Blog

It may seem like only yesterday that you took out your EIDL loan from the US Small Business Administration to help your business weather the challenges of the recent pandemic.  But for most EIDL recipients, 30 months of payment deferrals are about to come to an end, and minimum payments will be due to the SBA starting in the next few months (depending on when you received your initial loan.)

This post is meant to point out a few considerations that may be a surprise to some.

First, although payments have been deferred for the first 30 months of the loan, interest has been accruing at 3.75% annually since day 1.  So some EIDL borrowers may be surprised to discover that they owe more than the initial principal balance.  You should have received an email from the SBA directing you to create an online account with a specific online portal where you can access information on current loan balances, payment due amounts, etc.  It would be a good idea to do this now and plan accordingly.

Second, initial loan payments will be applied initially only to accrued interest until it is paid off.  This means that if borrowers simply pay the minimum amount due, it will be many months before their payments actually start to chip away at the principal balance.  (For instance, I did an amortization schedule for one client recently and found that it would take about three years to pay off all the accrued interest with minimum payments only.)  So you might want to consider paying more than the minimum to pay off the accrued interest more quickly and start paying down the principal sooner.

Finally, although payments were deferred for 30 months, the actual loan term did not change.  That means that if borrowers pay only minimum payments for 30 years, there will be a large “balloon” payment due at the end, representing the remaining principal.   (In the case of my client, I calculated that the balloon amount would be roughly 8% of the original loan amount.)  Borrowers looking to reduce their overall indebtedness more quickly or to avoid the balloon liability should consider routinely making extra principal payments to avoid a large liability at the end of the loan term.

[Note: this article pertains only to the EIDL loans, and NOT the Paycheck Protection Program (PPP), which was also authorized under the CARES Act.  It refers specifically to the loan portion, and not the emergency grant that many businesses have received.]

On March 27, 2020, in response to the COVID-19 pandemic, the U.S. Congress passed the CARES Act, which aimed in part to provide substantial economic assistance to businesses impacted by this unprecedented crisis.  The US Small Business Administration (SBA) was authorized to expand its Economic Injury Disaster Loan (EIDL) program, with substantial funding provided for immediate distribution to businesses.

Six weeks later, the SBA has processed a deluge of applications, and prospective borrowers are beginning to receive final documentation to sign up for the EIDL loans.   Businesses are being approved for loans of various sizes, which appear to be based on the overall size of the business (e.g. total revenue).  The loans have a fixed interest rate of 3.75%, repayable over 30 years, with the first payment deferred for 12 months.

Although loan approval is likely to come as a big relief, included in the fine print are a number of requirements that all EIDL borrowers should be aware of.  At a minimum, borrowers will want to understand how they are allowed to use the loan proceeds, what kinds of records they are required to keep, the implications for compensation from other sources like insurance or other government aid programs, and collateral and insurance requirements. 

Spoiler alert:  meticulous record keeping is a must.

Use of Proceeds.  The EIDL loan proceeds are to be used “solely as working capital to alleviate economic injury” caused by the COVID disaster.  The SBA.gov website defines working capital as “the amount of capital that is available for the day-to-day operations of a business. Working capital is typically used to pay for regular expenses, such as utility bills, employee payroll, rent, inventory, and marketing costs.” 

The SBA has also published a list of ineligible uses for EIDL loan proceeds.  These include repayment of stockholder/principal loans, expansion of facilities, acquisition of fixed assets, repair of physical damages, refinancing long term debt, paying down other SBA loans, paying down any federal debt except IRS obligations, legal penalties, or relocation. 

In addition, the funds cannot be used to pay any dividends or bonuses, or disbursements to owners, partners, officers, directors, or stockholders, except when directly related to performance of services for the benefit of the applicant.   This caveat seems to indicate that EIDL funds may be used by small business owners like sole proprietors who compensate themselves for their work by way of owner distributions.  This would be consistent with the spirit of the CARES Act, which explicitly indicates that sole proprietors and independent contractors are eligible.  Borrowers would be well advised, however, to verify this with the SBA.

