Preparing a Loan Application

Obtaining a business loan has become more difficult as the economy, regulations, and lendig policies become more stringent.  I took the following notes during a recent staff training presentation and hope they will help you to understadn what lenders need to see in a business loan appllication. 

I. Understanding the Lender

It is much easier to find a business lender if you understand what a lender needs in order to process your loan application. I recommend starting with the lender you are already doing business with but check for the most recent bank policies and procedures. Government regulation and bank policies are frequently updated. To prepare you application it is helpful if you know the following:

Bank Policies –

Loan portfolio mix, number of and type of loans they like to make.

Loan Programs they use? (SBA or USDA programs?)

Loan requirements – Minimum Credit score, Loan to Value, Collateral, Equity, Lending Ratios -- Liquidity, Debt Coverage, others

Risk tolerance – some banks are more liberal, others more conservative.

Lender’s experience with customers in your industry?

Recent changes in the bank’s corporate structure that effect lending policies.

Banking regulations that affect the bank’s lending policies.

Average time to close a loan.

• Loan Underwriting – The lender will only know what you provide, incomplete applications get denied. Your loan officer will need to justify a loan approval based on due diligence review of you and your business. Information they are looking for includes:

Is the loan purpose consistent with the type of loan?

Credit Standing (score and credit report)

Cash Flow, is the business be profitable?

.... Are losses explained?

.... How were losses funded?

Collateral

.... Quality and value

.... Collateral value covers loan?

Equity/Net Worth

.... Has equity increased or decrease over last three years?

.... Amount of contributed equity and earned equity (retained earnings)

Financial ratios

.... Exceed lenders minimum target?

.... Ratio trends over last three years

Business condition – Strengths, Weaknesses, Issues

Other

.... Other business owned

.... Other sources of income

.... Personal Financial history

II. Preparing a loan package

Presenting the lender with a complete package is critical. Your package must demonstrate your capacity to manage the business, your capacity to produce stated outcomes, and the market place capacity to buy your service/product. Incomplete packages slow review and errors or misstated information will result in a denied application. Lenders will be examining:

1. Financial Statements – History

• Profit Loss Statements- YTD  Revenue, margins, profit

 • Cash Flow: EBITDA and Working Capital needs, Owner draws, distributions, When you spent cash, when you received cash

• Last three years of Tax records, Explain differences between tax records and Profit & Loss Statements. Explain any expenses made for tax purposes

• Balance Sheets – current liquidity, asset quality, leverage, capital structure, retained earnings, Aging of A/R and A/P

• Budget Projections with assumptions

• Break Even analysis

• Ratio analysis - Liquidity, leverage, performance over time has been consistent and is sustainable Sales to Assets, ROI, ROA, A/R Turnover, Average Collection period A/P turnover, average payment period Inventory Turnover, Inventory on hand

2. Management

Character of top management, resume of management experience, experience as management in this business/industry. Team depth, who does the tasks of CEO, CFO, A/R and A/P. Succession (who runs the business if you can’t be there?) Performance as compared to industry standards and trends

3. Business Plans

• Supports and explains how you will accomplish what you claim in your budget. How you meet the five C’s of credit. (Character, Capacity, Capital, Conditions, Collateral)

• Explains market opportunity

• Provides budget assumptions.

• Describe the business, how you make money

• Describe the service/product, provide pictures, marketing materials, samples

• Associated documents, Articles of Incorporation (Partnership), Leases, Contracts, firm estimates on major purchases, Collateral

III. Presentation Tips

• Be enthusiastic

• Be professional

• Be prepared

• Make an appointment, be early and ready

• Be organized and bring copies of all the document to leave with the lender

IV. Deal Breakers

Some issues in your history can be deal killers, there must be extenuating circumstances before a lender can consider proceeding with an application. Other problems could result in a loan application being considered as a higher risk. If a loan were to be approved, these issues could result in higher interest rates and more conditions and restrictions.

Preparing a quality loan application package will help identify potential deal breakers and provide you the opportunity to explain what happened and what you have done to correct the situation. Remember, it is safer for the lender to say no if there is any doubt or perception that your loan is a higher risk than the lender wants to accept.

