Securing a bank loan to finance your small business is getting to be more difficult. In the past, banks were more likely to award loans based on character – the reputation or credit history of the borrower. But times are changing and this is no longer the case.
These days, banks base their loan decisions on more than just reputation. Profitability, solvency, liquidity and stability all come into play. They need enough information to be able to measure the business and financial risks of a potential borrower.
"Collateral is not as important as it once was," said Mark Fearon, CPA, principal, New Philadelphia office, "but the banks do look at it. Federal regulations require a bank to reduce the value of the collateral for cost of liquidation."
Banks now have financial analysts sitting behind-the-scenes to support their loan officers with the determination that they can make a loan to a customer. The analysts prepare ratio analysis, compute cash flow, evaluate collateral, and compare their customer's financial statements to industry norms.
According to Fearon, banks look at cash flow, or EBITDA (earnings before interest, taxes, depreciation and amortization), as they evaluate a loan request. "And the banks want to see a detailed list of expenses in the statements they receive, whether it is in the basic statement or in the supplemental information," he said.
Why have banks changed from their past practices? One of the major factors is that federal regulators of the banks are becoming more influential. A bank must have a complete file on a customer so the regulators do not force the bank to classify a loan as a possible loss. When a bank classifies a loan as a possible loss, it affects the bank's financial position, which can affect the bank's stock value as well as its ability to make future loans.
Your loan officer is still influential in any credit decision that a bank makes, but they must work harder if your financial performance is not at the standard required for the bank to approve your loan.
Your company needs to plan for any bank financing and work to improve its financial statement and performance. This is not always an easy task and it is never too early to start working to improve your business.
"I have never seen a bank turn down a loan to a company that could continue to operate effectively without the loan," said Fearon.
And remember, the larger the loan, the higher level of service most banks want from the applicant's CPA. Compilation reports are acceptable for most small loans, said Fearon, but depending on the size of the company, a review report is likely to be required when loans reach the $2 to $5 million range.
"An audit is more likely to be required for any loan exceeding $10 million, but remember that the banks are assessing their lending risk and could require an audited statement at a low loan balance," he said.
Whatever your loan situation, your Rea advisor will be able to get you prepared before you submit an application. Contact us today.
This article was originally published in The Rea Report, Spring 2007.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.