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5 Tips to Determine if your Loan is Bankable or Not

  
  
  

Are you bankable?  If so, what amount can you afford to borrow? And at what rate, terms and collateral?  Also, which bank(s) do this type of loan?  Business owners don't understand the variables or the metrics.  It takes a guide.  

are you bankable? 

Within the last two weeks, I've talked to a doctor wanting to do a debt consolidation loan for his practice, a pastor about how much his church can borrow to build a building, and a restauranteur that is being offered the real estate that his restaurant sits on.  All these questions come up and business owners really don't understand their options.

So, what are the 5 tips that make your deal bankable or not? Here we go:

1. Do you have skin in the game?  The days of banks doing 100% financing (if they ever did) are gone.  For real estate 20-25% equity is a rule of thumb, there are exceptions.  The same is true with equipment and the same with buying a business.

2. Do you have the cash flow to repay the loan with ample cushion?  Banks are looking for your historical cash flow to repay the loan with a 20-30% cushion.  Cash flow can be defined from the business only or from the business and the owner combined.  

3. Does the collateral you're providing (when margined) cover the full loan amount?  Banks are willing to loan 75-80% of real estate, equipment and accounts receivable; less on inventory, but more on cash value life insurance or some listed securities.

4. Does your company have a well proportioned balance sheet and a history of profits?  What does well proportioned mean?  A fair amount of liquidity (5-7 days sales in cash for example) and less than $4 of debt for every $1 of equity.  The last year should be profitable, preferably the last three, in order to obtain financing. 

5. What are the prevailing economic conditions in your industry?  During the Great Recession, residential and commercial contractors really struggled, many went out of business. Now, these industries are really doing quite well.  Is your industry cyclical? Where are we in the cycle and is it expanding or contracting?

Once you've answered these questions, you're halfway home.  The next step is to find a bank(s) that is doing the type of lending that you're looking for.  Stay tuned for part 2, finding the right bank for your loan.

Non-profits: Three tips you need to know about borrowing money

  
  
  

Recently, I’ve had several churches that are either looking for a building to purchase or refinancing an existing loan to improve and free up dollars for ministry.  It occurred to me that most of my tips and advice are intended for profit companies, but what about the non-profits?  If you are one, this article is for you.  Here's the top 3 tips non-profits need to know about borrowing money.

 borrowing tips for non profits

1) It’s hard to borrow for operating expenses from a bank.  Since the nature of your business is to collect donations from individual and corporate donors, most banks will not loan you money for operating expenses because their repayment will come from the same donations that are employed for your operating budget.

 

Banks will loan money for buildings or equipment where there is money earmarked in the budget to repay the mortgage or loan whether from excess funds or from a capital campaign of some type.

 

2) A bank will want to spread the risk of the loan over as many members as possible.  The rule of thumb for most banks is they will not finance a building to a church with less than 100 members.  Depending on the size of the loan, a rule of thumb for many banks is no one donor makes up more than $50/month of debt service and no one donor contributes more than $2,000 of annual budget.  Also, banks look for the total debt to be less than $3,000 per donor.

 

3) Due to the ministry aspect of your non-profit, most banks will not lend you more than 2.5 to 4 times your annual budget for a building mortgage.  They also want to be sure that less than 30% of your annual budget goes toward the mortgage leaving 70% to go toward your ministry budget. 

 

Applying these metrics will go a long way toward helping you be successful on how much a bank would be willing to loan your church and how much you can afford to repay from the bank’s point of view.

It's time to talk about the "D-word"

  
  
  

I'm going to talk about a four letter word that makes some squirm, especially when you have to apply for it. Debt.  So how much debt is enough and how much is too much?  How do you restructure it and under what circumstances is the bank willing?

debt is a four letter word

I have a client with a mortgage on his building at a failed bank.  He used his line of credit to get through the economic downturn and needed additional working capital to fund his growth after the recession.  We were able to restructure his mortgage, fold the line of credit in to the balance and obtain additional working capital to finance his sales growth.  The bank got a good loan and he got the working capital he needed, placed his mortgage with a well capitalized bank and reduced his payments in the process.

