I thought you might like to read the presentation a friend of mine gave last May to our local chapter of the American Subcontractors Association. It contained five simple rules for keeping your banker happy.
Tyrone Herbert titled his presentation "What Makes Me Bankable?" Tyrone knows what bankers want to see because, well, Tyrone just happens to be a commercial lender at the First National Bank of Olathe in Olathe, Kansas.
The following is my translation of what he shared. Since Tyrone did not get a chance to review this ahead of time, credit him for the parts you like and blame me for the parts you don't.
RULE No. 1: Assemble a Team of Professionals
Your team needs to have four members, all of whom must be experienced in the construction industry and understand the challenges faced by construction companies. Your team should include:
- A banker
- A lawyer
- An accountant
- An insurance/bond agent
You may remember that not using a professional services team is the tenth biggest mistake contractors make. Select an accountant your banker has faith in. You will see why in the next rule.
RULE No. 2: Accurate and Timely Financial Reporting
- For most privately owned companies, the primary outside user of their financial statements is their bank.
- If you are using off-the-shelf software, make sure it is producing reports according to Generally Accepted Accounting Principles (GAAP).
- Make sure you are presenting the right financial picture to your bank.
Timely reporting is very important to your banker. It signals the reliability of your financial information. Bankers expect your year-end statements to be available by early February. They expect mid-year statements (often quarterly) to be available with 30 days.
Taking longer than 30 days to produce compiled or reviewed financial statements sends up a red flag to your banker and his loan committee.
A quick explanation of Certified Public Accountant (CPA) terminology is probably in order. Accountants use three terms to describe the level of review performed. Those terms are COMPILED, REVIEWED, and AUDITED. Here is a layman's explanation of the terms
COMPILED means the accountant took the information you gave him, coded it, and created a set of financial statements that jive.
REVIEWED means your accountant verified that your debt, income, and expenses were properly presented and align to past statements.
AUDITED means your accountant verified that your debt, income, and expenses were real - that the statements are not based on false information.
Unless you have a horrible credit history or are tying to borrow a huge sum of money, bankers usually ask for REVIEWED year-end statements. They usually ask for COMPILED mid-year statements.
RULE No. 3: Have Healthy Key Financial Ratios
Bankers use financial ratios as their sanity check regarding your business' health. There are three classes of financial ratios.
- Debt-to-Worth. Total liabilities divided by net worth.
- Fixed Assets-to-Net Worth. Net fixed assets divided by net worth.
- Working Capital: Current assets minus current liabilities
- Current Ratio: Current assets divided by current liabilities
- Quick Ratio: Cash and equivalents plus net trade receivables divided by total current liabilities
- Sale-to-Receivables: Net sales divided by trade receivables
- Cost of Sales-to-Inventory: Divide COGS by inventory
- Cost of Sales-to-Payables: Divide COGS by trade payables.
This is the way bankers talk. Strange isn't it? When bankers lend you money they are gambling that you will pay them back. They are far more concerned about getting their money back than they are about the amount of money (interest) they are going to make on your loan.
Bankers use these ratios as a tool for judging the health of your financial situation. They use certain rules of thumb to check your ratios against. If you meet their standards, they are likely to lend you money. If not, don't expect to get that line or loan you need.
If the ratio definitions are not familiar to you, don't feel dumb...and have your CPA explain them to you. Being able to speak the banker's language will help you get the money you want.
RULE No. 4: Have a Vision
You should be able to communicate your vision for your business to your banker.
As Tyrone explained to me, his role as commercial lender is to represent your business to the loan committee. The better the story he has to present, the more likely the loan committee will approve the loan.
Loan committees are usually made up of outsiders who are successful business people. They want to hear a story that projects your business is going to be successful. Without a vision for your business' future, the story is going to ring hollow.
RULE No. 5: Retain Earnings in the Company
- If management chooses to pull all of the earnings out of the company they effectively shift risk to the creditors (bankers).
- The stronger the equity position the lower the leverage.
- Any distributions over and above the implied tax liability is classified as an excessive distribution.
Bankers need to be reassured that you manage your finances wisely and that you have faith in your business. Pulling money out of your business signals that you don't trust the future of your business.
Bankers expect you to pull a fair salary. They also expect you to leave a reasonable amount of net income in the company to weather financial storms.
When there are insufficient assets in the business to cover their loan, they odds of them losing their money grows. That makes them unhappy and puts a frown on their face.
Ron Roberts, The Contractor's Business Coach, teaches contractors how to turn their business into a profit spewing machine. To receive Ron's FREE Contractor Best Practices Newsletter visit www.FilthyRichContractor.com.