Why is this important?

Companies ordinarily obtain the funds to operate their business from shareholders equity and external borrowing.
Typically, a small to medium business will reach a point where shareholders are unable or unwilling to provide more capital or shareholders loans. When shareholder capital is not sufficient to meet all the needs for major capital expenditure, then, in order to fund trade debtors or to grow the business, companies need to borrow in one form or another.
Accessing external finance can be as simple as obtaining supplier credit terms by completing a one-page credit application, or by using a motor dealer in-house facility to finance a vehicle purchase.

However, when approaching a bank for major finance facilities, the process is more complex.

Banks tend to go through cycles with their lending policies. In good times, they relax their lending criteria, lend more freely and take more risk. When the economy slows, the result of this scenario is a rise in their bad debts and a tightening of lending policies. But in good times or bad, following some basic guidelines for seeking finance from your bank can greatly improve the chances of success.

What to do

A sound and well thought out approach is essential.

Make it easy for the bank to say 'yes'

Tell your story. The stark facts and figures of a business tell only a fraction of the story. You know your business better than anyone. Be prepared to sell it to the bank by putting the flesh on the bones of the numbers.

This can make all the difference between success and failure. You will be dealing with a huge, somewhat impersonal, institution but the decision will be made by an individual or individuals who need to 'believe in' the proposal.

If at all possible, develop a personal relationship. Most banks have relationship managers for their business clients. If you are applying to the bank for a substantial facility or funding that is crucial to your business, ask your relationship manager to visit your business. They will generally agree to do so because it makes their job of assessing the application easier, and their personal involvement certainly makes it easier for you to sell your story. Your relationship manager can then confidently recommend your application to his credit department.

Before you start

Consider whether you need to borrow at all. Are there alternatives like additional capital, a joint venture, supplier credit, asset sales, or inventory reduction?

What type of facility is best for the purpose and how much do you need?

The most suitable type of facility will depend on the purpose and the particular circumstances of your business. In considering the best choice of finance, it is important to match the method of financing with the purpose. In the course of making any decision regarding a major capital expense for your business, it is wise to consider whether to obtain finance for the purchase and what the most effective form of finance would be in each particular instance.

You may need to seek professional advice to ensure that the decisions you make take into account all the implications with respect to the tax laws and your financial circumstances.

Brokers

Should you use a finance broker? There are some advantages in doing so. A broker will generally have access to a number of banks or underwriters and can choose the one that may be most receptive to your particular proposal. They may also have a good relationship with these lenders and knowledge of how best to present the application, which can be useful. However, as a third party placed between you and the bank, they will probably not be in a position to sell the application as effectively as you can. Consider whether someone else can “tell your story” as well as you.

There is also the question of additional cost. In a commercial transaction, the brokerage will not be disclosed. The bank will pay up front brokerage to the broker, usually as a percentage of the amount financed and sometimes also a trailing commission. This brokerage can be substantial. This cost to the bank will be built into the interest and charges on the loan so that the bank will earn the same as if it had dealt with the client direct, with no brokerage.

How to proceed

Business principals should be closely involved in preparing and negotiating any significant finance arrangement. You will be the individuals with the ultimate responsibility for the loan.

Even if you have an in-house financial controller or accountant who is responsible for getting together the material and accounts needed, business owners need to control the negotiations. The same applies if you use an outside accountant or financial adviser. Ensure that you are fully aware of and agree to all aspects of the application and remain involved in negotiating the loan and agreeing to the bank terms.

How much do you need?

Be clear about how much you need to borrow. Take into account contingencies and cost variations. Provide the bank with detailed costings. It is better to be conservative than to have to approach the bank again for additional finance because you under calculated your requirements.

What the bank needs

No matter what type of facility, there are certain basic criteria the bank will look for in assessing an application.

Clearly, their first priority will be to ensure that they will be repaid, and within the terms of the agreement.

You will therefore need to satisfy them that you:

• are reliable, trustworthy and of good character
• have a clearly demonstrated ability to repay the loan
• are able to provide suitable security for the loan
• can explain that the purpose of the loan makes good business sense.

What you need to provide

The level of information that you supply to the bank is going to be important and demonstrates your knowledge and commitment to your business.

Purpose

Provide full details of the purpose for the loan including detailed costings. You should be able to demonstrate that the purpose is commercially sound and makes good business sense.

Provide details of how the loan will benefit your business and projections that justify the cost of borrowing. For example, if the loan is to acquire additional manufacturing plant, show the cost/benefit analysis over the appropriate term due to increased output, reduced unit costs, new markets or clients, economies of scale and competitive advantage.

