There is a saying that a banker is “someone who gives you an umbrella when it is sunny and takes it away when it is raining!”
I am sure many small businesses have felt this way when dealing with their bank or lender in gaining finance, or simply trying to maintain the finance agreements they already have. Over the years I have witnessed and experienced the stress, frustration and at times dismay of business owners when a loan approval is not forthcoming or conditions of an approval have not been acceptable to the business owner.
Unfortunately, the reality is that many small businesses do not represent their business well when negotiating with lenders, and that has a negative impact on the lenders decision making process. Some business owners believe it is their right to be granted a loan on the terms they desire, but in reality they need to prove they are at the least an “acceptable commercial risk”.
Positively, the process can be a lot smoother when some preparation time is committed prior to lodging with a lender.
At a very high level Banks want to gain comfort in two main areas:
1 .The businesses ability to repay the loan over the approved term
2. The security offered is acceptable should the loan not be repaid
Ability to repay the loan.
It is often regarded that the best indicator of future performance is past performance. So the first thing that banks will be looking for is the ability of your business to generate sufficient trade, profit and cashflow to both repay the loan and maintain your lifestyle, based on past financial accounts.
Then lenders will be keen to understand how well you understand your business and the key performance indicators of your business. While not an exhaustive list the following are the type of things you need to understand and be able to communicate about your business :
- What level of Gross & Net Profit you generate from each product or service line?
- What are your Debtor payment terms and how long does it take for a sale to hit your bank account. Remember profit doesn’t repay the loan, cash flow does. There are many cases of profitable businesses going broke because they needed to wait too long for debtors to pay!
- What is your optimum level of stock and how many days does it take you to turn over stock.
- Are you heavily reliant on a small number of clients or suppliers? How can you mitigate the potential risk if this is the case?
- Who are your competitors?
- What are your fixed and variable costs?
- How do you generate sales and how can you increase sale levels?
- Are you up to date with your financial commitments such as taxation and loan repayments?
If you are looking for funds to grow your business then you need to clearly articulate how the new loan funds will be used and how they will assist you in generating more sales and cash flow. For instance if you are buying new equipment will it increase your capacity to meet demand that you currently can’t meet?
If your historical financial statements do not indicate you can service a loan you can expect that you will be required to produce a forward cash flow projection detailing how you will be able to repay the loan in the future (i.e. increased production capacity).
From a servicing aspect there are many “Red Flags” to lenders that will dent their confidence in your business and a number of these are detailed below:
Servicing “Red Flags”
- Non payment or arrears in taxation obligations
- Financial Accounts not available within 6 months of the end of financial year
- Income and profit declining over recent years
- Errors in financial accounts
- Inability to provide YTD management accounts or BAS Statements
- Overdraft excesses or arrears on existing loans.
Once a lender is comfortable your business should be able to service a loan they will then look at what is their “second way out”. In other words how will the loan be repaid if you don’t, or can’t make regular loan repayments in the future? Simply put, what security can you offer that can be sold or called upon to repay the loan if ever needed.
The quality of security offered can dramatically impact the interest rates, terms and conditions of a potential loan. The stronger the security, the better the interest rates and terms that are likely to be offered.
Clearly an attractive form of security for a lender is “bricks and mortar”. Some type of real estate whether it be a residential or commercial property is considered the first choice security option by lenders.
If you are looking for loan funds to finance plant or equipment (including motor vehicles) there are specific products that can be offered that utilise that plant and equipment as security.
Some lenders may also consider lending against business assets in the balance sheet such as inventory, debtors and work in progress. However the level of funding available is likely to be heavily discounted as these types of assets can be difficult to realise for a lender and the ongoing value can fluctuate significantly. In simple terms, if a lender comes to the point that they need to realise on these securities, it is likely that there is limited value in such assets – because let’s be honest, if the business was in good financial health there would be no need for a lender to consider enforcing security!
If you are looking to obtain business finance you will have much better success if you present your business in the best possible position you can.
A Finance Broker who has experience in business lending will help you positively present your business to potential lenders as well as providing advice on the best lender for your individual needs.