Funding working capital in the new economy Take contrgl of your destiny

tTl"u BUILDINC INDUSTRY enjoyed I- unprecedented growth during a decade of economic expansion, which peaked in the first quarter of 2006.

Quarterly GDP growth, housing starts, and the U.S. banking system decelerated like a wild roller coaster in 2OO1 and 2009. Executives who engineered survival strategies should be given gold medals. Instead, their reward is a new challenge to fund the working capital required to finance the inevitable industry recovery amidst a changed banking system.

There is a silver lining to every cloud. Adversity breeds innovation. A glance in the economic rear view mirror serves as a shocking recognition of the realities of the "New Normal" economy. Business owners may be in the hot seat, rather than the driver's seat, in financing growth needs. Success starts with a mindset shift toward internally generated cash to reduce outside funding needs (better positioning a firm as a candidate for funding) and awareness of innovative new funding to align needs to solutions.

Economy of the future: t'New Normaltt

Some 437 banks have failed since 2007. This includes 306 in 20092010,92 in 201 l, and I I in first quarter 2012. The FDIC placed 844 of the remaining 7,436 banks on a watch list near the end of 2011. Trepp LLC's 2012 Banking Sector Outlook categorizes 218 banks as representing a high risk of failure. Reuter's "Credit Crunch an Unusual Ally in U.S. Lumber Rally" (March 14, 2Ol2) indicated distributors are having trouble buying lumber in the tight stocks environment and-unable to get capital from banks-are buying futures. This is continued evidence of the lingering bank credit crunch of recent years.

Bloomberg BusinessWeeft 's "Why Small Business Can't Get Financing" (Sept. 2010) highlights severe financing challenges faced by small businesses. The top concern of small businesses is access to capital. More than 507o felt they could increase sales with additional financing.

The Chicago Tribune's "Sluggish Economy Feels Like New Normal" (June I 2. 2010\ suggests economic sickness beginning in the financial system lingers in the economy a long time. This creates a long sluggish period with high government debt, slow economic growth of 27o to 2.57o, and sticky unemployment. This lasts so long, it begins to feel "normal."

These factors and unemployment drive housing starts, which create demand for building materials. Starts peaked at seasonally adjusted 2,213,00 in January 2006 and hit the trough of 478000 in April 2009. This is decline of 79Vo and the worst activity level since 1959. Starts were 610,000 in 201I, and are projected to be 678,000 in 2012. Putting this in perspective, starts did not drop below I million any year between 1960 and 20011

Companies survived this Great Recession by liquidating assets, stretching payables, and slashing overhead. The U.S. recession technically last 18 months, from December 2007 through June 2009. However, housing and building products lag overall economic recovery. Building products faces the "Great Hangover." Next? The welcome, but painful, need to finance working capital for growth. Given the lingering pain within the banking industry, fresh funding approaches are mandatory.

Building Products: Preparing for the roller coasterts "third turntt

The industry's wild roller coaster decelerated at "Turn l" in the third quarter of 2008 with financial market turmoil, a business failure epidemic, and GDP growth of -67o. This was a dramatic fall from 5.17o GDP growth in first quarter 2006. Turn 2 began in 2009 as housing starts plummeted 79Vo from the January 2006 peak, and continues as firms hold on for survival pending economic recovery.

The long-awaited Turn 3 is showing recovery signs of the market turning upward. Turn 3 presents a new challenge, one of funding growth driven by long-term housing demographics. Banking's loss-driven aversion to housing-driven businesses is a challenge. If housing starts double from around 610,000 in 20ll to 1,220,000 within a few years, which is possible, the industry's working capital needs will also double.

Executives face daily sales, operations, employee, and financial challenges. Cash is the "fuel" required to operate a business. Without it, the business stops.

Six steps to funding working capital & taking control of your destiny

At PLM, we understand that you need an insurance company with property and casualty insurance products and services that you can trust today and tomorrow.

Step

1:

Shift

Mindset to Prioritize Financial Concepts

Countless books bombard executives with magical solutions for improving working capital. There are no silver bullets. There is no substitute for disciplined executution of basic concepts. How and where should companies focus on financial priorities? The simple I, D & A approach: Inside the company. Down the financial statements. Across the order-to-cash cycle. This results in both operational and financial discipline producing and profitability.