Consider how long will it take for these benefits to take effect. Describe what affect the acquisition and borrowing costs will have on your cash flow, and ensure you can clearly demonstrate that the numbers “add up”.

There may be exceptions to the requirement to make a good business case (eg financing a new S class Mercedes Benz for the managing director). However, in these circumstances the bank will generally need to have a good history with their client and be comfortable with the risk.

History of your business

While you will submit your application to your relationship manager or local contact, the decision makers will be the bank’s credit personnel and usually you will not have an opportunity to discuss the application with them personally. Even if you have an existing banking relationship, do not assume that this background information will be available and considered by the decision maker unless it is presented as part of your loan application.

Provide some background and history of your business to place the loan application in context. This is an essential part of “telling” your story – it provides the bank’s decision makers with the background and other information that the “numbers” given in your financial statements do not tell. This background information should also cover your experience, expertise and special skills as the owner and manager of the business.

Your industry

Provide relevant background on your industry and your place in the market. Consider the following checklist:

• What are the competitive pressures?
• Who is your competition?
• What is the impact (positive or negative) of the current economic climate, and how are you dealing with these challenges?
• What is your market share, and is this growing or contracting? Give supporting data.
• What are your projections for your market, and how will this impact on your business?

Your strengths

Provide details of your strengths and your products or services:

• Do you have a unique position in the market or exclusive products that give you a competitive edge?
• Who are your clients?

Your management team

Give details of the strengths of your management and a brief profile of your key people. The bank will regard this information as very important. If possible, introduce your management team to your relationship manager. This is another reason why you should arrange for the bank to come out to visit.

What the bank looks for

Some of the things the bank looks for (but by no means all) are the following:

Type of facility and purpose

Provide full details of the purpose and the amount, type of facility and term you are applying for. You may settle this after preliminary discussions with your relationship manager. The bank may offer a different facility or mix of facilities. Make sure this offer meets your requirements and discuss with your financial adviser, if necessary, before accepting an offer from the bank.

Security

As mentioned above, the bank will seek to establish that you are trustworthy, reliable, have a viable business and can demonstrate that you have the capacity to repay the loan.

However, they will also want security for the loan in the event that you fail to meet the required repayments. Typically, the more security offered the more favourably the bank will regard your application. Security will need to have a value considered adequate for the amount of the loan, be regarded as suitable and unencumbered by other charges. If there are prior ranking charges or mortgages but sufficient remaining equity, the consent of the mortgage or debenture holders will be required for any further security being provided over these assets.

• Real estate: If a mortgage over real estate is available, the bank will apply a lending ratio to their valuation of the property, which may be something like 75 or 80 per cent. If there is a prior mortgage on the property but still sufficient equity to provide security, the ratio may be lower to allow for the accumulation of interest and charges on the prior mortgage.
• Debenture mortgage: This is a mortgage over all the assets of the company and, in the event of a default, will allow the bank wide powers to appoint a receiver, or a receiver and manager, to the company. Thus, take control from the company’s directors. This is also known as a fixed and floating charge because it is fixed over the fixed assets of the company (real estate, plant and equipment, etc.) but floating over current assets (debtors, stock, etc), which fluctuate from day to day in the normal course of trading. This allows the company to continue to conduct its business in the normal way unless and until the charge is crystallised in the event of a default.
• Director’s guarantees: Many private companies have limited paid-up capital and their affairs are usually closely linked to the financial position of their owners and directors. The bank will generally seek personal guarantees from the directors and or shareholders of the company to provide additional security and comfort. A statement of personal assets and liabilities from each guarantor will be required to show their financial strength, other liabilities and potential worth of their guarantees.
• Other security: Other forms of security may be required depending on the size and nature of the application. The bank will sometimes require things like key man insurance, noting their interests, because the viability of small to medium businesses is often dependent on a small number of crucial management people.

Cash flow

Cash flow, and budgeted profit and loss forecasts are often confused. You need to be able to demonstrate that you will have adequate cash at all times, to service the debt, meet your normal commitments and to allow for contingencies.
To do this you, need to prepare cash flow projections for a reasonable period into the future, in addition to your budget forecasts.

Profitability

In additional to your cash flow forecasts, you may need to provide the bank with budget forecasts to establish that (in addition to a positive cash flow) you will be able to continue to trade profitably after allowing for the new commitment and on the basis of realistic projections of turnover and expenditure.

Equity

The bank will consider the shareholders equity position. That is, how much capital have the owners invested in the business or built up through leaving profits in the company. This will be a crucial consideration in the decision about how much the bank will be prepared to lend.

