I had an email from a reader a little while back asking Kevin and me to delve into how bankers are stifling lean. My answer to the question is that the dumber and greedier bankers are, the better it is for all concerned. In particular, the email, speaking of the company for which the writer works owner/president, said …
"He doesn’t want to reduce any of our inventories because our line of credit is keyed to the value of our inventory (which they consider as an asset). If we reduce our inventory, we risk having our bank line of credit reduced accordingly."
This is really a case of dumb and dumber. To begin with, the banker is dumb for lending against inventory. Inventory is supposed to be valued at 'the lower of cost or market', and virtually every accountant concludes that cost is the lower of the two less a trivial allowance for obsolescence. The banker's lien against the inventory is supposed to be their security if the borrower defaults – a scenario in which the bank would seize the inventory and sell it off to recover the loan. There is no conceivable way anyone is going to buy that inventory at the bank's liquidation sale for the same amount the company paid for it. Market value is always lower than cost, but accountants are not about to give up their game of inflating profits through inventory accounting tricks.
If you have steel that cost you a thousand bucks, why would I pay you a thousand bucks for it when I can go to the steel company and get the same deal? I don't know for sure where your steel came from or what has been done with it since you bought it. Why take a chance? You have to give me a pretty good discount to make me want your steel rather than new stuff.
Who is going to pay you your cost for work in process? Why would anyone want a pile of half-built widgets valued at a price that includes a lot of allocated overhead expenses? And, while I may see the value in one of your finished goods, what am I going to do with a thousand of them? Inventory liquidation sales typically recover ten cents on the dollar, at best. A banker who lends money based on the inventory value as determined by a manufacturing accountant is a fool.
The real dummy in the equation is the owner/president, however. To my writer/friend whose anonymity I will respect, you ought to ask the big guy, "Let me get this straight: you don't want to pursue lean and reduce inventory by a thousand dollars and free up that much cash because it would take away the collateral you need to borrow something less than that from the bank?" Does this guy really not understand that every dollar of inventory reduction is a dollar of additional cash flow – free and clear – no need to pay it back or pay interest on it? The banker is not the obstacle to lean – the company president is the problem. The banker is only guilty of not knowing his assets from a hole in the ground.
At the other end of the spectrum, I ran into a guy over the weekend who owns a machining company and, like a lot of manufacturers, business is picking up. He was bemoaning the fact that his bank won't lend him money needed to buy equipment necessary to increase his capacity and meet demand. The bank's reasoning: his P&L hasn't looked strong enough over the last couple of years. At the same time, his inventory is only turning 4-5 times a year. He was oblivious to the fact that he had the ability to be his own banker – not too much lean effort and he will start turning that mountain of inventory into cash faster than he can spend it.
I don't know which banker is the greater idiot – the one who will lend money against a bunch of over-valued inventory, or the one who says that because the recession has hammered the second guy's P&L he won't lend him money even though he managed his business well enough to weather the recession. Either way, the bank is not the problem – it is the president who thinks inventory and banks have some value.
And I don't know which president is worse – they both seem to think that borrowing money and paying interest to a bank makes sense when they are sitting on all the potential cash they need. Bankers who won't lend money, however, are lean's best friend. They force companies to get lean and fund themselves.
Lean companies generate cash and enjoy the luxury of calling the shots when the bankers line up in their lobbies, hat in hand, begging for them to put it in their bank. CEO's groveling before banks – thinking they need them at all while sitting on big inventories - are foolish.