In Part 1 of this article I explained the premise that many troubled loans are as much the fault of the lender as the borrower. I discussed how to pursue a conversation with one or more banks about financing for your company. I warned of “the collateral trap” and suggested that your bank should begin by being concerned with the purpose of your loan request and the primary and secondary sources of repayment. Then I noted that the amount and maturity of 
your loan as well as your operating creditworthiness should be addressed through analysis of your financial statements. If your bank is doing a really good job of understanding your business financing proposal, their analysis should start with the following approach.
PCLL
When your bank performs its financial analysis, it should focus on four sets of data:
-
Profitability – the measure of viability of your business measured by net profit after taxes. Many institutions use EBITDA, but this standard is not as full a measure of viability.
-
Cash Flow – the ability of your business to finance itself, now or in the future, measured by GAAP cash flow including operating, investing and financing cash flows into and out of your company.
-
Liquidity – the ability of the business to pay its operating costs based on the relationship between your current assets and your current liabilities and the turnover of each.
-
Leverage – the degree to which your business can withstand the unexpected shock of negative operating events, measured by the relationship of your total debt (current and long term) to your GAAP equity.
These four data series will reveal everything there is to know about the operating financial risk of your loan proposal. Most banks will want to see several years of financial results to look for trends and dramatic changes in the key metrics, but this is where their attention will (or should) be focused.
There will be some questions regarding business plan, management team, overall strategy, your view of industry conditions and the impact of economic events on your ability to repay. That is all fine if it is related back to the results in the four areas above. But do not be distracted by a bank being captivated by your highly qualified management team, for instance, if the results above are trending the wrong direction. That kind of thinking (on your part or the bank’s) may well result in a problem loan.
The amount and maturity of your loan can also be determined by the financial analysis. The amount and duration of your current asset gap will show clearly how your short term financing should be structured. And the cash flow projections for several years forward will indicate how soon you are able to be cash flow positive and repay a term loan.
These measurements are critical in looking at borrowing for the purpose of working capital for operating enterprises. For borrowing to finance acquisitions, some additional, more complex considerations will be required—but it is still the basics that drive creditworthiness. These measurements can accommodate any layer of complexity necessary to get a full view of the performance of your business.
Any metrics you use to measure the performance of your business should also be clearly linked to results in these four areas. They ultimately drive the valuation of your enterprise. While lenders and business owners have focused on other measures in recent years, these “tried and true” metrics will consistently assure that you have a clear and full picture of your financial performance. And they will ensure that your bank fully understands what terms and conditions should govern your business financing arrangements.
Click on Ted's picture to see his bio
Contact Ted at ted.parrish@newportboardgroup.com
