I’m Taking All the Risk, It’s My Company! The Frustrations of Applying for a Business Loan

That’s a common reaction of many business owners who are frustrated with all the hassle of getting a bank business loan and complying with all the covenants and restrictions. In some respects, it’s understandable, after all, they personally guaranteed the loan and the bank has collateralized all the company and personal assets.

The lender views the relationship differently and needs to consider the possibility that the commercial loan may go into default. Taking the borrowers assets and enforcing a guarantee is the last resort and is an unpleasant prospect to the lender. Collateral liquidations are expensive and time-consuming. It certainly sours the relationship the borrower and quite possibly the community the bank serves. That is certainly not what the lender envisioned when making the loan. The lender ends up losing money when loans are not completely satisfied and liquidation costs are not reimbursed. Furthermore, it doesn’t reflect well on the loan officer, the bank’s credit management or the bank when loans fail.

Bankers seek to evaluate and reduce risk so a great deal of nonfinancial and financial information may be requested for review. Nonfinancial information will be gathered to determine the company’s legal and operational structure, the competency and cultural cohesiveness of management, levels of management and accounting internal controls and the company’s vision for the future, just to name a few. Nonfinancial information can be largely subjective but is no less important than financial information in establishing lender confidence.

Financial information generally begins with financial statements (P&L, Balance Sheet and Sources and Uses statements) but may also include detailed information on accounts receivable financing, inventory financing rates, fixed assets, accounts payable, notes payable, tax obligations, and other debts and obligations. Information regarding contingent liabilities and risk management insurance policies will likely also be requested. With numbers in hand, the lender will work with analytical tools to develop solvency ratios (how safe is the company?) and operational ratios (how well is the company being run?) to identify and understand areas that arouse concern.

Analytical tools provide alternative ways of looking at information. Some of these tools include:
Common Sizing Analysis (CSA)
Indexed Trend Analysis (ITA), and
Ratio Analysis

Common Size Analysis views various financial statement line items as a percentage of a total amount such as gross revenues, gross expenses, or total assets, etc. Changes in the percentages from period to period need to be understood.

Indexed Trend Analysis views annual increases/decreases of identical line item accounts as a multiple of a base year over several periods.

Ratio Analysis compares one value in the financial statements to another to determine its relative size. Financial ratio analysis is one of the most effective tools for finding corroborating or unusual relationships to justify either confidence or concern with reported financial information.
Solvency ratios are designed to reflect the company’s ability to pay its financial obligations. Lenders use short-term and long-term debt ratios and cash flow ratios to determine the likelihood and timing of loan repayment.

Operational ratios are designed to determine how well the company is operating. Performance, profitability, ROI, asset management and various cost/volume profitability ratios are used to determine if the company is operating profitably and if it is effectively using its capital investments in machinery and equipment.

When you hear a lender say they are going to “spread the financials” that means he/she is going to analyze the financial information requested. The trend and ratio analysis described above will be reviewed over comparable time periods (monthly, quarterly, or annually) to determine how fluctuating business activity was handled by the company. The lender may also compare the financial information to competitors in the industry.

Understanding the lender’s process as credit-related information is investigated, analyzed, and prepared for the loan committee will help alleviate frustration and may improve your chances of receiving the funding desired.