September 29, 2014

Manufacturers generally understand the need for some government regulation to limit the “bad actors” but they also agree that some regulations and more often, the uncertainty associated with regulations, can have a serious, harmful impact on business.

A recent report commissioned by the National Association of Manufacturers (NAM) claimed that government regulation cost the American economy roughly $2.1 trillion in 2012. The study found that manufacturers shoulder a larger percentage of that burden than other sectors of the economy. It further found that small and medium-sized manufacturers are impacted most heavily.

Why are manufacturers getting hit so hard by regulations? First, manufacturers face a significantly higher cost of compliance with EPA regulations than the average US business. Manufacturers also see a slightly higher than average cost for compliance with “Occupational Safety and Health and Homeland Security Regulations.”

The increased compliance costs for manufacturers are amplified for small and medium-sized companies who lack the resources and economies of scale of larger corporations. According to the NAM study, the average cost to comply with all federal regulations was $19,564 per employee for manufacturers compared to $9,991 for the average US Company. At $34,671 per employee, the cost to small manufacturers (less than 50 employees) was more than two and a half times greater than the average small US Company.

These are staggering numbers that some have sought to undermine. But according to a 2010 study commissioned by the US Small Business Administration (SBA), the annual cost of regulation came in at $1.91 trillion annually in today’s dollars.

Part of the problem is that federal lawmakers often have to rely on incomplete data regarding the cost of regulation. The US Office of Management and Budget (OMB) issues an annual report that attempts to quantify the benefits and costs of government regulation at the state, local, and tribal levels. According to their May 2014 report, between 2004 and 2013, federal agencies published 37,022 rules including 569 “major rules.” OMB’s cost estimate of just 116 of those rules comes in between $74 billion and $110 billion annually.

Aside from the direct cost to comply with government regulations, manufacturers also face uncertainty as a result of current and proposed regulation. This uncertainty can lead to supply chain disruptions, decreased employment, and altering behavior like delaying research and development of new products. Uncertainty is often mentioned when lawmakers and business leaders discuss specific legislation like the R&D Tax Credit or the Wind Energy Production Tax Credit which require regular renewal by Congress.

Regulatory issues being debated today

There are several regulations being hotly debated as we speak. The Environmental Protection Agency (EPA) has proposed a rule change that “seeks to clarify” the definition of Waters of the USunder the Clean Water Act. Currently, the rule applies to most navigable waters in the country but there is concern that the proposed rule as currently written could expand that definition to include nearly any water that could possibly end up in a navigable body. This could include flood plains and areas accessible to migratory birds. The comment period on this proposed rule change is open until October 20, 2014. You can find more information from the EPA here and from NAM here.

But that’s not all from the EPA. They have also proposed a rule change regarding carbon emissions in the US which threatens coal-fired power plants. Colorado is expected to fare better than most states if this rule is adopted but it could still lead to higher energy costs. The comment period for this proposed rule change has been extended to early December. You can find more information on this proposed rule change from theEPA here and from NAM here.

As if that were not enough from the EPA, they are considering proposing a rule change to regulateground-level ozone emissions. Specifically, EPA staff has suggested proposing a rule that would attempt to limit ozone emissions to as low as 60 parts per billion compared to today’s standard of 75 parts per billion. This change could have a profound impact on the US economy and will certainly impact Colorado, which has worked for years to decrease ozone emissions at a state and local level. NAM has warned that this rule change, if proposed and adopted, could be the costliest single rule in US history. Click to learn more fromEPA here and from NAM here.

Another type of regulation in the news recently is tax reform. The federal government is in the process of regulating “tax inversions” in an attempt to keep American companies in the US. At the same time, the federal government continues to drag its feet on the extension of the Export Import Bank and various tax credits, economic development opportunities like approval of the Keystone XL Pipeline, and Immigration Reform.

The Colorado Manufacturing Initiative understands the need for government regulation. But it is our firm belief that the best solutions are often found at the state and local levels rather than top-down, one size fits all, federal regulation. Additionally, when the government seeks to change behaviors, it should do so in a way that increases opportunity and expands the economy rather than adding bureaucracy and subjecting manufacturers to draconian laws.

The Colorado Manufacturing Initiative and CACI are hard at work to ensure a regulatory environment conducive to manufacturing in Colorado. You can read about CACI’s positions on federal regulatory issues and how to get involved here.

What does it mean to be “bankable?”

In the literal sense, every business is ‘bankable,’ but understanding what a bank is looking for from business owners is crucial for the relationship to be successful for both participants. Knowing what it means to be ‘bankable’ will help you navigate the waters of applying for a loan and serve as a useful tool in preparing for what the banker is really evaluating to conclude ‘yes’ or ‘no.’ For example, simply increasing revenue year-over-year doesn’t necessarily mean a business will get approved for financing, which can be shocking and confusing.

A bank is just like any other company – they want to see a profit in doing business together, just as any business owner would with its customers.  Consequently, the more one understands how banks profit and the risk they take in financing a company, the better one can negotiate with them.

The five C’s of credit serve as the basic model that most banks use: Character, Capacity, Collateral, Capital and Conditions. A banker will review all of these alongside one’s business model, so it is critical to understand the importance of each.

1.) Character is one of the most difficult to articulate, because everyone has his or her own definition. Some banks may simply look at a credit score to determine one’s character, while others are looking at references in the community offered on their behalf. Get a clear understanding of how far the bank is looking into this one, as it may make sense to provide references up front if necessary.

2.) Capacity, along with character, is arguably one of the most important from this list. Capacity means cash flow, or the ability to repay the loan. Business owners need to know their debt to income (DTI) ratio. Other key data to have on hand, include: fixed charge coverage ratio, cash flow coverage ratio, and EBITDA (earnings before interest, taxes, depreciation, amortization) to debt payments.  Keep in mind, that the banker will be operating under the general and logical premise that the business should be generating at least $1 in cash sufficient to service each $1 in debt. Most will want to see consistency for two to three years.

3.) Collateral is what banks fall back on when there are impairments to cash flow (capacity). But the reliance on collateral is where the debate comes into play. Some may wonder why the bank wants to see income for an extended period of time, if you have ample collateral. No question – collateral is a must, but the bank will have to take full responsibility of selling the collateral if the business gets into trouble and they have to take over. The bank will have to hire someone to sell it, which will take a cut into the sale, along with the stigma that goes with selling assets labeled ‘bank owned.’ One generally has to have some form of collateral to be ‘bankable’ but if a business is losing money, the strength of collateral alone will not make it ‘bankable.’

4.) Capital tends to cause the most confusion. The essential question is: what percentage of assets does the business actually own when the dust settles and all liabilities are paid off? It is not unusual to find a business or business owner who distributes all earnings from the company leaving very little strength to the balance sheet.  The bank does not want to be the only player with ‘skin in the game’ and will want to know that the company is committed as well.

5.) Conditions refers to the economic climate.  During the 2008 downturn, some business owners saw their covenants or loan terms change even with their company doing well.  This was an outcome of the economic climate. In conversations about financing, business owners should know how their industry is performing as a whole, not just their company specifically.  They should also be aware of the broader economic environment.

The five C’s are an excellent guide to learning how to be a ‘bankable’ customer, and how business owners can lead a conversation with their banker about obtaining competitive financing.

Sean Nohavec is senior vice president of business development at UMB Bank in Colorado. He can be reached at [email protected].