Loan officers tend to focus on historical finances and for good reason:
They provide a track record of your business's performance and offer
lenders a glimpse as to what it might look like in the future. This is why
it's important to be prepared to discuss your company's financial track
record, especially within the last two or three years, and any significant
changes that have occurred during that period when seeking a bank loan.
"Significant" means a sizeable dollar amount or a significant
percentage change of individual items in your company's financial
statements. For instance, doubling of your company's inventory from
$100,000 to $200,000 or an increase in rent from 10% to 20% of total
revenue would likely spark an inquiry.
You particularly should focus on what lending officers are likely to
perceive as negative changes. A small business owner's ability to discuss
the negative trends and assure lenders that the situation is under control
is the key to maintaining an existing loan relationship and securing new
loans.
It's impossible to cover all adverse events that can impact your
company's financial health. However, the most typical negative changes in
your company's financial performance that you should be prepared to
discuss are:
- Significant decline in revenue
- Sizeable increase in expenses, such as salaries, materials,
shipping, rent, and others
- Operating losses prior to payment of interest expenses and taxes
- Negative cash flow, as measured by EBITDA (Earnings Before Interest,
Tax, Depreciation, and Amortization) or other methods
- Slow inventory turnover, slow accounts receivable collections, or
slow payment of accounts payable
- Owner's distributions in excess of earnings
- Limited or even negative owners' equity in the company
- Very limited investments in equipment when your company is growing
by leaps and bounds or significant investments in equipment when your
company is not growing
To better prepare yourself for the tough questions, I've outlined a
number of step you can take before sitting down with a lender.
Step 1: Identify significant, particularly negative, changes in
your financial statements.
Closely examining your company's financial statements before meeting with
lending officers. As simple as it sounds, I have worked with many small
business owners who were not aware of various changes in their companies'
financial reports.
This
income statement from a restaurant provides a good example. On it,
you'll see that revenue declined by about $70,000 over a two-year period,
while operating expenses, particularly salaries, increased by about
$12,000. On the positive side, the restaurant improved its gross profit
margin from 73% to 75%. Having knowledge of similar changes on your income
statement can help you prepare answers for any question the lender might
have.
Step 2: Explain what is causing the changes.
Be able to provide reasonable, complete explanations of the trends and
changes you identified in Step 1 as well as their causes. In the
restaurant example, revenue in 2001 declined due to the economic recession
in the region and the impact of the terror attacks of September 11. Salary
increased primarily because the owner hired a new executive chef and a new
dessert chef, both of whom were very reputable and required higher salary.
Step 3: React to ensure that the negative impact on your
company's financial health is reduced or eliminated all together.
A crucial element of addressing deteriorating financial performance is
reacting to cure the situation. If a negative event is relatively recent,
and there was absolutely no time to react, you at least should have a plan
of action. This will tell the lender that you are on course to make
improvements. Considering that lenders receive your companies' financial
statements from several weeks to several months after the end of a
financial period, having a plan of action is expected.
In the restaurant example, the owner hired the two star chefs to
improve the quality of food and to attract new customers. In addition, the
owner joined a co-op to secure lower prices on liquor and fresh produce.
Step 4: Demonstrate to the lending officer the steps you have
taken to improve the situation and the results your actions have produced.
Being able to discuss your efforts is as important as following through on
your plan of action. Otherwise how are lenders supposed to know that you
are making progress? In this step your goal is to provide proof, whether
quantitative or qualitative, that you have taken action to improve your
business's financial performance. In addition, you should share the
results your actions have produced. The owner in our example showed that
joining the co-op helped improve gross profit margins.
If you are not able to answer some questions related to your company's
financial performance, jot them down and promise to follow up promptly. It
is always better to give the correct information later than the wrong
answer on the spot. If you forget to follow up in a timely manner or
provide incorrect information and a lending officer catches that, your
credibility could go out of the window.
Also, remember to be honest and forthcoming about your company's
deteriorating performance. Shying away from a difficult conversation with
your lender may be a preferred choice, but my experience has taught me
that being honest with your lender is a better way of recruiting his or
her cooperation.