Borrowers are also required, “to the extent feasible”, to purchase only American-made equipment and products with the proceeds.  Misuse of funds is subject to penalties including repayment in full at 1.5 times the loan value, as well as fines, imprisonment, and civil penalties.

Receipt Retention.  Borrowers are required to obtain and itemize receipts (including paid receipts, paid invoices, or cancelled checks) and contracts for all spending of loan funds.  These records must be retained for three years after the full loan proceeds are received and must be provided to the SBA whenever the agency requests them. 

Books and Records.  Borrowers are required to maintain “current and proper books of account in a manner satisfactory to the SBA” for the most recent five years and until three years after the loan is paid off.  These include financial and operating statements, insurance policies, tax returns and related filings, records or distributions, dividends, and other compensation to owners.  The SBA may audit these records at any time and may require inspection and appraisal of the borrower’s assets.  The SBA must be provided financial statements annually, and it can require borrowers to provide an Accountants Review Report prepared by an independent CPA.

Compensation from Other Sources.  Eligibility for the loan is limited to losses not compensated by other sources, such as insurance proceeds, grants and loans from other government agencies or private organizations, civil liability claims, or salvage of damaged property.  Any such compensation must be handed over to the SBA up to the full amount of the EIDL loan.  This provision will be of particular interest to borrowers who took advantage of state and local government programs, as well as programs provided by private companies like Amazon, Facebook, and Verizon.

Collateral.  All EIDL loans over $25,000 come with collateral terms.  To secure these loans, borrowers must grant the SBA security interest in all company property, including inventory, equipment, loans, letters of credit, healthcare insurance receivables, credit card receivables, deposit accounts, and commercial tort claims.  These collateral items may not be sold or transferred (except for normal inventory turnover), nor can they be used as collateral for any superior liens, without SBA approval.

Hazard Insurance.  Borrowers who are required to put up collateral must provide proof of an active hazard insurance policy covering at least 80% of its insurable value.  Coverage must be maintained throughout the entire term of the loan.

Default Terms.  Default under the EIDL program is broadly defined, and includes failure to make an EIDL loan payment, default on other SBA loans, transfer of collateral, withholding material information or lying to the SBA, defaulting on loans from other creditors in a manner that impacts their ability to repay the EIDL, failure to pay taxes, bankruptcy, and change of ownership with SBA’s prior consent, among other provisions.

In conclusion, the EIDL program is a boon to small businesses affected by the pandemic.  It is a very inexpensive source of working capital, with a 30-year term that keeps monthly payments low.  However, with those benefits come many requirements that must be met thoroughly and consistently.  Business owners who receive EIDL loans should ensure they have the right team of professional support lined up to ensure compliance.

Sources: SBA EIDL loan documentation; SBA Disaster Assistance Program Standard Operating Procedure (https://www.sba.gov/sites/default/files/2018-06/SOP%2050%2030%209-FINAL.PDF)

Small business owners wear a thousand hats.  With all of the demands on their time, it can be a challenge to take a step back and come up with an accurate assessment of how their business is performing.

Financial statements are complex, and therefore easily (and often) ignored.

A bank statement is easy to understand, but unreliable as a barometer of business health.

Do you know for sure if your company is making money?  Is it on the right track?

With the Money Mastery Roadmap, GT Business Advisory helps entrepreneurs become focused and effective business owners.   Step number one is conducting a 3-Point Inspection:  assessing the company’s performance by looking at the following three key numbers:

1)  Net income.  This one’s easy: it’s the bottom line on your income statement (P&L).  If the number is positive, then you’re making money — at least in theory.

2)  Cash balance.  This number comes from the balance sheet, and is the sum of all bank account balances (or “cash & cash equivalents”).  You certainly want this number to be positive, or you may be unable to pay your bills and keep afloat.

