The 5 C’s of Credit


You have evaluated all the various ways of funding your business and have concluded that bank financing is the way to go.  Now you need to know how to get a business loan.  Before you call your local banker, you should familiarize yourself with the 5 Cs of credit.  Loan applications are evaluated using the 5 Cs, along with other criteria, to determine the credit worthiness of a prospective borrower.  The better you understand these criteria, along with how well your business fulfills each criterion, will improve your chances of obtaining the financing your business needs to grow.

If you need to get a business loan, then you need to understand how commercial lenders will view your business, using the 5Cs of credit. Click to Tweet

Character (or Credit History)

This is largely based on your FICO score.  FICO scores range from 300 to 850, with the higher the score indicating better credit risks.  Do you know your FICO score?  You need this information before you start speaking with someone at the bank. If you are speaking with someone at your current bank, then your banking history with that institution will also provide additional background for the bank to evaluate.  Applicants with lower FICO scores are good candidates for SBA financing which the bank will recommend assuming you are a candidate.  Also be prepared to complete a Personal Financial Statement where you list all the various assets you own, because you will be the guarantor on the loan.

Capacity

The bank will want to evaluate whether or not your business has the capacity or cash flow to repay the loan.  A general rule of thumb is a 1.25 debt coverage ratio.  To calculate your ratio, take your net income and add back any depreciation, amortization and tax payments to derive the cash available for debt coverage.  Most bankers will add back some amount of wages/distributions you pay yourself to the available cash amount and possibly other non-recurring items from the past.  Next, calculate your estimated annual debt payment amount using a calculator or spreadsheet software based on how much you want to borrow.  If the available cash amount, divided by the annual debt payment is 1.25 or greater, then you have the capacity to service your loan.  If not, then you need to figure out what changes need to be made to achieve a 1.25 debt coverage ratio.  Some financial projections may be required.

Collateral

Depending on the size of the loan, the bank may need collateral.  Collateral sources include accounts receivable and inventory.  If you are seeking more than $100K, then you will most likely need to identify some form of collateral that the bank can use to secure your requested loan.  If you are an existing business, you should know what your accounts receivable aging looks like.  For example, how many receivable dollars are greater than 90 days past due?  How quickly are you turning over inventory vs. your industry average?  This is information that the bank is going to want to evaluate.

Capital

Lenders are going to want to see that you, the borrower, have some skin in the game, so to speak.  They want to see that a borrower has equity in the business and will look at various ratios such as debt to equity to evaluate the prospective borrower’s leverage.  Typically, new businesses are not going to have substantial amounts of equity or invested capital; consequently lenders will look more to the borrower’s net worth to evaluate credit worthiness.

Conditions

This pertains to the overall environment within which you operate your business.  Are you looking for money to begin manufacturing VHS tapes?  More than likely, that would be viewed as being an unfavorable condition given the ever shrinking market for VHS tapes (though vinyl is making a comeback).  Do you have one customer that comprises 90% of your sales?  That level of customer concentration would be viewed as an unfavorable condition because the loss of that client could sink your business.  Banks have a preference for businesses that are in growing market segments/industries, with large client lists and well articulated value propositions.

Hopefully your take away is not “I can’t get a loan” but rather “I have some homework to do.”  Many business owners I work with think that they have a money problem in that they cannot get access to the capital needed via conventional financing.  But in reality these business owners do not have a money problem.  What they have is an idea problem.  Business owners need to look at a wider range of possible capital sources and be more creative.  I will provide more information on increasing your creativity in future posts.  If you need help with pulling together a plan of attack for pursuing capital, please give me a call.  Let Profitwyse help you intelligently fuel your business’ growth.

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.
Plans are nothing. Planning is everything. –Dwight D. Eisenhower

 

6 Reasons Why Business Financial Planning Matters


Dwight Eisenhower knew what he was talking about given that he oversaw planning and management for the largest amphibious military operation in history, which is D-Day.  Just briefly, D-Day involved 6,000+ landing ships and other vessels carrying 176,000 troops onto five different beach landing areas (Utah, Omaha, Gold, Juno and Sword).  This does not include the paratroopers dropped behind enemy lines nor the hundreds of planes required to drop them into position.

Obviously, D-Day required a monumental level of planning and coordination, but all successful military operations are contingent upon successful planning.  Have you ever heard that quote that goes “amateurs talk tactics, professionals talk logistics” (I believe this quote is attributable to General Omar Bradley)?  Just as the military is with logistics, successful businesses have a solid operational and financial planning foundation.

