Approaching Your Bank for that Much Needed Loan
Despite the media coverage to the contrary, commercial banks continue to lend. In fact, lending is a large part of every commercial bank’s strategic plan. Even in the midst of this recession, credit standards have changed little and understanding how a bank approved a loan may help you navigate the credit process.
First, understand your personal borrowing philosophy and share it with your banker. Are you debt adverse? Are you more concerned about cash flow and low payments? DO you prefer to hold on to your cash and maximize borrowing? Or use you cash to pay down on purchases to minimize your interest expense? Next get to know your bank. All banks are not the same, having different expertise and varying policies. It is important to determine if your bank’s lending philosophy fits your needs.
Every business owner needs to have a relationship with their banker. A business owner should ensure their banker has some leave of expertise or understanding of their business cycle. If your first meeting with a banker is to present a signed contract with a request for a loan, the banker has no track record on which to base your request.
To determine if a loan will be approved, a bank analyzes the risks associated with the repayment of the loan. This is accomplished in three ways.
- Repayment of the monthly principal and interest payment. Funds should come from cash flow from operations and is documented with a term called debt service coverage. This is calculated as: Company’s cash available for debt service (shorthand method is to take net income and add all non cash expenses, i.e. depreciation, and interest expense) divided by company’s total debt service (all monthly debt obligations plus the new loan payment added together and annualized). The resulting number is called a debt service coverage ratio. Most banks look for their number to be above 1.25 times, which means for every dollar of debt service the company has, it generates $1.25 in cash to make the payment.
- Liquidation of the collateral. The type of collateral on a loan, often the item being purchased, generally dictates the terms of the repayment. Short term collateral such as inventory and accounts receivable has limited cycles and requires a short payment. A building with a useful life of 40 years allows for an amortization of between 15-25 years depending on the bank’s policy.
- Speculative loans. If the loan proceeds must be used to generate the income necessary to adequately repay the loan, the loan would be considered a speculative loan, which has a greater amount of risk associated with it. This type of loan would require additional sources of repayment, possibly including an SBA guaranty.
It is also important that the banker receive all the necessary financial data needed to determine a company’s ability to repay the loan:
- Three years of complete tax returns
- All owners of 20% or more of a company will need to provide current personal financial statement and two years of complete personal tax returns
- Listing of all business debt including monthly payments, maturity dates and interest rates
- Resume on the company and owners
All major financial decisions for a business should be made after consulting an accountant, attorney and banker. A banker is an advisor and should be relied upon when making any decisions that will ultimately affect the cash flow of the business or ability to repay new or existing debts.
Article written by Terri Bunten, Executive Vice President/Chief Lending Officer of First Landmark Bank.