OBTAINING A BUSINESS LOAN

You need a loan. Perhaps you are starting up in business for the first time. Or perhaps you are buying an existing business. Or perhaps you are already in business and need a loan to finance expansion or to buy a major piece of capital equipment. The following set out the procedure for a larger loan. For a smaller loan, the amount of information required by the lending institution will be less.

If you are already in business, you should ask yourself 'Do I really need the loan?' Could some finance be squeezed out of the existing business? Look at your Balance Sheet and consider the following.

Land and Buildings. If these appear on the Balance Sheet, consider selling them and then either leasing the same premises back or leasing other premises.

Vehicles. Could you get by with fewer vehicles?

Stock. Could you get by with less stock by introducing "just- in-time" stock control methods?

Debtors. Could you shorten the time taken to collect debts? For example, could you invoice more promptly? Could you be more active in chasing debtors for payment?

Balance at bank. Do you normally have a balance of several thousand dollars in the bank? If so, this could be utilised for other purposes.

Directors Loan Accounts. Could the existing Directors be persuaded to leave more of their wages in the business as a loan to the business?

Trade creditors. Could you obtain additional funds by delaying payment of your creditors? Would the creditors be happy with this?

If, after carrying out the above exercise, you conclude that you still need funds, you should consider leasing as an alternative to borrowing. However, there is really little difference between leasing equipment and obtaining a loan to buy the equipment.

Where you should you look for funds? Generally, you are restricted to a) a bank or b) a finance company. Get the loan from the bank if at all possible. Finance companies generally charge a considerably higher rate of interest compared to a bank. If the amount required is not large, would a Personal Loan from a bank suffice? There is much less hassle in obtaining a Personal Loan. The bank does not usually require security. The maximum term is usually around seven years.

If you come to the conclusion that you need substantial funds and a personal loan is not appropriate, how do you go about obtaining a loan? You should decide to approach your bank first rather than a finance company. The first step is to make an appointment to see your accountant. Tell him why you require the loan. Discuss how long you will require the loan for. For example, a truck drive is going into business on his own account and intends to buy a truck costing $100,000. He will always need a truck and, at first sight, he would appear to need a lifetime loan of $100,000. This indeed will be true if he does not retain any profits in the business. However, if the truck owner decides that he can leave $10,000 of his wages each year in the business, then he will only need the loan of $100,000 for 10 years. Many truck owners in the situation of needing a life-time loan make the mistake of going to a finance company and borrowing for five years. They fall into an endless cycle of borrowing for five years, repaying over five years and then borrowing for a further five years etc.

Once you and your accountant have decided on the period for which you need the loan, then you and your accountant must prepare some financial forecasts. The crucial figure in all financial forecasts is the Sales income. All other figures depend on this figure to a large extent. Do not be too optimistic when forecasting Sales.

The first financial forecast you have to prepare is a Profit & Loss Account for the business covering the first year after the granting of the loan. It would be wise to assume that it will be three months before the loan is actually received. The Profit & Loss Account should commence after this date and assume that the loan has been granted. The Profit & Loss Account will show expected income for the year, expected expenses including the loan interest and the resulting Net Profit for the year.

The next step is for you and your accountant to prepare a Cash Projection Statement. This is prepared for 12 monthly periods corresponding to the Profit & Loss Account time-span. It starts off with the bank balance at beginning of Month 1 and then shows the expected income, including the loan, for each of the 12 months. Likewise, cash outgoings for each of the 12 months are forecast. The result of these forecasts, of course, is that you can forecast the balance at bank at the end of each of the 12 monthly periods. These are the figures that the bank will want to see. They show that you can repay the loan. Your accountant will have a computer software package to assist in preparing the Cash Flow Projection. Following is an abbreviated example showing the first two months of the Projection.

