Small Business Advice on Bank Loans
April Vergara is a superstar Vice President for HSBC here in New York. She’s a commercial banker who knows how banks review loan requests from small businesses. She addressed my Fast Trac Growth Venture class last night and was just brilliant. Cash flow, Net Income and Retained Earnings are reviewed by every bank before underwriting a loan for your small business:
Small Business Tip #1: Cash Flow Is Reviewed
Your Cash Flow Statement highlights how much net cash (not revenues but the cold hard green stuff) your business is generating from operations after expenses. This is a reflection of how much debt your business can carry. If you don’t know how to read a cash flow statement or what it is, download our cash flow management whitepaper RIGHT NOW.
Small Business Tip #2: Net Income Is Scrutinized
Net Income is the same as bottom line. You’ll find this number at the very, very, very bottom of your Profit and Loss Statement. It’s always the very last line on your P&L. It demonstrates that your revenues are greater than all your expenses, combined (let’s hope).
If this number is negative, you’re showing a loss and don’t ask for a loan. If net income is not positive, you will not get a loan. Period. Full stop.
If you want a loan for $1, the bank wants you to show at least $1.35 in net income to prove you can cover the loan. The challenge here is the tug of war with the IRS. Some small business owners try to front load expenses to reduce profits so they can pay less in taxes.
There are plenty of grey areas so it’s not that this is illegal, it just comes back to bite you if you want to apply for a loan for expansion or if you eventually want to sell the business.
Small Business Tip #3: Retained Earnings is Scrutinized
Retained Earnings is found on your Balance Sheet. It connects your Profit and Loss Statement to your Balance Sheet. This is the net worth statement of your business. It shows all your assets (what you own), all your liabilities (what you owe) and the difference between the two.
If that difference, often called Owner’s Equity is positive, you have a positive net worth. You own more than you owe. This is a good thing.
The challenge here is if you ARE showing a positive net income and you distribute it all instead of keeping some of it in the business as Retained Earnings for future expansion, the bank doesn’t look kindly on that.
Again, the $1 loan/$1.35 ratio holds here. Let it be your guide on how much of your profits you want to distribute at the end of the year. If you want to apply for a loan later on, keep as much money in your business as you can before you apply and keep it there for at least ninety days after the loan proceeds are received.
This demonstrates to the bank or to any lender that you’re a great risk and you can handle the requirements to pay the loan back.
April provided some interesting insights from the bank’s perspective.
- In better times, banks would require $1 loan/$1.25 net income. Now the requirements are a little stiffer to reduce loan default risk. Restrictions will probably get tighter in the near term.
- Small business owners apply for loans do a lousy job of describing what they’re going to use the money for! Show the bank how their loan will make more money for your business.
- Small business owners need to move their entire banking relationship to the bank that loans them money. Usually, the loan is contingent on the ability to pay the loan back as well as the size of the total banking relationship.
- Your banking relationship includes the size of the balances the business keeps in the bank; not the number of transactions you flow through the account. The bank makes money on deposits, not just transactions.
- The size of the relationship is your bargaining chip. If you’re profitable, everyone wants you as a banking customer.
We thank Ms. Vergara for her wisdom. You can call her directly at 646-344-8235 if you have more questions.
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Download Cash Flow Management Whitepaper
If you haven’t done it already, download our cash flow management whitepaper.
It’s free. I wrote it because no one else was talking about this stuff.
If you run a small business, you need to read it. Fast and easy.
Tell everyone you know who runs a small business they should read it too.
In your corner as always,