18 Dec Bank Loans: Prove You’re Not Risky Business
If you want to ask a bank for a business loan, you need to prove to that you aren’t a substantial risk. The purpose of loan workup is to determine your level of business risk and whether the bank wants to take that on. So, before you even start the process, make sure you are doing everything possible to look good. The upfront preparation can mean the difference in whether or not you get approved and your interest rate if you do. A lower interest rate will increase your ability to qualify and make payments.
Loan Factors the Bank is Going to Consider
- Equity Investment – How much of your own money have you put into the business?
- Cash Flow – Do you consistently have more cash coming in than going out?
- Debt Ratio – How much debt do you have on the books compared to your assets?
- Working Capital – Are your current (liquid) assets more than your current (short-term) liabilities?
- Collateral – What can you offer as additional security in the event the business fails to repay the loan?
- Credit History – Have you been diligent in paying previous loans and taxes?
- Background and Character – What is your history and do you have any criminal or civil lawsuits?
- Business Plan – Do you have a solid plan of action that is well thought out?
- Years in Business – How long have you been operating?
- Resource Management – Are you able to manage the operations of the business effectively on a daily basis?
For the purpose of this discussion, let’s just focus on the last topic: Resource Management. Many of the other considerations are the direct result of how you manage your business. According to the SBA,
“Resource management is how you handle the day-to-day affairs of your business, including how you pay your debts, collect on debts owed to you, deliver your service or product to customers, and manage your inventory. Your proven ability to manage the resources of your business is a prime consideration when a lender is determining whether or not to approve a loan.”
This is where dedicating yourself to a system of continuous internal audit can greatly boost your credibility. It will make you stand out from the crowd. Depending on the size your business, some banks may require an official audit opinion by an independent CPA. But, for smaller and medium-sized business they do not because that is a very expensive proposition. They want to see that your financial statements have been reviewed and are a fair representation. But, internal audit takes it a step further and can really boost your credibility. Unlike a review done in preparation for a loan at a single point in time, implementing an internal audit system shows you are devoted to monitoring your business on a more frequent basis. It shows that you are looking closely at the details and taking corrective action. That your daily business operations structured in a way to reduce risk. Hey, isn’t that what the bank wants? Yes, they want to see that you are a proactive business owner who takes steps to make sure your business is healthy and that the information you are giving them is reliable.
In other words, you aren’t running your business by the seat of your pants. You are looking for errors, control weaknesses, anomalies, and fraud. You make informed decisions based on fact, not guesses. The four biggest areas are: accounts payable, accounts receivable, payroll, and inventory. None of these can be effectively managed without rolling up your sleeves and getting neck-deep into the transaction details. Too many businesses are making decisions based on summary information and dashboards. As they say “the devil is in the details”and if you aren’t looking at them, you aren’t managing your business.
So what if instead, you went in to the bank with documented proof of the tests you run on a consistent basis to make sure everything is in order and steps you have taken to fix any problems in a timely manner? If they can see that you have your eye on the ball, they are going to trust you more. They are going to be more relaxed to trust that the numbers you are giving them are real. For example, if you tell them you have $100,000 in inventory, how do they trust that valuation? When is the last time you did an actual count and made sure your books matched it? Are you removing the value of obsolete inventory or are your numbers inflated? What do you do to manage that you have the optimal level of inventory for your business needs and aren’t stock piling products that don’t sell well? Your answers to these questions show if you are actively managing your business or not.
What if you went into the bank and provided evidence that not only do you look at the details, you test every single transaction? Whoa, now that’s different. A review from an external auditor is normally based on a very small sample. Not really that compelling. Ok, so you have thousands of transactions and they looked at a few. That might make the bank feel a little better, but there is still a looming question mark. If you are consistently monitoring every single transaction, you are going to catch way more. That lends itself to building even more trust and less risk. You want to remove as many question marks as you possibly can.
How does this add up? Let’s take an example, you borrow $250,000 on a low interest SBA loan and have 10 years to repay. At 4.44%, your interest will be $111,000. At 3.78%, your interest will be $94,500. That’s a savings of $16,500. Or how about a more extreme example, what if your interest rate could be reduced from 10% to 8%? You would save $50,000. Big difference. So, it’s well worth it to go the extra mile before you apply for the loan. Plus, you will learn so much more about your business that can make you more profitable through better decision-making or resolving problems.
To me, it’s a no brainer. It simply costs too much time, money, and opportunity to not pay attention to the details. You will look better to the bank and sleep better at night knowing that you have you done your due diligence.