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This is not advice. Items herein are general comments only and do not constitute or convey advice per se. The information contained in these articles is for guidance only and should not be relied upon without obtaining professional advice having regard to your direct circumstances.


Inside the mind of your banker

Your chances of attracting finance from your bank are always going to improve if you understand what bankers are looking for and how they assess risk.

Contrary to recent media coverage, more and more businesses are finding that it is possible to obtain finance and have close working relationships with their banks.

However it is true that, more than any time in recent history, bank funding is scarce and bankers are under pressure to make every cent lent to customers count towards their profit targets. Approve a bad loan and a banker’s career could be jeopardised. Business is finding it harder than ever to convince banks that investing in them will prove a profitable investment, with minimal risk of failure.

A business loan approval can be an extremely subjective decision, especially when you are relying on business assets and ongoing cash flow to secure the facility, rather than a house. Boiled down, most bankers are looking for three things when making a lending decision:

• Does management have integrity and is it sufficiently skilled?
• Can the business demonstrate an ability to pay back the money? (Serviceability); and
• Is there a way to get the money back if things don’t go to plan? (Security)

For anyone planning on approaching a bank for finance, the following pointers will help maximise your chance of a successful bank approach.

Demonstrating your integrity and skill

Bankers are trained to constantly watch for indicators of dubious characters or poor business skills. And the more money you are asking for, the more people will be watching you. Often the Bank Manager you are dealing with is not the end decision maker. Banks are approving up to $2m loans now with computers and automation. Generally loans above this will end up with a Credit Manager in a centralised assessment environment, away from the customer to ensure independent assessment is made.

While it is easy for the Bank Manager you deal with to get a feel for your integrity, the centrally located credit manager uses clues in the information provided to make his or her assessment. Fail to impress either your Bank Manager or the Credit Managers, and your loan chances are adversely impacted.

Dos and don’ts of borrowing

Following are some clear dos and don’ts to help with this aspect of the application:

• Do help the bank to understand your proposition in writing.
• Don’t leave it up to your banker to construct the case for lending to you, feed him/her with the ammunition required – you are the only expert in your business. You need to tell your banker why your business is low risk, and provide the ammunition that they need to understand the value of the proposition. They can then use this to accurately share this value internally.
• Do expect bankers to investigate you thoroughly
• Don’t hide information relevant to assessing the risk of your proposition – you will invariably get caught not disclosing key information, and you can kiss your chance of success goodbye. The bank automatically wonders what else you have failed to tell them and the “credit clam” shuts. Common often unintentional omissions include: other entities and trusts in the group, tainted credit histories of business or directors, significant trade relationship issues, and competitive or market issues.
You can have negative aspects to your application and still be a good bank customer. Address them up front and you are showing that you are on top of your business and in control of your destiny.
• Do identify and proactively address risky elements to your proposal
• Don’t leave it up to the bank to guess how these risks influence the application – bankers are trained to assume the worst when presented with only half the story. It is not in their interests to believe that the missing information will not have high risk indicators hidden in it. By proactively addressing issues, it shows that you have nothing to hide and leaves nothing to the imagination, and that the business is on top of its problems.

Demonstrating Serviceability

There are two parts to assessing serviceability:

• How the business has performed in the past; and
• How the business is likely to perform in the future.

The past

If a business is making profit then in most circles it is a success story. However this is only part of the picture for a bank. Surplus Cash Flow, generally measured as Net Cash after Operations, is the number one consideration. This is because this is what a business will use to make bank repayments. A business can be making a profit and not have surplus cash, thereby making it a bad banking proposition.

Net Cash after Operations is a company’s Gross Profit value, less cash related operating expenses (ie not including depreciation, amortisation, asset revaluations and bank interest expenses), less taxes payable and including movements in current and non current assets and liabilities (predominantly movement in Debtors, inventory and creditors). A bank wants to see that its repayments, plus interest, are met by the surplus and there is still something left over for a rainy day.

The “rainy day” component is measured through a calculation called Interest Cover (Earnings before interest and tax / Interest Expense). Business needs to be earning more than twice as much profit as the interest expense.

Example: Financial trends that bankers might worry about

• Inventory is growing disproportionately to Revenue – Unless told otherwise, this could be caused by a stockpiling of unpopular product lines indicating management doesn’t have a good grip on market demand.
• Debtor days (Accounts receivable/Revenue * 365) growing – This might imply that debt collection processes are poor or worse: that customers are not paying because of service/product quality issues.
• Is COGS (cost of goods sold) growing disproportionately to revenue?
• Are there supplier issues causing cost increases that could jeopardise future viability?

Bankers will spend hours poring over your financials looking for issues and reasons to be concerned as this is their primary information source and skill set. The more you can pre-empt concerns and address them in a manner that shows you know your business, the more comfortable a banker will be.

You also need to demonstrate that the business has great likelihood of trading. If there are industry, regulatory or competitor related storm clouds on your horizon, you need to demonstrate that you are aware of them and that you have a plan to succeed in spite of them. Banks have economics department that can feed lenders market information so they are usually reasonably well informed.

The conventional way to demonstrate future trading expectations is through a cashflow forecast. The danger with these however is that bankers are wise to the fact that there is no such thing as a bad forecast. Hence assumptions need to be extremely detailed and noticeably conservative. Best case/worst case scenarios can assist with this as well.

Putting the family home on the line

No business manager wants to put the family home on the line for the business. However if the assets of your business were to be sold at a distressed business valuation, would they pay back your loans? This is the challenge that you face if you are to avoid the bank’s insatiable appetite for bricks and mortar security. One way out of this is to use current assets and equipment to secure asset specific funding, including debtors and inventory, which is growing in popularity.

And even if you do have unsecured facilities, the likelihood is that you will have provided an unlimited guarantee as a director. This can be a trap for directors as in a distress situation you are likely to have to sell your home anyway. But because it is not directly linked to your loans the bank can justify charging you an extra 3 per cent in interest because the loan is deemed “high risk”. If you know that the likelihood of your business failing is slim, you might actually be better off financially to just directly link the house and take the discounted rates. In this example the ultimate safety of your house doesn’t change, you just get a more favourable interest rate.

Nathan King
My Business, November 2008


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