Profits On Purpose | Do Your Sources and Uses of Funds Match?
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Do Your Sources and Uses of Funds Match?

The title of this article may be a little confusing, but let me de-mystify it if I can. In your business, you need funding for certain things. You might be buying a business, a building, a piece of equipment or just need funds to meet operating expenses including payroll. These things I just identified are all uses of funds. So what’s the funding sources of these uses? Often many business owners fund these out of cash flow, some will take out term loans, mortgages or lines of credit.

It’s important for these sources and uses to match. By that, I mean long term uses (purchase of long term assets) like a business, a piece of equipment, or a building should be financed with long term sources of funds, a mortgage or term loan. Short term uses like operating expenses or funding payroll should be funded with a bank line of credit, a short-term source of funds. The reason for this is most lines of credit are repaid from short term assets like accounts receivables or inventory.

Your line of credit will typically have a use of proceeds section that stipulates that the line is to be used for temporary working capital, short term uses. It will also have a 30-day annual payout which means that the line must be at 0 for 30 consecutive days. If you’ve used the line for a long-term use like purchasing equipment for example, you may have unintentionally violated the use of proceeds agreement, but you won’t have the cash flow to repay the line in full for 30 days. You run the risk of the bank declaring a default because you have violated the commitment from the bank’s point of view. On long-term sources of funds, you typically try to match the amortization of the loan to the book depreciation schedule of the asset, 3-7 years for equipment and 15-25 years for real estate.

Also, you wouldn’t take out a 3 year term loan to fund payroll for last month, which would be a short term use with a long term source. You end up paying interest over three years for one month’s worth of payroll. You end paying more interest than is necessary.

Sometimes as business owners we get busy. We’re juggling multiple priorities and we don’t pay attention to things like this. Sometimes, the path of least resistance is the one we take to get it done. Therefore, we may have a situation where we have unintentionally shot ourselves in the foot if we funded a long term use with a short term source or vice versa. Take time to review your balance sheet and cash flow statement to be sure that your sources and uses of funds for the last 12 months match and if they don’t consider taking steps to correct the situation.

Bill McDermott
bmcdermott@mcdfs.com
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