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Growing Your Business |
Building Your Financial Credibility(Part 2 of 2)Developing a successful loan application.Second of a 2-part series; click here for part 1. 
Interview with Larry Hulvey, Vice President and Credit Administrator for Community Business Market; Andrew Niemer, Vice President, Community Business Center; and Gregory Foxx, Vice President/Manager, Minority and Women's Business Center, all of Bank of America. WORLD SWEEPER: In part 1, we talked about the need for good planning and the importance of establishing rapport and a track record with your banker. When you come looking for a loan it takes preparation, and conventional wisdom says that you need to look professional when you walk in through the door. Niemer: That's exactly right. If a small business owner comes in with a loan application package that is well prepared and complete, he/she is going to have a much greater chance of success than the owner (even if they been dealing with that bank for a long time) who just walks in and says, "Well, I want a loan," and the conversation proceeds something like:The banker says, "For how much?" "Well, I don't know, I want to buy a new sweeper." "How much is a new sweeper going to cost?" "I don't know, I'm still thinking about whether to buy one and what to get." "Let's look at your financials." "Financials? I don't have any financials." And so a personal financial statement is penciled out and submitted along with some old tax returns. But if the sweeping company is dealing with malls and municipalities, it is going to have assets other than just sweepers. It will have receivables, and probably payables. If business owners can't present a good financial picture of their business, they're not going to have any success with their bank. But if they can present their business data and are able to show that they understand it from a financial perspective, they're going to have much better success. Foxx: The last part that Andy just mentioned is very critical. Showing understanding of the business - by having a well-thought-out, professional proposal - is very important. It's critical that the owner really, truly, understands the numbers in his/her business plan. Often small companies will hire a service provider to put together a business plan or business proposal for them to take to their bank. Unfortunately, in many of these situations it soon becomes apparent that the borrower really doesn't personally understand the information. All too often people pay someone to put a professional-looking proposal together, but don't have a clue as to what's really in it and what it all means. Remember that the bank is looking at that business plan as the borrower's road map of how he/she is going to get from point A to point B. It's very frustrating, as bankers, to have clients come in with financial statements where it shows "Accounting Fee: $5000.00," then, when the owners are asked to explain some of the numbers, it's easy to see that they have no idea - their accountant prepared it and gave it to them. We just cringe at that. Hulvey: At this point I would like to reinforce that the numbers - tax returns, financial statements, projections - are only part of what we are talking about here. As Greg said, the business plan is the road map. It tells the story - takes the vision that the owner has in mind - and allows the reader (the banker) to know where the company is going. It allows the banker to become a partner as well as to be an advocate for his/her client. WORLD SWEEPER: Does it matter if the accountant comes in along with the owner? Foxx: No, because the borrowers themselves really need to understand their background information. They are the ones who will be making the critical decisions into the future. If they are unable to understand why certain expense categories are higher than the plan originally indicated they would be, then they won't have the where-with-all to make the necessary decisions about where to cut back in operating expenses so that they make the profitability that they originally planned for. So it's not just a simple matter of bringing the accountant in on a meeting with the banker to explain the numbers. Entrepreneurs need to really understand their operation and the numbers that are behind it. That's their road map to success. WORLD SWEEPER: Rather than a road map, isn't it an even better analogy to liken it to a map of a streambed: The stream modifies the surrounding landscape all the time, and one must keep up with where those modifications have taken place - what turns in the stream are causing the erosion here or the increase in deposits over there. Niemer: Yes, that's right, it's a living document. You don't just write it and file it away. After you write it you use it, change it, and modify it constantly. WORLD SWEEPER: How often? Niemer: As often as necessary to ensure a reasonable return on investment. If the business is in a growth mode, modification may be needed monthly, or at least quarterly. If growth hasn't taken place the way it was planned, there may be a need to modify the expense side on a monthly or quarterly basis. Modifications can be as frequent as monthly or out as far as maybe six months at a time. Hulvey: That is true for the operating plan. However, we do not mean that the owner shouldn't do some long range planning as well. Again, it is very important for owners to have a vision of where they want to be in, say, three years or five years, and it is just as important to share that vision with his/her banker partner. WORLD SWEEPER: When somebody has been in business for several years, do you want to see just current information or do you want to see financials from the past which show how they started and where they came from? Foxx: Three years back gives us a picture of the history of a firm. Then we want something as current as possible to give us the interim information, maybe no more than 60 or 90 days past - no older than that. You have to remember that a financial statement is just one point in time. Just having the most recent statement doesn't give a picture of the life of the business and how well the cash flows. We prefer three years to be able