I am generally under the mindset that if you couldn’t pay cash for it, you shouldn’t buy it. This means I advise against debt if it can be avoided. There may be times when debt can’t be avoided and you need to get a loan. At these times, it is helpful to know what your banker or lender is looking for. Getting along with your banker often means getting a loan from your banker.
In your personal life, you may need to borrow to buy a reasonable house or a reasonable car. Some may also need to borrow to complete an education or training (in my opinion this should only be done if you are able to pay off the debt within three years from program completion). Day-to-day expenses should never be financed with debt. Debt should never be used to purchase anything that will be gone shortly thereafter.
In your business life, you may need to borrow to buy a building or a piece of equipment. At these times you will have to determine if a lease (or rent) (a form of debt without taking ownership) or a loan (debt secured by ownership) makes the best sense. Sometimes a rental agreement with a purchase option is best, giving you time to determine if you really need to own it long term and if it will be able to pay for itself.
Your lender will look for five things to determine whether or not they will grant you a loan. Whenever a lender gives you a loan, they are only doing so because they believe that you are more likely than not to pay it back and/or their loss exposure is small compared to the potential gain. These are the five C’s of determining if you are fundable or unfundable.
The first is Character. A good banker will take the time to get to know you to help determine whether or not you are the type of person who is honest, keeps promises and is deserving of a loan. They will also check your background and financial position. Some bigger lending organizations will only do this impersonally through background checks and reporting agencies and not get to know you.
If you don’t have a relationship with your banker, it is time to start one. Reach out to the bank or branch manager and introduce yourself. Get to know them and let them get to know you. Discuss your accounts with them and ask for advice. The better they know you personally, the more likely they will be willing to stand up for your character.
The second is Credit. A good banker will run your personal and business credit reports. They will consider your experience in the industry and your dealings with lenders in the past. They will look to see how much other debt you have and if you are servicing it properly.
The third is Cash Flow or Capacity to repay. The banker will want to determine that your business (or you personally) will have the cash flow to service the debt. They will want to see a track record of profits and good management of resources. It would be a good to identify and plug cash flow leaks before you apply for a loan.
The fourth is Collateral. The lender wants you to have skin in the game should you fail to service the loan. If your business fails, they don’t want to be the only one to suffer the failure. They will ask to secure the loan with business assets and personal assets. While you may have equity in your business, generally equity can’t be turned into cash unless you sell your business so most don’t consider equity as an asset. The lender will look at your capital assets and the value if they are sold as well as your cash and working capital positions. If you have collateral risk, the lender believes you are more likely to work through hard times to keep the business going.
The fifth is your CPA. Your CPA, believe it or not, can help tip the scales in your favor when applying for a loan. Going over your financials regularly with your CPA and at tax time shows that you care about your business and how it is doing. Knowing that you regularly have these meetings give the lender some comfort that you take your business seriously and are watching over how it is doing. Your CPA, if hired to do so, will help you improve your cash flow as well.
Getting a loan is not always easy, nor is it always necessary. Being prepared should you need one by keeping in mind the five C’s will help you get a loan if the need arises.
This blog allows you to experience the raw, gut wrenching drama of human conflict through accounting in each of its three stages: preparing to do battle, the thrill of victory and the agony of defeat.