MY previous article was about the importance of a good business plan to capture the attention of bankers, or potential investors. Many have asked me about a business plan to get a loan.
Generally, there are four broad stages in the loan application process – the preparation of the business plan, the submission of the loan application, and the assessment and approval of the said application.
Stage 1: Preparing the funding memorandum. To facilitate the loan-processing procedure, it is important that you provide the financial institution with full and complete information on your company. This is to ensure a speedy and smooth processing of your loan application. Before applying, you will need to prepare a business plan.
A funding memorandum is a written plan outlining your vision, mission and strategic objectives of the business. A well-written and structured business plan should encompass and provide relevant information on the business. In addition, it should be clear, simple and concise. It is then converted into a funding memorandum which is basically a business plan written for a lender, having the approach of reviewing a business from a different perspective.
Stage 2: The application process. To expedite the application process, you should submit a duly completed loan application form together with the business plan and include all other relevant documents as required by the financial institution.
Each financial institution has its own loan application forms and checklists. However, most of them require more or less the same list of documents for verification and evaluation.
You should make full disclosure of all financial information about yourself and ensure that it is accurate at the time of your application. Declaration of the correct information will also ensure that your application will be processed in a timely manner.
Financial institutions may carry out interviews and conduct a site visit to your business premises to better understand, verify and assess your financial position.
The questions posed during the interview and site visit relate to the nature of business, management structure and market positioning i.e. market share, competitors, market outlook, future plans and product life cycle.
Stage 3: Assessment of the loan application. The third stage of the consumer credit process is credit evaluation. During this stage, a decision is made to approve or reject the credit facility. Once the information is verified, the financier proceeds to the evaluation stage.
Credit evaluations are not based on a single factor, but upon how an applicant matches a set of lending criteria laid down by the lender. Correspondingly, these criteria inherently reflect the risk-tolerance levels of the credit grantor concerned. In short, these criteria reflect how the lenders want to do business, their business policies, strategies etc.
In addition, banks make use of financial ratios to rate a particular business. Some of the financial ratios used for credit ratings are the percentage in growth of sales year-on-year, as well as profitability and stability ratios to determine the level of net working capital required, while also taking the repayment ability of the said business into consideration.
The broad principles that financial institutions apply to assess your business’s credit risk can be summarised by the 5Cs (which comprise both qualitative and quantitative assessments):
To lenders, this is the most important requisite and the most difficult to measure precisely. The financier needs to determine the willingness of a potential borrower to repay the loan facility. It must be highlighted that even if a potential borrower has the capacity to make sound repayments, his credit facility may still be declined if there are grounds to suspect or question his willingness to make repayments;
The factors normally considered in examining a character of potential borrowers include past records or credit history of the borrower; stability and duration of his employment/business; experience and qualification, and reputation.
This is a measure of the shareholder’s commitment towards the business. Generally, shareholders who inject larger amounts of capital into the company are deemed more committed to growing the business;
The client’s capital is determined by his current level of liquid assets, current level of unsecured borrowings and their list of income sources, fixed expenses, as well as contingent liabilities;
To the lenders, the capitalisation ratio (%) i.e. total net debt over total capitalisation, and tangible net worth over total capitalisation will determine the commitment and debt level of the business and, correspondingly, the size of loan extended.
However, lenders will also look at the industry of the said business and perform a set of benchmark ratios as a reference. For instance, a manufacturing company will have a higher capitalisation debt level compared with a trading company.
Capacity looks into the client’s ability to pay and handle the proposed new level of debt;
Here, the company’s profitability ratio is analysed by studying the company’s profit margin i.e. gross profit margin and net profit margin;
The NBIT over sales figures will reveal the company’s ability to service its finance cost from the total debt bearing interest category;
Liquidation ratios are also analysed at this stage by studying the coverage ratio i.e. total borrowed funds over tangible net worth, which is then used to determine the speed at which a business is able to sell its assets to repay debt;
It is also determined by past earnings, projected future earnings and past records of meeting financial obligations.
This will prompt the financier to examine whether the client’s employment or business will withstand the vagaries of the economy, social, political and international environments, government regulations, competition or changes in banking policies;
The turnaround days are analysed at this stage by looking at inventory turnover, the average collection, and the payables period. This will then project the relationship between suppliers and customers and any other issues in regards to collection and payables;
The lenders will also look into the company’s list of suppliers and customers to determine the business risk with regards to the immediate parties – the supplier and customer.
Collateral is considered only as a cushion for the financier to rely on when there is a default in its primary source of income;
A financier would prefer that a loan is repaid rather than having to collect proceeds through auction of the collateral;
Collateral is examined based on its ease of disposability and whether it is adequate as security i.e. fixed deposits are always preferred to fixed assets in terms of disposability factors.
However, banks will obtain satisfying proportions of both assets as mentioned above, in addition to other forms of security – corporate guarantees, director’s guarantees and third-party security documents which are deemed acceptable.
Financial institutions will conduct credit checks and study the patterns of the business current accounts, repayment records of their loans and existing trade facilities. Some financial institutions have their loan evaluation matrix in the form of scores as part of their credit evaluation processes.
Stage 4: Approval of the loan application. Once the financial institution approves your loan, it will issue a letter of offer that sets out a detailed credit facility, interest rate for each facility, collateral and terms and conditions under which the facility will operate.
You will be given a period of acceptance upon receipt of the offer letter. Read and understand all contents therein and revert should you feel that there are contents which are not suitable or in line with your company’s financing objectives for changes thereon. There are times when the intent and discussions of the borrower and the documentation from the lender do not match.
Upon acceptance of the letter of offer, the financial institution will proceed to the documentation stage. Here appointment of professional and legal advisors will take place to satisfy all terms and conditions under the letter of offer, and to prepare for a drawdown of credit facility.
The entire timeline from start to prepare a business plan, converting it into a funding memorandum to final disbursement, provided the checklists are met, usually ranges anywhere from three to six months. The process is faster if the applicant knows what the lenders really look for.
by Girish Ramachandran, executive director of RSM Strategic Business Advisors