3)  Operating cash flow.  As the old saying goes, profit is an opinion, but cash is a fact.  This number comes from the Statement of Cash Flows (an often neglected but critically powerful document).  You will find it named something like “Net cash provided by operating activities”.  It is the change in your cash balance that resulted from the day-to-day activities of your business.  Ideally, this number should always be positive as well, and certainly MUST be so in the long run, or your business will run out of cash and die.

But it is important to do more than just look at these numbers in isolation.  You need to look at their trends over time, and how they relate to one another.  An easy way to do this is to look at these numbers for the past three years, and ask yourself:

• Are all three metrics positive and growing over time?  If not, why not?
• Is the cash balance growing more slowly than net income?  If so, why?
• Is operating cash flow significantly lower than net income?  If so, why?

Comparing these three numbers over time provides critical top-line information on how your business is doing.  That is why the Baseline Check is the first step in the Money Mastery Roadmap.  If this analysis provides nothing but good news, then you can feel pretty confident that there are no obvious negative trends impacting the immediate financial health of your business. 

If the answers are negative, or more ambiguous, you will need to dig deeper.  If your cash balance and/or operating cash flow are underperforming net income, the most likely culprits are to be found on your balance sheet:  Accounts Receivable, Accounts Payable, and Inventory.

Accounts Receivable represents the total value of invoices that you have sent to customers which have not yet been paid.   In accrual-based accounting, when you create an invoice, that dollar amount immediately goes on your books as net income.  But the cash is not yet in the bank.  So an invoice for $1000 will increase net income by $1,000, but operating cash flow and your bank balance don’t budget by a penny.  The larger your A/R balance, the wider the gap between net income and your actual cash resources.  So the goal is to collect payments quickly from your customers, and keep A/R as low as possible

Accounts Payable is the total amount of bills you’ve received from vendors that you have not paid yet.  Again, in according to accrual accounting rules, those bills are immediately deducted from net income, but they don’t affect operating cash flow or your bank balance.  In this case, however, A/P works in your favor.  A vendor bill for $1000 will reduce net income by that amount, but your cash resources don’t change.  The larger your A/P balance, the more cash that remains available to fund your business.  So the goal is to pay vendors as slowly as they will allow. 

For example, you may the kind of person who likes to pay their bills immediately.  That is a fine practice in your personal finances.  But in business, if your suppliers give you 30 days to pay them, you should pay them on day 30 (or maybe day 29, to allow for any hiccups).

Inventory is the value of goods for sale that you have in stock.  (If you are in a services business this likely does not apply to you, so feel free to skip ahead.)  Buying that inventory costs you cash at the time you purchase it.  But accrual accounting says that you cannot record an expense for inventory until you’ve sold it.   So your operating cash flow and bank balance will go down when you acquire the goods, but net income won’t budge until they go back out the door.   This is why managing your inventory is so important.  The greater your supply of goods waiting to be sold, the less cash you have available to pay your bills and stay afloat.  The goal should be to keep in stock the minimum level of inventory necessary to avoid disrupting your likely sales and keep inventory levels as low as you can.

In sum, if your operating cash flow and cash balance are growing more slowly than net income (or shrinking, for that matter), the first place to look is the trends in your Accounts Receivable, Accounts Payable, and Inventory. 

Paying Yourself Too Much? There’s one additional scenario to consider – when your net income and operating cash flow are healthy, but your cash balance is lagging.  In that case, one likely cause could be that you are paying yourself too much. 

To investigate this possibility, look to the “Financing Activities” section of your Statement of Cash Flows.  This should detail all of the Owner’s Distributions that you took, which reduce cash balance.  (If you pay yourself a salary, you can also take your salary payments from the income statement into account.)   If the total amount you paid yourself exceeds your operating cash flow, you as the business owner are the culprit, and you may need to right-size your compensation to suit the current size of your business.

There are a host of other factors that could be impacting your results.  But the ones described in this post are amongst the most common and likely problem areas for most small businesses.

Now you know the first step you must take to achieve money mastery in your business, by doing a 3-Point Inspection. 

Want some help?  We can offer you a 3-Point Inspection for just $97.  Click on “Schedule time with me” below to set up an appointment.