Business Finance experts look at key factors in lending decisions

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Your Tameside member, Genesis Business Finance  explore the key factors influencing a funder’s decision to lend to businesses.
As we’ve seen, statutory accounts and management information provide a lender with information on the historic trading performance of a company; this information enables a funder to assess the current financial strengths and weaknesses of a business and establish if the business is meeting its current financial obligations. However, any funds advanced by a lender will be repaid by the future performance of the company and so the funder will want to understand how the business is expected to perform over at least the coming 12 months.
 
Financial forecasts have no statutory format and so can be presented in whatever style a business prefers. However, funders will want to be able to see Profit and Loss, Balance Sheet and Cash Flow forecasts so that they can establish the following:
 
1. Profit and Loss Forecasts
 
– Is the business going to be profitable in the next 12 months?
– Are Gross, Operating and Net Profit margins falling, stable or increasing?
– Are the fixed costs and overheads of the business expected to increase?
– Is turnover expected to fall, remain stable or increase and why? What will turnover be made up of?
 
2. Balance Sheet Forecasts
 
– Is the company taking on significant additional debt?
– How is it expecting to treat its Debtors and Creditors?
– Are the Directors or Shareholders injecting funds into the business?
– Is there a significant increase in assets or liabilities forecast?
 
3. Cash Flow Forecasts
 
– When is it anticipated cash will be received from sales?
– When are the cash ‘pinch points’ for the business? Are the forecasts too ‘smooth’?
– Is the business realistic in its expectations for receiving payment?
 
A funder will take this information and  ‘stress test’ your forecasts to see how they stand up to changes in expected margins, interest rates, overheads, sales levels and payment terms.
 
It is worthwhile to have done this yourself prior to submitting forecasts so that you can explain why you believe these figures are realistic assumptions for your business – its also a useful exercise for your business in its own right!
 
Forecasting is never an exact science and nobody can predict the future. However, if you’re able to supply a funder with your expectations for the future financial performance of your business and explain why you’ve reached those conclusions you give a funder confidence that you’re managing the business well; consequently you will stand a much better chance of having a funding request approved.
 
In the second of the series of articles looking at the key factors that influence a funder’s decision to lend we explore statutory information, namely formal accounts.
 
All companies, large or small, have to produce formal, statutory accounts. For limited companies these are then filed at Companies House up to a maximum of 9 months after the date of the accounts. As we explored in the previous article, management accounts assist a lender by giving an insight into the trading performance of a company for the period in between the production of statutory accounts. However, analyzing statutory accounts will always form an important part of assessing any lending proposition.
 
Unlike management accounts formal statutory accounts have to be produced in standard formats – the most widely used for small companies in the UK is GAAP although some companies may make use of IFRS (all listed companies use the IFRS standard). Regardless of which format is used a lender will be looking at the trends evident from a comparison of different sets of accounts – a single year’s accounts will usually not be sufficient and a lender will look for a minimum of 3 years information. A lender will also want to see the full accounts, not the abbreviated accounts that small companies can file at Companies House as these only show very limited information. (Commercial credit scores use this information which is why they are not particularly helpful for a business looking for additional finance – read more here).
 
Different lenders will have different criteria that they assess accounts against. However, as a general rule lenders will all want to understand the reason behind the trends the accounts show. Lenders want to know if a business can afford a facility and are likely to ask:
 
    If turnover is falling, why is that?
    Are profit margins comparable with the general sector?
    Does the business have proportionally high overheads and if so, is management taking steps to control these?
    What proportion of profits are being retained in the business year on year?
    How highly geared is the business and how reliant is it on debt to continue its operations?
    Is there evidence of the business overtrading?
    What does the cashflow model of the business show about its finances?
 
 
 
Whilst many business owners and managers focus on turnover and gross profit margin a lender is far more likely to be concerned with profit levels, retained profits and current debt levels. Understanding this is critical if management is to provide a suitable commentary to the accounts, explaining the trends.
 
A lender will also want to look at the statutory accounts in order to see if a company’s auditors have made any comments or passed any opinion on the financial statements, as well as to examine the notes to the accounts for greater detail and insight into how the headline numbers have been produced.
 
If management can provide all the above, along with an explanation for the numbers and trends, they will have a greater chance of success when attempting to raise finance. As with management accounts, providing as much information as possible upfront helps speed up the process, gives comfort to a lender and can be the difference between a business accessing the finance it needs or not.
 
In the first of a series of articles looking at the key factors that influence a funder’s decision to lend we start by exploring management information and management accounts.
 
Unlike Annual Accounts, Management Accounts do not have to be in a particular format and are for the internal use of the Directors and management of a company. Often produced monthly – or at the very least quarterly – management accounts give a picture of the current trading performance of a business, helping management to keep control of costs and to understand the impact day-to-day decisions are having on the financial health of the company. Management Accounts were traditionally the preserve of larger businesses with internal accounting departments and dedicated Management Accountants; very often small businesses will tell a potential lender that they do not produce Management Accounts.
 
This can cause significant problems when trying to access funding.
 
Firstly, a potential lender is primarily concerned with whether the potential borrower – the company – can repay the facility. Whilst Annual Accounts can be useful in assessing the past performance of a company they don’t provide any information on current trading and as such, have limited value. Therefore, a potential lender wants to see up-to-date information on the performance of the company and without it it’s difficult to assess whether a company can afford the additional debt it is requesting. To give an example; if an individual requested a statement from their bank for their current account and received information that showed the account balance from 11 months ago with no newer information it wouldn’t be particularly useful!
 
Secondly, if the information is not available questions are immediately raised about the management of the business. If they don’t know what’s currently going on how can the lender accurately assess that the facility will be repaid? Annual accounts can be filed up to 9 months after the financial year end for a company so, theoretically, a lender may ask for recent accounts and receive information that is more than 20 months old – it is doubtful if anyone can safely run a business without knowing what the financial position of the company is for that long and so a potential lender will already have doubts about the company’s ability to repay the facility.
 
So what is the solution?
 
Even though a business owner or Director might not produce formal Management Accounts in reality it is highly unlikely that they don’t have some kind of management information available. Electronic, and now cloud-based, accounting packages are able to produce Profit and Loss, Balance Sheet, Cashflow, Debtor Ledger and Creditor Ledger statements on demand. Knowing how to quickly produce these and including them in the pack of information provided to a potential lender not only helps speed up the decision making process but shows the lender that management is proactive and is on keeping on top of the company finances.
 
Putting in place a process whereby this information is exported and analysed on a monthly basis enables company management to monitor the trading performance of the business – just 1 simple procedure and suddenly the business is actually producing regular Management Accounts!
 
Equally, specialist external accountants can produce regular management accounts at a fraction of the cost of employing an in-house specialist. Using the skills of a qualified Management Account – not just using a bookkeeper – can bring significant financial rewards for a relatively small investment.
 
Some accountants specialise in using online software packages, combining the best of both worlds and there are even software add-ons which can produce detailed financial forecasts, enabling company management to plan for the impact of different scenarios such as rising material costs or higher interest charges due to taking on additional debt.
 
Ultimately, having the right information available not only helps access finance but actually enables better management of a company – a win-win scenario for everyone involved.
 
Genesis Business Finance is one of Tameside and the High Peak’s leading independent providers of business finance solutions. Their team has over 35 years combined experience of securing finance for businesses throughout the UK.
 
You can contact them on 0330 22 33 560 or log onto http://www.genesisbf.co.uk/
 
 
 
 
 
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