Will It Work? Tips for Determining the Feasibility of a Business or Project

Entrepreneurs are often faced with answering the question “Will it work?” Lenders, investors, perhaps

suppliers and others involved in the project should also ask that question or scan the business plan to see if

“will it work” is addressed. Whatever the specific project—starting a new business, expanding an existing one, or even selling or buying a business—the basic issue is feasibility.  Can it be implemented successfully?

Here at the Small Business Development Center (SBDC) we work with entrepreneurs on a variety of projects, and most of them involve feasibility. Here are some tips on feasibility that we’ve found work in most situations.

Do A Rough Analysis First

A good starting point is what we call “back of the napkin” analysis. In a short amount of time and with little data, you can often get a rough idea of the feasibility of a project. The results of this rough analysis may quickly decide if you need to spend more time on the detailed analysis, alter your idea a bit, or move on to

another idea.

For example, say you are thinking of making cookies to sell to stores, cafes, espresso stands, and restaurants. In a short amount of time you can gather some basic data:

• The cost of ingredients of a batch of cookies, and how many cookies a batch makes.

• The time it will take you to bake them.

• How much rent will be to use a commercial kitchen (assuming you will lease space until you are established).

• The price of competing cookies (the price to your customer—the store, café, espresso stand or restaurant, that is).

• How much money you need at a minimum to take out of this business for yourself for the time you spend in it.

Although you will have other costs (insurance for example), you can quickly calculate using the above data, what your capacity is (how many you can make in the time you have in your leased commercial kitchen), and what your gross profit (sales less cost of ingredients) per cookie will be. You can then calculate how many cookies you need to sell per month to pay the rent, and provide you with the income you have decided is the minimum you need. You can then see if at this very basic level of analysis if it seems feasible enough to continue.

If the rough analysis seems feasible, you can gather more detailed costs and refine the analysis. Then you can start your market research to determine the level of demand. While our example is a simple one, this approach can apply to any type of business: starting a commercial fishing business, expanding a manufacturing business to add a new product, or starting a service business, such as bookkeeping services.

The tasks are the same:

• Gather rough estimates of your basic and largest costs, including profit for the owner(s)

• Figure out how many of your product you need to sell to cover these basic costs.

• Ask yourself if the resulting sales figure seems reasonable. Calculate how many different customers you might need.

• If your rough results are encouraging, proceed to next steps.

• Refine your cost estimates and redo the analysis.

• Start your marketing research to determine demand

What happens, though, if the rough analysis is not encouraging? Rework your idea — explore various options for parts of your plan. Being successful in starting a business or expanding an existing one involves determining if the venture is feasible — will it work. Start your analysis and contact the SBDC if you need assistance.

Do You Have Effective Internal Financial Controls in Your Business?

One of the very first private consulting jobs that I took on, several years ago was for a well-established company in the Midwest.  Day-to-day management of the company fell to the owner’s wife when he suddenly passed away. Since she was new to the daily operations, she began to scrutinize the financial information more carefully as a means of educating herself on the business financial condition. It didn’t take her too long to know that something wasn’t quite right but she couldn’t put a finger on the problem.

We worked together to analyze costs, analyze pricing and develop strategies for positioning the business to be put up for sale. Meantime, she shared with me that she had a concern that one of her employees was stealing from the company. So we turned our focus to the development of internal controls while we tried to identify whether or not her concern was valid. As it turned out, the tightening of internal controls caused the person in question to leave the company after over 20 years with the business. The owner, and her sons, were completely devastated to find out that the employee had been stealing from them consistently for many years. This employee was highly valued by the business and was considered almost like family after many years of service. The moral of the story is simply that no business is too small to institute effective internal financial controls.

How can you begin to develop controls? First you need to identify the areas that are high-risk in your business. High-risk areas may include: Cash receipts and disbursements, customer credit and collections (writing off bad debts), purchasing and storage of inventory, payroll (including worker’s compensation insurance fraud). Under no circumstances should an accountant, bookkeeper, or the Controller of the business be given check-signing authority. Fraud can easily be concealed if this person has authority to sign checks. The owner/manager should sign all checks. If there are multiple owners, at least two signatures should be required. Do not create a signature stamp that can be used in your absence.