MONTH 1 MONTH 2
INCOME
Balance at bank   10,000   20,000
add sales 100,000 150,000
add loan received 500,000
TOTAL RECEIVED 610,000 170,000
LESS OUTGOINGS
Various expenses   90,000 140,000
Equipment 500,000
Loan repayment    8,000
TOTAL OUTGOINGS 590,000 148,000
Bank balance at end of month   $   20,000   22,000
TOTAL 610,000 170,000

Once you have done the Profit & Loss forecast for the first year and the Cash Flow forecast for the first year, then you should do a forecast of Net Profit for the first three years after the granting of the loan. This can be a relatively simple affair showing the expected income for each of the tree years, the expected expenses for each of the three years and the Net Profit for each of the three years. You must also prepare the following for presentation to the bank manager. 1. A brief statement setting out the amount of loan required, the use to which it will be put, the period of the loan and the expected repayment terms. 2. Details of the owners, paying particular attention to their experience in the business. 3. A list of the personnel in the business. 4. A history of the business. 5. Details of markets, competitors and pricing policy. 6. Details of current orders. 7. Objectives of the business. 8. List of securities offered. In addition to the Profit & Loss Account, Cash Flow Projection and items mentioned above, you should take with you to the interview with the bank manager copies of a) Financial Statements for the business for the past five years and b) Tax Returns for the business for the past five years. All documents should be neatly placed in a folder and an Index provided at the front. You need at least four copies, one for you, one for your accountant and two for the bank manager.

The List of Securities mentioned in 8 above could include the following.

1) Land and Buildings either owned by the business or by the owners personally. These can include the family home. State the values. Banks will generally lend to around 60% of their value. The bank will normally take a first mortgage over them.

2) Equipment. Give description and values. The bank might lend on half their market value and take a Chattels Mortgage over them.

3) Fixtures and Fittings. The bank might lend on half their realisable value.

4) Vehicles. The bank might lend on 60% of their realisable value and take a Chattels Mortgage over them.

5) Goodwill. The bank will not normally accept Goodwill as security.

6) Shares. The bank might lend on 60% of their current market value. The share certificates and a signed blank transfer must be deposited with the bank.

7) Life Insurance policies. The bank will lend on their full cash surrender value.

In addition, you may be able to offer a guarantee. If the business is incorporated as a company, the bank will normally require the directors to personally guarantee the loan. In any case, you may be able to offer names of friends or relatives who have agreed to act as guarantors of the loan. Guarantors must be people of substance. A "man- of-straw" is useless as a guarantor. You should fully explain to potential guarantors the liabilities they are undertaking.

In addition to the above methods of securing the loan, it is possible to give the bank a general right to appoint a receiver and to sell the business as a going concern it the loan is not repaid.

When you arrive for the interview, be as forthright and candid as you can. Explain to the bank manager how you will keep him informed of the progress of the business if the loan is granted. For instance, you might emphasise that you will be revising your Cash Flow Projection every three months and that if anything untoward turns up, you will be immediately contacting him. Emphasise how efficient your record-keeping system is. The bank manager will generally be concerned only with three requirements. These are:

1. Will the applicant be able to repay the loan? Points in your favour here are a) Profit & Loss Account showing a forecasted profit for the business, b) Cash Flow Projection showing ability to repay, 3) Quality of personnel, including experience in the business, 4) Track record of business and, in particular, showing good history of repayment of any previous loans. It should be noted that showing a profit in the projected Profit & Loss Account does not guarantee repayment of the loan. The business could over-trade, it could invest in capital items or the proprietors could draw excessive amounts of cash from the business. Any of these events could result in the business being unable to repay the loan even though the business is making a profit.

A bank manager will be constantly on his guard against advancing money to a business which is making a loss. In such a case, the loan would be used solely to make good the loss and keep the business going. Obviously, there is no future in this.

2. The second thing the bank manager will be concerned with is security. In the unfortunate event of the business being unable to repay the loan, will the Bank be fully secured? Points in your favour here will be first mortgages over land and buildings to 60% of value, chattel mortgages over equipment, guarantees by persons of substance and a well- drafted loan agreement giving the bank the right of entry and sale of the business.

3. The third point the bank manager will be concerned with is availability of funds. Has the bank got the money to lend? Economic conditions vary. Sometimes the bank is flush with funds, sometimes money is tight.

If the answers to all three questions above are positive, then you are likely to get the loan from the bank.

On the other hand, if you do not succeed in obtaining the loan, take a philosophical view of it. Reflect that it might have been in your best interests in the long run. If the bank has concluded that the venture is uneconomic, then they are probably right. By refusing you the loan, they have saved you from engaging in a loss-making enterprise which could have resulted in your bankruptcy.


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Copyright 1994.





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