Bankers want to be sure you have skin in the game before they loan you money.  A good rule of thumb is 25% you, 75% bank and other liabilities. So, if you have $1 million in assets, the liabilities should not be more than $750,000 and your equity should be at least $250,000.  

Watch out for intangible assets (goodwill) or shareholder notes or receivables.  Depending on the situation, those could be subtracted from your equity which changes the percentages.

There needs to be a good reason to restructure debt.  A lower interest rate or payments or obtaining additional credit that wouldn't be available otherwise are all good reasons to restructure.  Recently, many banks have not granted credit based on their financial health.  So, relocating to a healthy bank to have access to debt would also be a good reason.

Are there any other debt stories out there that may have been a little sticky, but had a happy ending?  If so, please share them.

Does a bank make loans based on interim numbers?

  
  
  

Probably not.  Banks believe that the best indicator of the future is the past.  If you lost money last year, the bank thinks you’re going to lose money this year.  Even if you are showing good trends in the interim, it’s unlikely that the bank will give you credit for just a partial year.  You need to show a full year of profits to get the bank to go along.  Here’s a story of how one my clients handled this situation.

 interim financials

 

2010 and 2011 were not kind to this client who wholesales products tied to residential construction.  Seeing over $200,000 in losses for these two years left their company starved for cash.  To make matters worse, the industry was starting to recover and my client was predicting an 18% growth rate. Growth requires cash they didn’t have. Mid year 2012, the company was showing nice progress and we showed financials to the bank only to be told “Wait until you have a full 12 months of profit and we’ll consider it.”

 

The growth created higher levels of inventory and receivables. The only alternative was to ride payables and have the owners put a little money in the company.  However, after a full year in 2012, the company did have a 20% increase in revenue made a nice profit and had a $180,000 positive swing in earnings.

 

Finally in 2013, we were able to obtain a loan that consolidated the mortgage on the company building, paid off the existing line of credit with the previous bank and obtained $150,000 in additional working capital.  The additional working capital and decrease in monthly payments was a huge help to the company cash flow.  Problem solved!

 

Avoid the pain of asking the bank to increase your line of credit when you only have 3 to 9 months of improvement.  Wait until you have a full year, then go see them.  

Have you outgrown your money?

  
  
  

Have you ever had the experience where you need to fund payroll on Friday and there's not enough cash in the bank?  You may have a line of credit, but there's not enough there either.  If this is you, maybe you've outgrown your money.

outgrown you money

 

I have a client in a service industry that is growing rapidly this year.  We negotiated a nice line of credit, but they quickly used it and were looking for funds to fuel their growth.  They negotiated short term loans with shareholders, but their cash flow projections showed they wouldn't have the money to repay the shareholders.  It would be sitting in accounts receivable and would need to be spent on the expenses necessary to fund that growth.

Growth requires cash.  If your revenue grows at 20%, it's likely your receivables will also grow about 20%.  They can grow more or less depending on your collections and timing, but the more you have sitting in receivables, the less you probably have in cash.  

Many business owners experience a funding gap when they reach funding requirements between $250,000 and $5 million.  The funding gap is created by the funds they have available and the funds they need.  These businesses that are too big to be small and too small to be big are experiencing very limited access to capital and their business borrowing exceeds their personal assets they have available to borrow from.  Bank consolidation, bank reregulation and tight credit markets make this even more difficult.

To get the capital you need to finance your business, you have to reduce the amount of actual or perceived risk for the lender/investor.  Here's a couple of things to help with that:

  • Have skin in the game.  If you're aren't taking your share of the risk, it's hard to get people to take their share and yours.  Skin in the game = shareholders equity/net worth.  Most banks are willing to accept you having 25% of your capitalization as equity, but not less than that.
  • If you're in a difficult industry, (contracting) provide industry outlooks that show a favorable economic outlook for your industry.
  • Profits and liquidity.  If a lender sees a profitable, liquid company (cash in the bank) that goes a long way to reducing the risk.
Can you think of any other ways to reduce real or perceived risk?  If so, please comment.
Here are a couple of other articles related to cash flow planning and money.

