Chapter 10 of the Business finance basics section in the 'Achieving financial success' series

By David Jenkins*

Banks and other lenders are generally very good at providing assistance when you are looking for finance.

However, you should remember that many have not run, or been involved in a small business.

While they may have some industry knowledge, they are not business owners. So if you are seeking debt finance for your business, you need to educate a potential lender about your business and industry, in order to help them make a decision about whether to lend to you (and to help you decide whether you want to borrow from them).

If you take the time to discuss the key drivers of your business - how sales are generated and how you manage your business on a day-to-day basis - your banker or alternative lender will be far better placed to meet your needs and to act as an advocate on your behalf when you are applying for loans and other services offered.

Do shop around. You are trying to find a lender that meets your needs.

By developing a solid relationship with your lender, you will benefit from the support they will provide your business. Lenders and bankers can be great sounding boards for new business ideas, and provide insight into what is happening in your industry, as they will most likely have other customers that service your industry or area.

The key to a successful loan application is not only in the presentation of the information, but also in the provision of information.

Lenders are analytical by nature. By providing all the relevant information in your application, you ensure the lender will have something tangible to review and pass on to the credit manager and other key decision-makers.

In most cases, the loan officer processes the application and makes recommendations to the credit manager and/or loan committee. By providing all the relevant information to your loan officer, you ensure he or she will have everything required to present and support your loan application.

HINT
If you follow the guidelines as detailed in this section, you will be better prepared, better informed and therefore more confident in your approach to potential financiers.

Preparing a loan application

The objective of preparing the loan application is to show the lender that providing you with a business loan is a sound proposition.

One of the most important aspects of your loan application is to demonstrate to the lender that you can organise your thoughts and ideas in writing and can support them with financial information. If you have used an adviser or accountant to prepare your financial information, make sure you understand it before meeting with the lender.

To increase your chances of success, your loan application package should be easy to review.

An example of how to collate your information is detailed below.

Many people in business overestimate how much a bank knows about their business or industry, and because of past actions by some banks, they also can feel somewhat intimidated. However, if you take the time to educate your banker, they can be an asset to your business.

The preparation and presentation of a loan application is critical to the success of the application. By spending appropriate time on these, you ensure the application indicates to the financier that you run a well-organised business.

Details of the loan required

The potential lender will need to review why you are applying for a loan.

You will have identified the amount of the loan when preparing your cash flow forecasts, and now you need to provide a detailed description of the loan required.

The application should contain all the information on the funding required and should include the following information:

• purpose of the loan
• amount of the loan
• duration of the loan
• how the loan will be serviced
• what security is available to support the loan.

Each of these points is discussed in more detail below.

Purpose of the loan

A detailed description of why the loan is required should be included in the application. Although this sounds like an obvious inclusion, the purpose is very important to a potential lender. Most lenders will not be willing to provide a loan to assist in funding operating losses or the purchase of luxury assets for the business owner.

The purpose should be set out simply and clearly. This may include:

• funding capital expenditure such as plant, equipment, vehicles, property and improvements

• increasing working capital or supporting increased stock holding as a result of growth

• replacing existing equity with debt

• succession planning to provide an exit strategy for family members

• acquisition of another business or part of a business

• research and development or commercialisation stage

• expanding distribution or developing new markets.

Example of statement of purpose
As a result of a new sales agreement with XYZ, our business will require an increase in stock purchases to fulfil the contract requirements. The funding will support this business growth through the purchase of additional stock. This contract will increase annual revenue by a minimum of 20 per cent.

If the loan is to be used to purchase an asset (such as equipment or property), or for a contracted service, then provide the lender with all the important documentation that you have collected relating to the purchase.

The important documents should include any agreement or contract to be signed, quotations for the asset or service, and any specific requirements for the installation of the asset or provision of the service.

It is imperative to link the purpose of the loan to the overall business benefits that will be achieved as a result of the additional funding. It is also important at this point to state when the funds will be required. We often underestimate how long it will take the bank or lender to process the loan application, and this can have an adverse effect on the business if the funds are not available when required. Make sure you submit your application with plenty of time for the assessment to take place.

Amount of the loan

The amount of funds required will be determined from your planning. Whether you are starting up a business, or funding an existing business, the planning stage will be the same.

In a start-up scenario, the planning will be undertaken as part of the initial business planning process. For an existing business, a new business plan should also be undertaken. It is good financial practice to revisit your business plan when key elements of the business change.

In order to determine the total amount of funds required, you will need to prepare a cash flow forecast as if the loan has been successful. This forecast should cover the expected duration of the loan. (All of these details were covered in Chapter 6.)