Gearing

Essentially, the bank will want to know what other borrowings the company has, in particular:

• the ratio of external borrowings to equity
• the ratio of external debt to assets
• the ability to service existing and proposed new debt
• whether a servicing margin exists to accommodate upward rate movements in floating rate facilities.

You will probably need to provide a commitment schedule showing all the company’s external borrowings (term loans, leases, hire purchase contracts, mortgage loans, rental agreements, etc.) and the commencement dates, maturity dates and monthly repayment commitments for each.

Reputation and standing

As part of the bank’s assessment of the application it will want to ensure that you and your company are reliable and trustworthy.

The bank will do credit checks on the company and the directors and/or shareholders personally. Credit reports will show not only whether there are any default listings, court actions, etc, but also a history of finance enquiries and existing finance providers.

The bank may require trade references to assess how the company meets its trade creditor commitments or finance references for any existing or previous finance commitments.

Ability to service

Your ability to service the commitment will be assessed on a combination of your historical profitability, your credit history, and your projections for future profitability and cash flow, mentioned above.

Also taken into account may be any additional revenue and profits from new activity generated by the loan purpose. However, the latter will probably not be heavily relied upon.

Financial statements

Provide the three most recent sets of financial statements possible. At the very least you will need accounts for the last financial year. If you need to have these prepared by your external accountant, give him or her as much notice as possible.

Ensure the accounts provided to the bank are a full set with all relevant notes and declarations, and signed are by the directors and your accountant. Make sure that all the figures provided to the bank are credible, complete, carefully prepared and legible. It is not a good idea to send accounts by fax as they are often hard to read. Remember, you are making it easy for the bank to say “yes”.

Where the most recent set of accounts are more than three months’ old, up–to-date or interim or management accounts should be provided. These may need to be prepared by your accountant, but you can check whether the bank will accept internally prepared management accounts generated by your in-house accounting software.

Provide explanatory notes or further particulars, where necessary. For example, if extraordinary items in the accounts have impacted on your profits or balance sheet, provide an explanation.

Financial statements are historical documents, and show only what has happened in the past. A balance sheet is referred to as a “snapshot” of a company’s financial position because it captures the position on a certain day (the day the accounts were prepared). The position of an actively trading company will change constantly and the changes may be material.

The profit and loss account records the activity and net results for a particular historical period.

Where there have been significant changes to the financial position of your company since your last accounts were prepared, you should provide full particulars to the bank.

Business plan

Your business plan will be useful to the bank in assessing your application.

It should reflect favourably on your management ability, your vision and plans for the future and provide valuable information about the future viability of your business and the likelihood of achieving your goals.

Feasibility study

Depending on the nature of your proposal, the amount of the funding required and its impact on the company’s trading results, a detailed feasibility study may be a useful addition to your application.

Further information

Be prepared to provided further information if requested by the bank. Supply this promptly. If your application is place on hold for any period, awaiting further particulars, it is a sad fact that chances of a favourable decision are reduced.

If you are relying on third parties like external accountants, make sure you expedite and control the flow of information. It is important not to let the application process get out of control at this stage. Have all additional information come to you and review it before passing it on to the bank.

Supporting documents

Provide any other documents that can support your application. These may include company brochures or catalogues, publications, articles or references – all useful in 'telling your story'.
Provide the link to your website.

Negative information

If you are aware of any negative information that may adversely affect your application, do not try to conceal it. For example, disputes with customers or suppliers resulting in legal action will probably appear on your credit file. Adverse trends in your trading results will show up in your financial statements.

Do not allow what are sometimes minor issues to take on undue significance. This can easily happen if the bank identifies these negatives in its credit assessment process. It is far better to flag these issues and provide explanations and, if necessary, documentation, to put the matter to rest and allow a balanced consideration of the proposal.

Fall-back position

Be prepared to have a fall-back option, in case your bank declines your application, is too slow or unreasonably demanding. This could be an instance where you use the services of a finance broker.

However, it is best not to approach more than one financial institution at a time and certainly is not wise to mention that you have a better offer elsewhere in attempting to bargain for a more favourable deal. Your bank will be unimpressed if it has put considerable time and effort into getting a facility approved for you.

Each enquiry for finance appears on your credit record and it will be immediately apparent to any bank if you are 'shopping around'.

Where to go for help

Do it yourself

Professional advice on accessing R&D grants, export grants  and the R&D tax Concession/Credit system.   

Ph: 02 9797 1777  Email: aiserv@bigpond.net.au Website: www.australianindustryservices.com.au

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