 

Business and Finance News Update

  
  
  

Our business and finance news round-up is here. We hope you enjoy a few top articles discussing relevant issues to the business and financial worlds.

describe the image 

A simple trick that made my company cash flow positive

SBA loan programs a vital lifeline 

How to motivate employees in less than 5 minutes

Business and Finance News Update

  
  
  

Our business and finance news update is here. We hope you enjoy a few top articles relevant to the business and financial worlds.

describe the image 

6 secrets to getting a business loan (even in tough times) 

Twitter seeks credit line of up to $1 billion 

SBA lending program for veterans is troubled, GAO reports 

The state jobs recovery is no where near where it should be

All sales growth is good, right? Sorry, it's not...

  
  
  

You're coming out of the recession, sales are starting to pickup and you see the opportunity to make some profits.  However, cash is tight and you don't have a line of credit or enough of one to make things work.  The only thing increasing is your AR balance and that won't cover payroll or your payables that are due.

 

cash flow planning

 

I have a client that runs a very successful service business.  However, he decided to take on a new venture.  He raised some money (about $200,000), but the money had strings because it's due in about 120 days.  He collects his receivables in about 60 days (a little slow).  The new venture has billings weekly of about $40,000 and payroll weekly of $25,000.  So, his capital raise will cover his payroll.  But, he will bill $320,000 in the first two months before he collects his first dollar of AR.  Where's the cash coming to payoff the money?  It's not.  It will be sitting in his AR and the cash will be used to finance payroll.

Here's his problem:

-The increase of $160,000 on the new venture combined with his growth in his core business is more than he can sustain.  He has to increase his line of credit or raise equity.

So, how much growth can he sustain without a line of credit increase or equity raise?

-The sustainable growth rate of any busines is the (return on equity x 1- the dividend payout ratio (for taxes or other distributions).

If his ROE is 50% and his dividend payout ratio is 25%, 50 x .75 (1-.25), he can sustain a growth rate of 37.5%.

-If his growth rate is higher (and it is), he won't be able to pay his investors unless he can take them out with a line increase from his bank.

-He needs to factor the increased borrowing cost in his pricing.

-Also, if he's dropping prices to increase volume, he may be getting hit double if he has to borrow additional money to handle the increase.  Cost to borrow should be included in his pricing model.

Companies often get themselves in to trouble when they try to grow too fast or when they face gross margin decreases due to increased volume.

Have you ever heard of a sustainable growth rate?  If so, how have you used it in your business?  If you haven't, was this information helpful?

 

Business and Finance News Update

  
  
  

Our business and finance news round-up is here. We hope you enjoy a few top articles discussing relevant issues to the business and financial worlds.

describe the image 

Wells Fargo, PNC try new banking concepts 

Measure of US jobless claims falls to six year low 

How to read a balance sheet

BankSpeak-Cash flow

  
  
  

Have you ever been confused by the terms your banker used during a meeting?

Bankers seem to have their own language that I call Bankspeak. 

Recently, I attended a closing for a line of credit based on my client's accounts receivable. One of the bankers used the term ABL (Bankspeak for asset based lending).  My client asked the question, "What's ABL?"  All the clients in the room had never heard of the acronym, but all of the bankers had.  

We're going to define some Bankspeak terms like ABL in a series of blog articles.  This week we're discussing "cash flow."

.cash flow

What is the definition of cash flow?  A basic definition of cash flow is the movement of money in or out of a business over a certain period of time.  However, a banker can expand on that definition:

  • Cash flow can be defined as ebitda (earnings before interest, taxes, depreciation and amortization).
  • Cash flow can also mean the cash flow statement which is sometimes a schedule in your accountant prepared financial statements.
  • Cash flow is used as the numerator in a debt service coverage ratio, cash flow/debt payments.
  • Be sure to define what's included in the calculation of cash flow, taxes or not, shareholder distributions or not?
How do you define cash flow for your business?
For some articles on related topics:
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