In this guide we try to share with you the process Banks follow and give some practical tips to support you in getting the credit you require.
HOW A BANK LOOKS AT YOUR CREDIT.
All banks have their structure for credit analysis, but you won’t go far wrong if you follow this structure:
- Character of the business
- Ability to repay
- Purpose of loan
- Amount of loan
- Repayment terms
- Character of the business
A bank will conduct an internal and external analysis of your business. Internal analysis looks at:
- Management– Determining how good the management of your business is will go a long way to determining the lending decision.
- Resources and skills– The skills and resources of the people within your company will also be looked at.
- Structure and systems– What are the production skills and capacity of your company?
- Trading activity – A bank will be looking for evidence that your business is reputable and sustainable, and well equipped to cope in a period of economic volatility. You should be prepared to provide management accounts, projections and budgets. Your published accounts, ratings and broker reports will also be analysed.
- Industry outlook and positioning – How is your industry impacted by the economic cycle?
Competition and market – Is there a market for the products your company offers?
- Ability to repay - Banks are now more than ever concerned with a business’ ability to repay the loan.
- How do you intend to finance the repayment?
- How is the loan to be repaid?
When evaluating your business’ accounts, a bank makes an assessment of the borrowing risk. This is achieved using the Gearing Ratio, which measures the proportion of the business’ total capital that is borrowed. It is calculated as follows:
Gearing Ratio =
Your business’ ability to service borrowings is determined by an assessment of its ability to cover interest costs – the Interest Cover Ratio. This measures how many times your business can cover its interest costs from its operating profit (Profit before Tax and Interest) and is calculated as follows:
Interest Cover =
Applying sensitivities to the forecast numbers and performing break-even analysis allows the lender to assess the margin of safety within your business, should turbulent trading conditions arise.
The interest rate on bank borrowings is comprised of a base rate and a risk margin. The risk margin is dependent on the bank’s credit risk assessment and is based on the level of risk in the capital structure and your business’ ability to service the borrowings.
Purpose of loan
Typically, a business borrows for one of the following reasons:
- Funding trading activities (working capital)
- Financing investments in fixed assets (term loans)
- Funding a loss
A responsible lender will also look at whether the purpose of the loan is in the best interest of your business.
Amount of loan
You should carefully consider the required amount, as lenders will assess the following:
• Is it enough or too much for what your business needs?
• Will your business be able to finance the borrowings (Interest Cover)?
• Will your business be able to repay the loan (capital and interest)?
• What is your stake in the overall purpose of the loan? Are you willing to invest in the business yourself?
The term of the loan and repayment structure will be considered. The longer the term, the higher the risk, both for you and the bank.
Most lenders will look for protection against the possibility of your business not repaying the loan. In most cases this will be in the form of security, whether that is property, a letter of comfort or some other form of security.
HOW YOU CAN GET THE CREDIT YOU REQUIRE.
Every lender will have their own credit requirements, but here are some of the practical steps which may help you to get credit:
- Reduce your existing debt– the higher your gearing ratio, the higher your credit risk for a bank.
- Cash is paramount– you will need to show there is sufficient cash cover to service the debt. The bigger your cash buffer, the higher your chances of getting a favourable response from a bank.
- Increase your stake– a bank will look at what you are willing to stake in your business. What is your loan to value? If you are not willing to put your own money into an investment, a bank is unlikely to want to put their money at stake.
- Provide security – A bank will want some comfort that the money they are giving you will be paid back. The more security you provide, the more reassured a bank will be that your business will not default on the repayment.
- Manage your financial records– a bank will want more trended information these days, so make sure you present them with as much historical information on your business’ financial performance as you can. Management records, forecasts, sensitivity analysis and published records going back for three years or more will give a bank much more information to work with to prove your business is sustainable and creditworthy.
- Prepare thoroughly for any discussions with a lender– go through the questions a lender will be asking you for a credit decision and provide as much of the information upfront as possible. Banks have found that businesses who present this information in a well laid-out business plan are in a better position to get a quick credit decision. Banks will need to build up a detailed knowledge of the business, which also serves as a useful platform for understanding its plans and the underlying assumptions behind them.