Following are other recommendations:

• In a small company, if you cannot separate duties to provide a check and balance system, consider job-sharing through a cross-training arrangement.

• Require that employees who work in high risk areas take vacations. Pay attention as to whether employee life/styles seem to match what you may know about their salaries.

• Limit access to accounting records and year-end entries.

• Make surprise audits and inspections

• Discuss computer controls with your accountant or a computer security specialist

• Be sure that you pay attention to the legal aspects of internal controls. Be sure any controls that you put in place do not violate the privacy rights of employees or customers.

Article written by Susan Hoosier, Longview Small Business Development Center  To locate your local SBDC advisor please visit the SBDC web site http://www.wsbdc.org/

Taking Your Business to the Next Level

“How can I evaluate new business opportunities?” “How can I determine whether to sell one of my three businesses?” “How can I better plan for future contingencies?” “Will I be able to sell my business in ten years and afford to retire?” These questions and others like them are ones that small business owners should be  asking themselves. As often happens, we become complacent when all is going well. We can breathe--and even take a vacation! However, businesses often take on a life of their own and may be headed down a path that is different from what the owner envisions. The owner just hasn’t told the business of his or her vision. Taking your business to the next level is that type of planning. It asks: “Where is my business going? Where do I want it to go? How can I get there?”

The First Step—Your Current Reality

To begin this type of planning, you need to know where you are—what is your current reality? This involves some data gathering and analysis. While this will be different for each business, there are four main areas you’ll typically need to look at to assess your current situation: finances; marketing; employees; and facilities. Let’s briefly look at some of the issues in each of these areas.

• Finances: Do you prepare monthly financial statements? If not, then this is the place to start. If you do, do you analyze them? What do you see when you look at trends in revenues and major expense categories? Are they changing? Is the change positive or negative? By calculating a few standard financial ratios, you can better understand what’s going on. You will also gain an idea of how your business compares with others in your industry.

• Marketing: How much do you know about your customers? Who are they? Where do they live? What other demographic data do you know about them? What influences their buying decisions? Has your customer base changed over the years? Is one type of customer more profitable than other ones? Who are your competitors? What are their strengths and weaknesses? What is your competitive advantage—why should customers come to your business and not the competition? What about your prices—are they too high or too low?

• Employees: Do your employees know what you expect of them? How do you communicate this? Can they take over for one another when necessary? Do they know what values your business is run on? What is your employee turnover rate? And why do employees leave?

• Facilities: Is your space adequate? Can you expand? How would your customers and employees evaluate your location and facilities?

The Next Step—Creating a Vision and a Plan

Where do you want to go and what do you want your business to accomplish? Now that you know where you are—what the current reality is—you can begin creating a vision of what you’d like to see as a future reality. Your vision can be broad in scope, including personal goals and goals for your community. Now ask yourself what part you want your business to play in fulfilling that vision. Your answer to that question becomes your mission statement. Armed with a firm understanding of your current Taking Your Business to

the Next Level  reality and what you’d like to create as your future reality, you can prepare an action plan that will help you to realize your vision.

How the SBDC Can Help

At the SBDC, we work with small business owners to help them gain an understanding of their current situation, create a vision, and develop a plan to get there. For example, a few years ago we worked with an entrepreneur who owned three businesses. He had a good understanding of his current situation and he had some components of a vision: he wanted more personal flexibility to enjoy life as he got older, and he wanted to be able to take advantage of opportunities to sell one or more of his businesses. We worked with him to fine-tune that vision, and we helped him to develop not only an action plan, but also a series of analytical tools for decision-making.

Businesses are never standing still, they are either moving forward or backward. By using the approach outlined above, you can move your business forward to the next level of success. Let us know if we can help you with this.

Kathleen Purdy is the Center Director of the Olympic Peninsula Small Business Development Center (SBDC),  This article was first published in Olympic Business Journal