Some things change. Some things stay the same. Banks have traditionally asked for 20% down on real estate financing and as much as 50% down on receivables, inventory and fixtures. Prior to the 2008 recession it was easier for small business owners to come up with that 20% or more down. The chief asset small business owners have, outside of the business itself, is the equity in their homes. Since 2008 home values have plummeted wiping out that equity source for many.
An additional hurdle that small business owners have to overcome is the cash flow coverage ratio (CFC, the ratio of cash available for debt service to total debt). Banks calculate cash flow by averaging the 2 or 3 most recent year-end financial statements or tax returns. A bad year pulls that number down for the 1 or 2 years surrounding it.
Five Things You Need to Know to Secure Bank Financing Today
1. Cash Flow Coverage
Find out how your bank calculates Cash Flow Coverage (CFC). If they average three years of statements, ask what it would take to get CFC calculated on two years, instead. Usually, whether the bank asks for two or three years of statements depends on the amount of financing requested. If you can get by with a smaller loan amount, you may be able to show better CFC.
Some banks are now calculating based on a rolling year, rather than a fiscal year. This means that they will calculate CFC backwards from the date you apply for a loan, rather than the last fiscal year-end. This can work to your advantage, particularly if 2009 was your worst year and you’ve improved since. It may be worth the expense to get accountant prepared interim statements.
If you have a family business or multiple businesses, the bank may be able to add in other income sources when calculating CFC. Make sure you are giving your banker complete information.
2. Collateral Coverage.
The collateral value of your business property may have fallen, as well as the collateral value of your personal property. In the New Economy you may have to cross-collateralize some assets that you had been able to keep separate in the past. You may have to pledge personal assets that you haven’t pledged in the past. This is not likely to change any time soon.
3. Cash flow vs equity lending.
In the past, community banks often relied more heavily on equity and overlooked problems in cash flow. This contributed to small business failures when asset values plummeted. All banks are taking a harder look at CFC now. If you can show improving cash flow, your bank may be able to help you with a guarantee program that compensates for other weaknesses.
4. Nobody likes surprises.
If you have problems that show on your personal credit bureau, let the banker know before credit bureaus are pulled. If the circumstances that caused the problem were outside your control or have changed significantly, you may still be a good credit risk from the bank’s point of view. Commercial underwriting is not tied to personal credit scores the way personal underwriting is and special circumstances can be taken into account. If the banker sees an adverse condition or warning on your credit bureau that she wasn’t warned about, she may wonder if you are trying to hide something.
5. Some things remain outside your control a/k/a the regulatory environment.
Different banks have different regulatory constraints. In Wisconsin there are at least three different agencies that might govern your bank: Comptroller of the Currency, FDIC or State Department of Financial Institutions. Even when governed by the same agency, banks are subject to different rules depending on asset size and capitalization. If you are told you don’t qualify for funding because of changes in bank regulations, you may not get the same answer from the next bank down the road. You can check out bank ratings from numerous sources on the internet. The more sound the bank, the less likely they are to be under certain lending constraints.
Feel free to share your questions and experiences in the comments.