Focusing "inside the company" generates cash before relying on loans. Concentrate on what you control. Companies will generate more cash and/or become a better candidate for subsequent financing altematives.

Step 2: Look Down the Balance Sheet for the Greatest Cash Opportunities.

Think of the 80/20 rules. Which 2O7o of balance sheet items provide 80% of the cash generation opportunity? Receivables, inventory and payables are obvious targets.

Step 3: Look Down the Income Statement for Profit Margin or lf you're looking for quality and value from your insurance provider, please contact us at 8OO.752.1895 or log onto www.plmins.com/adlMM.

For over 'l OO years, our experts have been providing quality claims and risk management services to the lumber, woodworking and building material industries. Remember, "you get what you pay for." We understand wood. We know your business... because it's our business too. Wood is all we do.

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Cost Improvements.

Olrportunitics to irnprove profit rtrargirts and/or recluce operirtin-u cxpelrses. albcit even by sniitll percclltages. producc significant bcncfits.

Step -l: Use the Statement of Cash Flows to Understand Working Capital Requirements.

Cash, not nct inconre. is kingl This irnportiint. grtlssly undcrutilizccl tool rcconciles net incontc to net cash.

Step 5: Look Across the Order-to-Cash Cycle to Tighten Costly Process Gaps.

Cf'O Muguz.llre '.r "Working Capital Scorecarcl" (Jttne

20 I l) bcnchnrarks working capital across many industries by using a Days Working Capital (DWC) nreasure. DWC is cornprisecl of days of sltles outstanding in acctlunts reccivable (DSO). plus days of inventory on hand (DlO). less outstancling accounts payable (DPO). (Notc: Many l-irrns use cost ol'goods sold in lieu of sales fbr both inventory and payablcs calculations.) Figure | (ubrtve) illustratcs thc workir.r-l capital intensive nature of building products br.rsinesses. ancl distribr.rtors.

What clocs 53 days of working cripital outstanding mcan? Exarnplc: A building ntaterials business with $60rnillion annual sales. dividcd by 360 days, generatcs

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$167,000 in sales daily. A one-day improvement in DWC is worth $167,000 in working capital. The 53 DWC days multiplied by $167,000 equals $7,651 000 in net working capital funding.

Most businesses suffer from process linkages and inefficiencies across the order-to-cash cycle, such as billing delays, which add working capital needs in addition to the DWC calculation above.

Accounts receivable is a large, critical working capital improvement lever. Why? Receivables are the "closest to cash" asset, and can account for up to 40Vo of assets and half of the net working capital investment. Waiting 35 to 45 days for payment is problematic enough, but there is also the risk of non-payment loss.

Inventories are equally important. Both receivables and inventory must serve as a solid collateral base for working capital loans. Poorly managed receivables and inventories are not attractive to funding sources.

Step 6: Seek New Funding Options Available in the Market.

Success with steps 1 through 5 positions any business as a stronger candidate for traditional or new funding solutions. Internally generated cash results in a "cleaner house" with more efficiently managed capital assets and quality lender collateral.

Financing sources prefer to fund growth of a well-run company, rather than funding the clean up of old problems. In a market with more aversion to risk, tight underwriting standards, and limited funding, firms with wellmanaged working capital assets have more success with [inancing.

Working capital funding alternatives

Business owners have many options. Each is designed to meet different needs, and each has both pro and con tradeoffs. Types of traditional working capital funding include:

Bank Line of Credit (LOC)

This has been common for established businesses with strong credit, quality assets, and solid cash flow. Small businesses are challenged to secure this type of funding in today's banking environment.

Asset Based Loan (ABL)

ABL loans may be a fit for highly

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seasonal businesses with detailed historical financials and significant assets, which may be tightly monitored. Lenders today are concerned about valuation of collateral.

Equity

This works if the owner is willing and able to invest significant personal assets in the business, and/or take on new partners. However, it is often the most expensive type of financing.

. Factoring of Receivables or Purchase Orders

Factoring can be an expensive funding option, albeit with advantages for early stage or high growth businesses with quality accounts receivables or purchase orders.

. Equity Investors and/or Sale of Your Business: neering & Construction Group, sees a large buy-side demand in the market.

