Good Debt is a Good Thing

Is debt ever good for music retailers? It can be, according to financial gurus Alan Friedman and Daniel Jobe of Friedman, Kannenberg & Co. At the 2015 NAMM Show, they discussed the appropriate kinds of debt and when debt can create opportunity for a business to grow.

Friedman and Jobe acknowledged that many people feel uncomfortable about being in debt and associate debt with going out of business. According to Friedman, that’s not necessarily true, and the way we look at borrowing is changing.

“We’ve found that many of our best retail clients have used debt to grow their business and have been very successful in doing so,” he said.

Here are highlights from the session video.

Profitability Versus Cash Flow
Friedman and Jobe stated that there’s a big difference between profitability and cash flow, and both are directly tied to debt. They debunked the common myth that if there’s no money in your checking account at the end of the year, you haven’t been profitable. Friedman pointed out that you could have used the cash to buy inventory or pay down debt. On the other hand, if you have cash at year-end, you may be funding losses. So, cash flow often has no bearing on whether or not you’re profitable.

Which is more important: profitability or cash flow? Simply put by Friedman, “If you’re profitable, you can probably borrow money. If you don’t have cash flow, you can’t borrow.” He added, “Chances are that bankers won’t lend to you.”

Poor cash flow is a symptom of a problem, according to Friedman and Jobe. Friedman suggested that the problem could be something as innocent as debt being due too quickly, and you can fix that with an amortizing note. Jobe shared an example of a retailer who paid his vendors before the net 30 due date but couldn’t meet payroll. “Use the time and payment terms,” Jobe insisted.

5 Classifications of Debt
Debt is something you owe, typically money. Friedman and Jobe shared their five debt “buckets” and the pros and cons of each.

1. Accounts Payable. Trade, credit card and other debt incurred to purchase goods for resale and services needed to run your business. Something you’ll be paying in the next 30, 60 and 90 days.

2. Floor planning (asset-based lending). Not available for everyone. A financing arrangement between a retailer, supplier and financing company. Used to finance large-ticket items, such as pianos. Many don’t realize these options are out there. It’s like consignment (often referred to as OPM, or other people’s money), but it may or may not be right for you. You must move the product to take advantage of this.

3. Accrued Expenses. Payments/non-invoice liabilities that will come due at some point. These include sales tax deposits, customer deposits, unpaid taxes, payrolls, unearned lesson income and so on. You don’t manage this as much. Let your accountants worry about this at year-end.

4. Lines of Credit. A constant availability of bank funds to finance A/R and purchase inventory. The bank expects you to pay it back in full for 30 days during the year. LOCs should be used to finance quick-moving inventory.

5. Amortizing Notes. Typically, your bank loan that calls for a set amount, including principal and interest, at a set rate for a set number of months. This is a little more serious because you approach your bank with a business plan and proposal. Amortizing notes are for the things we typically finance over a long period of time—a vehicle, leasehold improvements, store furniture and fixtures, computers, fixed and rental assets, rental pools, and real estate.

Debt is Good When You …
• Manage your inventory.

• Monitor profitability.

• Build retained earnings—when you make money annually and don’t take money out of the business.

• Are involved in the business.

“Don’t throw good money after bad,” Jobe said. He shared an example of borrowing money to get into the rental business, and being successful at it. But if another area of your business costs you money, you’re masking a problem by borrowing more money. So, make sure you take a good look at your areas of profitability.

Debt is a great tool to make potential profits (and investments) a reality. Jobe cited an example of using debt to buy real estate—it saves on rent, plus you can diversify. Still, he cautioned: “You have to have great banking relationships, have your finances in order, be profitable, and you can use debt as a tool.”

“We’re trying to get you comfortable with borrowing money—if you maintain profitability,” Friedman said.

To Achieve Good Debt
1. Match inventory turn with financing terms.

2. Manage your inventory, and don’t let it age.

​3. Pay your supplier or financier according to the terms.