to establish the actual trends. Niemer: Bankers need to be able to determine cash flows and establish trends because, when considering an application, cash flow is paramount. There is only one thing that repays a loan, and that is cash. Banks want that cash to come from the operational cash flow of an ongoing business activity, not from the liquidation of that business' assets. Many people do not recognize that aspect of lending. They think that as long as they offer enough collateral, they should be given a loan. But, again, banks want to be repaid with cash, they don't want to own collateral. They are not set up to refurbish and resell equipment. That is one reason businesses may find it easier to finance equipment through equipment dealers. Dealers, if they have to, can more easily take used equipment, spruce it up, and resell it. This greatly reduces their risk, which enables them to rely more on collateral than cash flow. This reliance on cash flow is what makes it a little tougher to get a bank loan as opposed to dealer financing. That is not to say, however, that banks don't want collateral. Foxx: Bankers also want to have downside support. If the primary source of repayment fails, a bank wants to know how it is going to get repaid. That's why, when collateral value is considered by a bank, a loan will only be made for, say, 70% of the cost of the piece of equipment. At some point in time if the equipment has to be repossessed and resold, the bank will want to make sure that it gets enough cash to pay off the original loan. Niemer: These two points - identifying the cash flow that is the primary source of repayment and identifying a secondary source of repayment - are key factors in the financial analysis of a credit request. But there are a number of other financial indicators the bank looks for in order to approve a loan. For example, bankers look at working capital, net worth, and debt service that is not excessive. The look at the makeup of assets, the liquidity of current assets and the useful life of fixed assets. They look at credit reports, payment histories, and the management of cash and profits. Some rule of thumb figures for existing businesses are [to allow] no more than a four-to-one ratio and no less than a two-to-one current assets to current liability ratio. New businesses should not have more than a two to one debt-to-equity ratio, and a very strong operating capital position. One thing to be aware of is that the basic guidelines for credit underwriting are universally held by banks. Individual banks will apply them differently, however, depending on their current lending philosophy. A bank which is more aggressive in its growth goals may give more collateral value to a business person's particular equity offering. It may be willing to accept a little lower debt coverage ratio than another institution, because it wants to build its assets. Or maybe it's that bank's comfort level with the client - that goes back to having a good ongoing relationship. That relationship may encourage them to take something for collateral that another bank might not, or that they may not accept from another borrower. Regardless of what a bank's lending philosophy is, or how familiar they are with a client, preparation and full and honest disclosure are always very important. Banks want to have personal financial statements, as well as complete business financial statements. The more complete and honest information they can get, with explanations if things seem kind of odd or out of the ordinary, the better is the business owner's opportunity for a successful outcome. For example, if there's a significant increase in an asset, but no supporting information for it, the bank's going to wonder why that happened. Let's posit an example where accounts receivable have jumped out pretty far, and on the surface it looks like receivable collection days have stretched out; that's of concern to a banker. But maybe what happened is that the client took on some jobs with municipalities at a very high profit margin, but then the trade-off is that they had to accept a 60-day invoice payment rather than the normal 30-day schedule. In such a situation the fact that accounts receivable is stretched out is not a negative. The actual fact is that the business is getting more profit on those jobs, and they're getting more jobs, so over time it'll be fine. Without an explanation attached, however, it will look odd to the banker. If that information is already provided in the multiyear financial statement as a footnote, the banker has fewer questions to ask and they're more comfortable because the client appears to be doing a good job of managing his or her business. We have pretty much covered what bankers look for when evaluating a loan request, concentrating on the financial aspects of a business. But bankers do go beyond the numbers and look at many other issues. Those include the character of the business owner(s), the industry the applicant is in, and the business owner's knowledge, experience, and understanding of his/her market and the important issues facing his/her industry. There is no magic or wizardry involved in bank credit decision making. Bankers use the same information that business owners use to manage their company and pay taxes. They don't make numbers up, or change the numbers provided. They take the information and interpret it in accordance with accepted methods of evaluation, as well as accepted accounting principals, in an attempt to highlight indicators of success. With that, a decision is made to invest in a business, or not invest. That investment is in the form of a loan. As with any investment, the more information that the investor has, and the better that information is prepared, the greater the chances will be that the investment will be made. As with anyone trying to sell an investment, the business owner must fully understand his/her business, as well as the potential investor being courted. In short, communicate. Get to know your banker, and be sure your banker knows and understands you and your business. You will find that the result will be a rewarding, mutually beneficial partnership. |
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