Real time accounting offers many benefits for business owners! It is something we implemented at…
A question regularly asked by business owners is what do Banks need to lend against a business?
Another common question is – what key criteria do I need to meet so that I can have my home removed from the Banks security arrangements?
The answer to this will vary widely depending on:
Lending Against a Business – Your Track Record is Critical!
When lending against a business two key questions Banks ask is:
A good track record extends to things like:
Lending Against a Business – Who is Taking the Risk?
A key focus of Banks when lending against a business, is what equity do the owners have in the business?
That is; who is taking the greater risk – the business owner, or the Bank?
For example, a business with greater than 40% equity, (Net Tangible Assets /Total Assets), will provide more comfort to Lenders , than than one with only say 15%.
A low level of equity, in most instances, means there is little room to move if things start to go wrong.
It is not dissimilar to your home, where if you have a good amount of equity, you would have greater flexibility than if you had only say 10% equity.
Where the gearing of the business is high – this presents additional risk to the Bank, which is why they often seek:
Quality of Earnings
When satisfied with the gearing and risk, the next focus is your track record of revenue growth and profitability:
Most businesses go through different cycles. It is therefore important to explain the reasons for changes in growth and earnings.
This may be due to:
Raw numbers can paint a misleading picture if they lack a background story. It is important to explain the reasons for changes within your business.
What are we Lending Against?
When lending against a business, Banks look for comfort as to the quality of the assets in the balance sheet:
Other key questions Banks will consider are:
Are Earnings Reinvested in the Business?
Another element Banks will examine is what happens to profits generated by the business?
Crucially, are sufficient earnings retained to support ongoing operations and fund future growth?
In small business, owners often distribute profits to support their lifestyle, for example, to purchase a home or an investment property.
Whilst completely understandable, it often results in the company balance sheet being highly geared.
It can also mean insufficient funds are available to take advantage of opportunities, fund growth or ride out difficulties when they inevitably arise.
Where the balance sheet is highly geared, Banks may ask that the assets purchased using the distributed monies, be provided as security.
When lending against a business, Banks focus heavily on the historic and expected performance of the business.
They also consider what the business and assets will be worth if things do not go to plan.
The liabilities will be real – so the quality of the assets is a key focus.
They will look at the supporting policies and processes within the business that make it all happen.
If you would like to learn more about lending against a business, don’t hesitate to give me a call!