A Banker’s Perspective on Small Business Loans – Your Bank Demands "Cash Flow," and So Should You
The more you can think like your small business banker, the more you can get out of your banking relationship. As a long-time trainer of commercial loan officers, let me take you inside the mind of your banker to tackle key issues in creditworthiness. Your ability to take your banker’s perspective, and not just your own, has a lot to do with your success in seeking financing.
“C” Is For Creditworthiness, AND…
I have found that it is all too easy for bankers to overlook critical issues that determine the financial health of their borrowers, and whether or not they repay their loans. To make sure none of these critical issues are missed when reviewing a small business loan request, I teach business bankers to remember a simple system of “C” words as they review your data. The “Six C’s of Commercial Credit” include Character, Capacity, Conditions, Capital, Collateral, and Cash Flow.
Not everyone singles out “Cash Flow” as a separate criterion for creditworthiness. But at most banks, it has become such an important part of credit analysis that I feel it deserves extra attention in the banker’s mind… and in the business owner’s mind, as well.
Cash Flow
In the end, “Cash” pays for everything, including debt. Bankers look for strong evidence that the business generates cash with each normal business cycle, sufficient to pay for operations and repay debt. Cash flow means much more than simply making a profit, it means using what is earned appropriately.
Cash flow analysis is a highly technical and sophisticated process, but it is intended to answer basic questions like these:
- How is cash generated by the business, where does it come from? What are the sources of cash?
- Are these sources stable and repeatable? Or am I seeing cash from one-time events?
- How is cash used by the business? Where does it go?
- Are these outflows predictable? Are there major uses of cash in the company’s future that they are not dealing with at the current time?
- Does borrower ownership understand their uses and sources of cash, and take explicit steps to manage them for optimal results? Can I see their efforts to manage cash flow reflected in their financial statements?
- What constraints do industry practices and conditions, and their customer and supplier relationships, put on their ability to manage cash flow?
- Is cash taken out of the business (e.g., owner compensation) at a rate that leaves the business vulnerable to shocks, unable to respond to sudden changes in Conditions?
- Is cash generation sufficient to support ongoing operations? Or is debt a permanent and indispensable feature of their operations?
Answer These Questions Before Asking for Credit
Demonstrating a good understanding of your own Cash Flow, how you generate and use cash in your business, is a powerful contributor to a successful credit discussion with your business banker. Take the time to work through these issues before approaching your bank.
While you may not be in a position to do a complete cash flow analysis, it is worth your time to develop a basic understanding of the inflows and outflows of cash in your operations. A business owner that understands, and even manages, Cash Flow, can give a banker confidence that the necessary resources will be there with it comes time to repay that loan.
Jeff Judy brings a unique perspective to his work with business owners, as they navigate the challenges of working with their banks. Jeff has trained thousands of bankers across the country in how to evaluate the financial health of their business customers. He uses that experience to educate business owners on how bankers think, and to show them how to tell their stories to optimize outcomes from the banking relationship. Visit http://www.JeffJudy.com/businessowners.html.
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