Understanding the Bank Loan Package
If you’re looking to grow your business—perhaps through expanding a product line, offering a new service, or opening a new branch—you may be considering funding options. Debt funding, through a bank loan, can be advantageous for your business. Bank loans, unlike venture capital funding, allow you to keep full control of your company and offer little interference regarding how the money is used as long as the loan is repaid.
What Does a Bank Loan Package Entail?
Deciding to go the bank financing route, however, is just the first step in the process. A banker will generally ask for a bank loan package to be prepared. A bank page includes financial statements and projections about the company. Essentially, the business must prove that they are credit-worthy. We’ll highlight some common key components of a bank loan package in the following sections.
The balance sheet looks at a company’s financial position at a specific point in time. It can be described by the formula Assets = Liabilities + Equity. This shouldn’t be confused with the income statement; however, if the balance sheet isn’t reconciled, the income statement won’t be accurate.
Balance sheet reconciliation means comparing balances in the general ledger with other documentation. This assures that transactions are accurately recorded to asset, revenue, liability, and expense accounts.
The income statement is synonymous with the profit and loss (P&L) report. The income statement provides insight into a company’s financial performance over a period of time, as opposed to a specific point in time. It takes into account overall income and expenses, cost of goods sold, gross margin, overhead, selling costs, and revenue.
Statement of Cashflows
The statement of cashflows provides data regarding all cash inflows that a business receives from operations, investment, and funding sources. The statement also includes cash outflows that pay for business operations and investments during a specified period. The sum of operations, investments, and financing totals a business’ net cash flow.
This shouldn’t be confused with a cashflow forecast, which tracks and predicts a business’ cash in and cash out.
Personal Financial Statement
A personal financial statement provides a snapshot of the business owner’s financial position at a specific point in time. It generally includes assets, liabilities, and net worth. Banks often will request this information in case of a default as part of the bank loan package.
Audit or Review
Depending on the institution’s requirements, the lender may require either an audit or review of the borrower’s financial statements. If the loan or line of credit amount is high, an audit is more common. An audit provides reasonable assurance of financial plausibility, involves testing transactions, and can be an expensive, tedious process.
Other banks may only require that statements be reviewed rather than audited. A review is less detailed than an audit, as it involves more analytical review work rather than testing transactions and substantiating balances. As such, a review is less expensive than an audit.
What Else Is Required In The Bank Loan Package?
In addition to the components above, a bank may ask for a business credit report, tax returns, relevant legal document, and collateral. Additionally, accounts receivable and inventory information may be required to determine the borrowing base—the amount of money that a lender is willing to loan.
One of the considerations for the borrowing base is 80% of the accounts receivable of a business, although lenders may be wary of concentrated, foreign, or governmental AR. Another consideration for the borrowing base is 50% of the borrower’s inventory. This can present a challenge with valuation, since inventory can change in value and price, or become obsolete altogether.
What About Loan Covenants?
A loan covenant is a clause in the loan agreement that requires the borrower to do certain things, such as maintaining specific financial benchmarks and ratios. A few examples of ratios that a lender may care about include the following:
- Debt Service Coverage Ratio: This is a cashflow measure that reflects a borrower’s ability to fulfill its debt obligations.
- Working Capital Ratio: This ratio is often used to assess a company’s financial performance. IT reveals whether the company has enough short-term assets to pay of its debt.
- Debt to equity ratio: This is used to evaluate a company’s financial leverage. It is a measure of the degree to which a company is financing its operations through debt compared to wholly-owned funds.
The Bottom Line
It’s no secret that bank packages are complex. They require accurate, in-depth financial statements and reporting. Additionally, borrowers may have their loan applications denied due to disorganized financials. This is why bringing in an additional, outsourced service can ensure that the application process runs smoothly. Not only can your business receive the funding it needs, and also gain full visibility into its financial position.