Many private equity investors are warming up to investing in building materials related firms. "Buildine Products ManufacturersA Mitigated Strategy to Invest in the Distressed Real Estate Market" (March 15,2Ol2), by Don Walker, John Burns Real Estate Consulting, is encouraging. He indicates that an investment in building materials manufacturing allows one to bet on the recovery without the complexity of investing directly in distressed real estate.

FMI's Porter Wiley, managing director of the Building Products Practice, reports seeing lots of demand on the buy and sell side. Both sources, along with others, indicate the challenge is multiples not being in line with historical averages due to depressed EBITDA. An improving housing market should alleviate this to enable more M&A activity in 2012-2o13.

Economic adversity also breeds innovation, in the form of new types of funding. "Entrepreneurs Turn to Alternative Finance" (BusinessWeek. com, Sept. 2009) indicated that assetbased lenders, factors and others are filling the void created by banks tighr ening lending standards

Focus on accounts receivable first is paramount. Why? Business trade credit in the U.S. is 1.5 times larger than the commercial bank loan market (Credit Research Foundation, 2009). For building products firms, accounts receivable is one of the largest, controllable and the closest-to-cash asset.

Professional Collection/Receivables Management

receivable collections and reduce overhead expense.

. Sale of Old or Written Off Receivables

All firms have sustained uncollectible accounts receivable accounts resulting in charge-offs to bad debts. Brown & Joseph offers a program to evaluate these old receivables free of charge and pursue collection of same based on pure contingency fees. This can be "found cash."

. Business Line of Credit (Business LOC)

Atlanta-based AdvancedAR offers a business line of credit altemative to direct bank financing, by combining professional accounts receivable management with fast access to financing at attractive rates. By improving your receivables processes to reduce DSO and bad debt, accounts receivable serves as collateral for the credit line.

. M&A Liquidity Options

Many business owners have survived the recession and desire exit options. Atlanta-based M&A Marketplace by CHC is an innovative concept to connect owners/sellers with pre-screened buyers via a sellerfriendly auction without the cost and complexity of the investment bankinglbroker process.

Reverse Factoring

"M&A:

2011

Review & Look Ahead," by BMO Hanis Bank's Engi-

Firms like Chicago-based Brown & Joseph combine the latest credit intelligence technology with professional resources typically unavailable to smaller firms. Businesses are utilizing outsourcing-type solutions to more effectively manage accounts

Montreal Rackr Racks Systems

ExpoCredit Corp., Miami, is partnering with Banco Sabadell to provide a program that helps business cost effectively extend trade payables to suppliers. This is an opportunity for a business to extend trade credit financing, while enabling the supplier to obtain faster payment.

. Trade Finance, Purchase Order Financing, & SBA-Backed Loans

Hana Financial, Los Angeles, provides an array of alternatives. This firm handles financing for all sizes of clients with options ranging from factoring of receivables to complex purchase order financing and SBA loans.

' Supply Chain Financing

Konnecta, Atlanta, has developed an innovative program with HSBC Bank, combining a rich technology platform, trade credit expertise, and financing pre-qualification to cost effectively facilitate trade credit financing for both suppliers and cus- tomers. With pre-arranged banking support and electronic visibility across the supply chain, trade payables or receivables may be extended or accelerated.

Summary

U.S. businesses suffered mightily during the longest and deepest recession since World War IL No industries have been hammered more than homebuilding, building materials, and banking. All are related

The "new normal" business recov- ery will include an economy with slower growth and a forever changed banking climate. This warrants new approaches, and now is the time to start. As summarized in Figure 2 (above), a back-to-the-basics approach should focus first on internally generated cash. This better positions a company as a stronger candidate for financing.

Many new types of non-banking funding and cash generation solutions have evolved to meet today's conditions. Private equity and merger and acquisition activity is improving. Savvy investors understand housing cycles. This will generate positive interest in, and options for, building materials firms.

- A longtime building materials industry executive, Robert L.Turner III is c.e.o. of Smart Profirability Solutions LLC ( wwru.s mart safe ty g ulfc oa st.com) and t he founder of Management Services & Associates LLC, providing middle-market firms with liquidity solutions Jbcused on generating working capital. Reach him at bo bt ur ne r @ msallc s it e .c om.

By Dave Kahle