It is important to remember that you will have to pay a number of costs when the lender provides the loan. Some of these costs must be paid at the time the loan is made available; other costs will be incurred over the period of the loan. Make sure these costs are included in your cash flow forecast to ensure you will have adequate funds to cover all costs.

Upfront costs can include:

• establishment fee
• guarantee fee
• legal fees
• valuation fees.

Ongoing fees can include:

• half-yearly loan charges
• interest (can be charged monthly, semi-annually or annually)
• transaction fees (charged every time the loan funds are accessed)
• default fees.

When determining the amount of funds to apply for, in addition to including the costs associated with the loan funds you should consider including a “buffer” amount. This is an amount above what your plan shows as the minimum required to finance your activities.

Generally speaking, it is not possible to forecast all events.

A buffer will allow for any unexpected expenses or lower than expected income over the period of the loan. You will need to make an assessment of an adequate “buffer” amount. Discuss this with the lender, as they may be able to assist in determining the level of contingency required.

Term of the loan

Through your planning, it will become obvious how long you will need the funds for. A cash flow forecast shows the movement of cash in and out of the business, and indicates when the business will be in a position to repay the funds.

Another important factor in determining the term of the loan is the type of loan you seek. Some types of debt finance have a maximum term available. For example, where funds are required to purchase an asset, a lease may be the most appropriate debt product, and the lease company may provide lease funds over a maximum of five years. So again, the cash flow forecast will assist in determining what types of finance products you are able to consider.

Servicing the loan

The most important element of the funding application is to show the lender that the business has sufficient cash flow to make the regular loan repayments, including all the associated costs of the loan, over the life of the loan, and ultimately to repay the loan. This will entail having a good understanding of your financial statements, most importantly the cash flow forecast.

You must be in a position to make a strong case to the lender on how the forecast cash flow will adequately support the repayment obligations of the loan within the allocated time frame. Reviewing the financial ratios on your forecasted profit and loss and balance sheets will also provide information on the expected profitability and financial health of your future business operations.

Security for the loan

For most types of loans, lenders will require security (also known as “collateral”) over the loan. As part of your preparation, make sure you identify what security you are prepared to offer a lender. Appropriate security provides the lender with some comfort that in the event the business is not able to repay the loan funds borrowed, they can liquidate the security items to repay the outstanding funds.

For a successful loan application, it is important that the security offered matches both the type of loan and the lender’s perception of the risk associated with the loan application. For example, where the loan is for a medium term of three years, stock or customer receivables will not be acceptable as they are short-term assets. The lender will be looking for security that has value that exceeds the duration of the loan. So more appropriate security would be equipment or property that has a valuation in excess of the loan over a lifespan of more than three years.

It is recommended that you identify and provide details to the lender of the security available, as part of your loan application. This way, you will be able to present your preferred security before the lender nominates their preferred security.

Forecast financial information

A lender will pay particular attention to the budgets and forecasts, as these will show how your business will operate during the period of the loan.

It is therefore important to know how to prepare these forecasts in line with your lender’s expectations.

By preparing both a cash flow forecast and profit and loss budget, you will have sufficient information to prepare a balance sheet budget. Remember, a balance sheet is financial information “at a point in time”; therefore, it has less importance to a potential lender when they are reviewing forecasts, because they are using the forecast information as a guide to the continuing operations of the business.

Cash flow forecast

A cash flow forecast is probably the most important information for the lender. It will provide the necessary detail to a potential financier on the cash available to pay back the loan. (Refer to chapter 6 for information on how to prepare a cash flow forecast.)

Profit and loss budget

A profit and loss budget will indicate to the potential lender whether the new business plan is profitable. (Refer to chapter 3 for how to prepare a profit and loss budget.)

Personal information

Although lenders are in the business of lending funds to business, they like to make sure that the funds will be repaid. One of the most important indicators for them will be your own personal spending habits, which will show them how you manage your own finances, and will be particularly important when the business loan application is for a business start-up, where a history of business patterns has not yet been established.

When you are applying for loan funds, it is most likely the lender will undertake a personal credit check; the authorisation to do so is usually included on your application form. A clear report will mean you have not, in the past, defaulted on any payment obligations and this will impact positively on your business application. Therefore, maintaining a good personal credit rating will help. A history of having paid your credit cards and personal loans on time will contribute to a lender’s confidence that you will continue to meet your debt obligations.

The types of personal information the lender will be looking for can include:

• personal assets - purchase price and date, independent valuation if available, ownership documents (such as mortgage or leasing agreements) and, for any policies, the most recent policy statements

• tax returns - you may be required to supply supporting documentation to the tax schedules, such as proof of income from investments

• personal bank details - all statements issued from the bank or financial institution. For bank loans, include the original loan agreement as well as the statements.

