THIS ARTICLE BY ALMA JOHNS WAS ORIGINALLY PUBLISHED ON PROFIT GUIDE ON JUNE 15, 2015.
A great relationship with a bank is predicated upon a business having excellent historical financial performance and a stable balance sheet. But business owners often approach banks without understanding their company’s “bankability factor,” and are quick to blame the Canadian banking system for its supposed conservatism—what the banks would call prudence—when their financing application is rejected. “Banks don’t understand my business,” is a commonly expressed sentiment among business owners.
Understanding business banking basics is a must for every entrepreneur who plans to grow his or her business and needs access to financing to do so. Banks like to broadcast their intention to support entrepreneurs, but that doesn’t mean business owners can simply assume that they will get the financing they desire. Adequate preparation is a must.
Here are some things that can increase your chances of getting the bank to say yes and transform your financial institution into a powerful business partner.
Prepare Your Financial Information
Before meeting with a bank manager, make sure that you have a copy of your most recent financial statements. An internally prepared statement that shows year-to-date performance may also come in handy. If you’re a small business that does not prepare financial statements, have your Corporate Tax Return (T2) and T1 ready.
Create A Business Plan
Banks don’t expect comprehensive business plans from small businesses. A 2–5 page summary that describes the company’s products and services, managements’ skills and experience, market and competitive landscape, and a strategy highlighting what makes your company unique and how you will stay profitable, should be sufficient.
Prepare Financial Projections
Furnish the bank with financial projections that demonstrate your business will achieve sales growth and that cash flow will be sustainable to service your payments throughout the term of the loan. Outline assumptions and variables that support the numbers. Banks like to see a monthly cash flow projection for the next 12 months, then annual projections thereafter.
Keep Your Ratios Healthy
Banks use financial ratios to assess your credit risk. These ratios should demonstrate a stable balance sheet via debt to tangible net worth ratio and your ability to repay the loan via debt service coverage ratio. Ideally, your debt to tangible net worth ratio should be around 2:1 (for every $2 of debt, you have $1 in equity) and your debt service ratio should be at least 1.25:1 (every $1.25 of cash flow should cover $1 of principal and interest payments).
Know Your Numbers
Make sure you have a good handle of each item on your financial statements. Demonstrating that knowledge gives your bank manager a high level of comfort about your ability to successfully manage the business and shows him or her that you are genuinely concerned with protecting the money that was entrusted to you.
Anticipate and Plan Your Financing Needs
Knowing how much financing your business will need and when ahead of time demonstrates preparation and the ability to foresee where your business is going. You may not have a crystal ball to predict the future, but poor planning often results to credit application getting declined and leaves little room to explore other financing options.
Understand Your Negotiables
Knowing your concessions will benefit your banking relationship. If the bank manager believes your risk profile is on the edge of their lending criteria, don’t ask for a significant interest rate discount or for fees to be waived. Bankers work within defined parameters. The terms and conditions on your loan agreement, while negotiable, are based on your company’s risk profile. Expect to pay an interest rate premium if your ratios are less than ideal.
Communicate Negative and Positive Developments
If you secure a windfall contract or acquire a new client, share the good news with your banker. The same rule applies to undesirable events such as loss of a major customer or anticipated decline in sales. Communicating potential business deterioration allows you to negotiate possible solutions with your banker before the worst happens.
Have A Fall Back Plan
Even the best businesses occasionally run into trouble. A contingency plan will help your business prepare for eventualities that can disrupt cash flow. Although some form of collateral secures most loans, you don’t want the bank to exercise its recourse against you. Your fall back plan might include personal savings, surplus home equity, or a potential silent partner. Be prepared to inject equity into the business when necessary.
Have an Advisor On Your Side
Accountants, part-time or full-time CFOs, and financial consultants who are former bankers can provide assistance in dealing with banks and in preparing a financing proposal. They can improve both bargaining power and the chance of getting your credit application approved. A good expert on your side also enhances the bank’s comfort that you’re not alone in managing the financial affairs of your business; such advisors fill management gaps and boost the prospects for continued success.
Alma Johns, MBA, is President of Bench Capital Advisory Inc., a corporate finance advisory firm focused on senior debt and alternative financing transactions for SMEs. She has two decades of experience in corporate and commercial banking from three financial institutions. She received her MBA from Schulich School of Business and has published articles on financing, succession planning, management buyouts and business valuation.