Given all the evidence regarding the importance of planning, I am always surprised to see how little thought and importance my clients place on financial planning for their businesses.  Here are a number of the reasons I commonly hear along with my responses to those concerns:

  • I do not want to be constrained by a financial plan – The purpose of financial planning is not to constrain businesses but to get “everyone on the same page.” Regardless, plans can be changed, that is why we have forecasts.  No plan is cast in stone.
  • It takes too long and is outdated once the ink dries – Unless the business is so dynamic or there is a detrimental level of customer concentration, then planning should be able to iterate and evolve right along with business circumstances.
  • Everyone ignores it – This is an easy problem to solve. I tell business owners to link bonus compensation to achieving plan targets, which instantly resolves the issue.
  • It is difficult to gain ownership – Typically apathy toward planning results when plans are generated in the C-Suite without any input from line management. If you want more ownership, then increase the number of participants in the planning process.
  • Reporting actuals vs. plan is nearly impossible – Generating financial plans in Excel is generally not conducive to the integration of actual financial results, unless you have a really good Excel jockey on staff. There are a number of software tools that are actually better planning tools than a spreadsheet application and more readily facilitate the integration of actual results with plan data.  More on this in a later post.

If you are experiencing any of these issues, the root cause maybe the importance placed on closing your books in a disciplined fashion.  You should note that successful companies place a high importance on how many days it takes to close the books.  Ford is able to close their books in 4 days.  If a huge multi-national firm can close their books in 4 days, why can’t a midsize business close their books in three weeks?  How about two weeks?  Is there really any reason a midsize business can’t close their books in five days?  Really there is no good reason.

Below are 6 reasons for creating financial plans, some of which are corollaries to the reasons why businesses do not create financial plans above:

  1. Just going through the rigor imposed as part of any planning process adds value, especially as business owners attempt to articulate exactly what differentiates their offering from the competition’s offering (aka value proposition). Also, time should be spent on determining business drivers and key performance indicators.  All of which provide important feedback regarding the effectiveness of the company’s strategy.
  2. Creating a framework that generates valuable insight into both how well management understands its business model and generates feedback that can produce corrective actions.
  3. Facilitating alignment of employee goals and actions with business strategy.
  4. Providing evidence to external stakeholders of professional management capability.
  5. Generating data about operating efficiencies which helps management implement continuous process improvements. A focus on process improvement also fosters more thought around quality assurance, that can increase customer perceived value.
  6. Creating better cash flow management tools that reduce the chance of unexpectedly exceeding available cash on hand.

Just as Dwight Eisenhower harnessed the power of planning to successfully launch D-Day, you too can use financial planning to more effectively manage your business.  If you would like to learn more about ways a CFO advisor can help your business intelligently grow profits, please use the links below to contact us via email or call (747) 224-1297.

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.

6 Reasons For Effectively Closing The Books


A common source of problems incurred by emerging and mid-size businesses stem from the priority businesses place on properly closing their accounting books.  When I talk about closing the books, I am referring to the process used to finalize and report monthly/quarterly/annual results.  Many businesses view the entire process as a “check the box” activity that adds little value.  Once a “check the box” mentally settles in, the accounting close is assigned a low priority. 

A common problem for many privately held businesses is a dearth of financial performance data. Here is why you will want to focus on closing the books. Click to Tweet

Issues with lackadaisically closing the books:

  • The time required to close the books begins expanding. Historically a business may have been closing in 3 weeks, but now it takes 6 weeks;
  • The bank statement reconciliations typically follow the close schedule and consequently are delayed or put on the back burner;
  • Monthly financial statements are produced later and later or not at all, because no one is looking at them;
  • The bank starts calling because the business is not meeting their loan covenants with respect to sending in periodic financial statements. This is when lenders start thinking about moving the business’ loan to the special asset group;
  • Funding payroll becomes more challenging because no one is generating a cash flow projection or when a projection is made it is of little value because it is based on old or erroneous data; and
  • Management is constantly surprised because information is stale by the time it is reviewed making the implementation of corrective actions less impactful.

If you are experiencing any of these issues, the root cause maybe the importance placed on closing your books in a disciplined fashion.  You should note that successful companies place a high importance on how many days it takes to close the books.  Ford is able to close their books in 4 days.  If a huge multi-national firm can close their books in 4 days, why can’t a midsize business close their books in three weeks?  How about two weeks?  Is there really any reason a midsize business can’t close their books in five days?  Really there is no good reason.

If you’re a business owner, here are some things that you can focus on to bring more discipline and speed to closing the books:

Reasons to bring more discipline and speed to closing the books:

  • Start to pull in time lines with a target in mind. You should be able to close the books in a week, but it may take some time getting there;
  • Demand that bank reconciliations are generated monthly, within two days of statement receipt;
  • Have your accounting staff produce a close calendar listing all the various tasks and their interdependencies;
  • Make sure the accounting staff is taking full advantage of technology. For example, is your accounting team able to upload complex journal entries;
  • Establish a fixed date, e.g. second Wednesday of each month, to review all the financial statements with your accounting team; and
  • Be sure that issuance of financial statements to your lenders is referenced on the close calendar and immediately follows your monthly review (so you are prepared to talk with your lender in the event a conversation is necessary).

These are a couple of recommendations that can quickly improve the timeliness of your financial data.  The big improvement will be your ability to gain insight much quicker, allowing for time to actually react to changing circumstances before circumstances take control of you.  If you need assistance bringing more discipline to closing the books, contact us today.

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.