To gain an understanding of your personal position, the lender will usually require the key information from the past three years. This is to ensure any unusual circumstances are “averaged” over the period. The checklists below can be used to prepare all the relevant personal information required for the loan application.

Historical business information

For existing businesses, the lender will want to review historical financial information. Typically, where it is available, they will want at least three years’ business records to give an indication of the business operations.

The financial information they require will be the statements outlined in Chapter 1 - balance sheet, profit and loss statement, and cash flow statements.

Ideally, this information should be prepared and/or reviewed by an accountant. This will give comfort to the lender that all the information contained in the statements is accurate, complete and correct.

In addition to the financial statements, the lender will most likely also want to check the historical operating data of the business. This will provide an overview of the way the business is managed and some insight into the character of the owner(s).

Such information may include (but is not limited to):

• annual tax returns, including assessment notices received from the IRD

• current accounts receivable and payable schedules (debtors and creditors lists)

• bank statements for all bank accounts and loans for the past three years

• details of any current or previous bank or other loans, including all loan agreements and statements

• details of any other types of financings such as leasing or hire purchase

• previous bank relationships

• key customer relationships.

Use the following checklist to help prepare the historical information:

This checklist can also be used when preparing for the annual review by your current lender.

TIP
The more information you present to the lender about your industry, the company, key management and your marketing plan, the easier their job becomes to review and support the loan application. Loan officers agree that a complete, well-prepared loan application will go to the top of the pile.

Presentation of the loan application

The most important assets of a small business are the experience of the owners, the potential value of prospective customers and other non-financial items. It is for this reason that the meeting with the lender will be as important as the package presented.

The lender will be looking at your confidence, management style and capacity to understand financial and other risks associated with your business.

It is extremely important that you meet personally with the lender. In doing so, you will be able to present yourself, your business and your financial needs in a manner that will convey a message of confidence and capability to the lender.

This may well be the first step in developing an ongoing relationship that will foster the growth of your business in the future.

HINT
Make sure you understand all the financial information that has been prepared and is being presented.

To ensure your meeting is successful, determine the expectations of the lender before you meet with him or her. This can be done by looking at the website of the financial institution or by contacting the institution and asking for a checklist of the information that will be required.

In addition to the loan application package, be prepared to discuss certain aspects of your business, competitors and industry.

Be prepared for the lender to look at relevant financial ratios. Make sure these ratios on your forecasts are within acceptable levels and that you understand what the ratios mean.

Furthermore, a good presentation will include discussion on the sensitivity of the ability to repay the loan. This means you know where the risks in the forecast may be and have thought about potential fallback plans in the event the activities don’t go according to the plan.

Be confident when you present your loan application. Dress for success. If you have forgotten something, don’t get flustered. Explain to the lender that you have forgotten the item and that you will deliver it later that day or the following day. The same goes for any additional information that the lender may request that you have not included in your application.

The role of advisers

Accountants and business advisers can assist in preparing a loan application. They will be well versed in translating your future ideas into financial forecasts.

They will also be able to assist you in your meeting preparation, as they will be able to emphasise the potential areas the lender will focus on. You may even want to practise your presentation with them.

However, it is important to remember that the lender will be looking at your ability to manage the future growth of your business, so you must ensure you fully understand the information you present.

The finale

If your loan application is denied, find out as much as you can about why it was not successful. This will assist you in any future loan applications you may consider.

Above all, remember that the lender is in the business of providing loans, and therefore will be looking for future business.

Often loan applications will fail not because the business is too high a risk, but because the loan application was poorly prepared, indicating a lack of dedication and/or understanding, which sends immediate warning signals to the lender.

For more information on applying for a loan for your business, visit the respective web sites of potential lenders.

TIP
When applying for a loan, always meet your banker in person to discuss the application.

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The full Guide is available in the .pdf attachment, or here »

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David Jenkins is the New Zealand-based manager of the global professional accounting body, CPA Australia. You can contact him directly here »

You can read the Introduction to this series here »  The related Glossary is an important resource. And readers are encouraged to read this page first »

Chapter 1 is about Understanding financial statements and you can read it here »
Chapter 2 is about Assessing your busines's financial health and you can read it here »
Chapter 3 is about the Importance of Budgeting and you can read it here »
Chapter 4 is about the Maintaining Profitability and you can read it here »
Chapter 5 is about the Improving Cashflow and you can read it here »
Chapter 6 is about the Managing Cashflow and you can read it here »
Chapter 7 is about the Debt, equity or internal funds? and you can read it here »
Chapter 8 is about the Transactional banking and you can read it here »
Chapter 9 is about the Importing and exporting finance and you can read it here »

Chapter 11 is about Refinancing your debt and will follow next week.