideration. In order to maintain a reasonable length to the newsletter I will present in several parts. My recommendations for your consideration are:
- Reduce debt
- Improve gross margins and manage overhead
- Diversify marketing
- Improve customer service
- Be proactive
- Improve your training and orientation program
For those that have heard my speaking or reviewed my writing you may find my first recommendation to be counter to previous statements. The reality of our industry is that bills are usually paid in less than thirty days and collections take longer than 30. This is where the assistance of a bank comes in to help float cash. It has traditionally been my recommendation to have a line of credit of about 10% of annual revenue or 30 days sales in order to comfortably manage your cash float. If there is risk that borrowing costs will substantially increase in the future then that needs to be figured into your strategic plan. Today Interest rates are at record lows and banks are being encouraged to lend money. Given the current banking environment, why would I recommend cutting debt? There are many circumstances that are in play on a macro-environment that may impact interest rates and lending. I do not know the timing for any changes but I think that it would be judicious to make decisions so you could run a cash-positive business if and when things change.
To some this economic discussion may make their eye's gloss over but if you have or want a operating line of credit then you need to understand the complex macro economic situation. The following are issues that you need to consider when assessing your reliance on variable interest rate credit to assist your business operations. I do not claim to know more than the president of the Fed or other experts. Given that limitation I present my thoughts for your consideration - you can choose to do your own research and make educated decisions since this could have a dramatic impact on your business.
You may have heard of "quantitative easing." What does that mean? This basically means that the government is buying their debt. In laymen's terms this means that the treasury is printing money and buying treasuries. This money is then put into the money supply to stimulate economic activity. This process keeps interest rates low and is part of the reason that 30 year mortgages have been below 4% this past year. This also influences the prime rate which is used as the basis for most business lines of credit. The Federal Reserve is essentially forcing rates artificially low in an effort to stimulate borrowing and spending and to prevent deflation. This is a dangerous game that could have a negative impact on interest rates.
There is a complex relationship between interest rates and inflation. The official government measure of inflation, the Consumer Price Index, shows that inflation is nearly non-existent. On the other had a study of the commodities page of the paper will show a substantial increase in the cost of basic communities that we all use every day such as coffee, sugar, wheat, corn, oil, cotton and many more. In many cases, the cost of these goods has risen over 40% this last year. The fact is that the money supply has been dramatically inflated. This is a genie that the Fed may not be able to put back in the bottle. A bigger money supply in a recovering economy will most likely lead to inflation no matter how it is measured. In the face of inflation the Fed often increases interest rates to fight the consequences of inflation - think 1978. At this time you should only understand that there is a massive fight between inflation and deflation. The end result will likely be inflationary.
Additionally, our current national debt is a bit over $13 trillion dollars. There are other committed costs that have not been realized that include Social Security, Medicare, Fannie Mae and Freddy Mac guarantees, FHA guarantees, pension guarantees, and more have all added over $100 trillion to the potential debt. These numbers can be challenged yet the reality is that our government owes more money than can be realistically repaid. This is significant when you realize that the total tax receipts are in the annual neighborhood of $2 trillion. According the Trends magazine there are several options for repayment but the most likely option is a moderate level of inflation. If moderate inflation occurs then moderate interest rates should not be devastating to your business. The unknown question is can rates of interest and inflation be contained?
This creates a challenge for restoration companies and will create risk and stress for many company owners. I would make several recommendations as a contingency to potential increases in borrowing costs. The first recommendation is to see if you can cut the amount of your loans substantially. This is a multifaceted challenge but may become a reality so you should figure how to exist without a line of credit IF needed. You should also work on your collection and payment policies now so you avoid crisis management in the future. Have a strategic plan in place that would anticipate a substantial increase in your borrowing costs. Cultivate relationships with several banks in case the lending practices change with your current bank and your loan is challenged. I would work hard at creating a cash reserve and have a twelve-month plan to reduce or replace any variable rate loans. Currently interest rates are very low. In this environment you can have confidence in your costs but you should be working on a contingency and perhaps start to generate a cash reserve account.
I feel there is a risk of severe consequences to federal monetary policy. There are others that would argue this point with me and they may be right. I feel that there is substantial risk that borrowing rates may be substantially higher at some point in the future. I cannot tell you if this is six months or six years. Preparing for this situation would not harm your business and actually would help strengthen your company. Given the no risk option of reducing debt and the realities of our world I would make debt reduction a priority for 2011.
