Bank Financing For Established Businesses
By Christopher Yuskiw Guest Contributor
So youve made it two years and are now entering your third year in business. Congratulations! You are no longer a start up! If youve been in business for two years or longer most banks will view you as an established business. What does this mean? Well it should mean that you wont have to jump through as many hoops as you had to while seeking out start up capital. By now your business should have a stable cash flow cycle and there is hard evidence of the businesss revenue. The more stable your cash flow the easier it is for banks to better understand your business which should help them to be more comfortable with lending your business money.
Again while each deal is different there are some common things you can do to determine how likely you will be in requesting credit; you should also keep these points in mind while preparing a credit request. You should really perform your own acid test prior to submitting your request so that you arent caught off guard by a banks decision. Banks will initially use the following five metrics to determine how credit worthy the business is:
1. History
Prior year results two or three years of year end financial statements will be used to determine the businesss trend; banks like to see positive net income and a positive trend. Be prepared to provide at least two years of business tax returns.
2. Debt Service Coverage
Debt Service Coverage will be used to determine how much of the businesss income is being use to pay debt. To determine your DSC take your free cash flow net income interest expense depreciation expense and divide this by the sum of all the debt payments short and long term. Banks typically like to see this number above 1.2 the higher the better though. Dont forget to include the projected payments of the request in your calculations. How much of your income is being used to pay off debt?
3. Debt to Worth
Debt to Worth will help the bank to understand how leveraged your business is. To determine your DTW divide all of the businesss liabilities short and long by the retained earnings net worth of the business. Typically a 3 to 1 ratio or better here i.e. 2 to 1 or less is what a bank hopes to see.
4. Collateral Coverage
Collateral Coverage is the amount of assets that the business has to put up to secure the deal. Collateral includes everything from realestate accounts receivable inventory equipment etc. Anything that has tangible value here counts. Banks typically like to see a collateral coverage of 1.20 or higher; this means that your business has 1.20 worth of collateral for every 1.00 in debt you have. If your business doesnt have much in terms of assets dont worry too much! This does not mean that you wont be able to get financing; while this might reduce the options available or the amount you can apply for. There are ways to get financing when you do run into a collateral shortage; the SBA is often utilized to help with a collateral shortage. Also if you are purchasing real estate or equipment this will help with collateral coverage.
5. Guarantor Strength
Guarantor Strength i.e. credit score and personal net worth will be factored into most decisions. The stronger the personal guarantee the more comfortable the bank will be.
Again while each deal is evaluated on a case by case basis these five things should help you get a feeling of how your credit request will go. Other factors to be aware of include: industry risk fall back capital economic conditions and institutional appetites some banks dont like certain risks on the books. My advice is to start at the bank you know and go from there. If you and your business have an existing bank relationship then it might be factored into the decision. Banks are becoming more conservative in todays environment and they are not looking to lend money to new clients as aggressively as they use to.
One last note: use the information above as guide and not as scripture. Every bank has their own set of underwriting policies and procedures; what works for one bank might not work at another. Also if your business is light in one area but strong in another then they might compensate for each other.
About the writer: Sparxoo is a business blog that inspires breakthrough by tomorrows leaders. We are a strategy consulting firm with a pulse on marketing branding and development. See our talented team of experts and our parent company dCap Advisors.
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