Planning to borrow? What lenders want to see from your business

Before asking:

How much will the bank lend us?

There is a better question:

There is a big difference between borrowing to:

• replace a truck
• purchase productive equipment
• fit out another location
• acquire a competitor
• purchase commercial property
• fund stock for a large order
• cover a short-term timing gap
• continually support a business that is losing cash

The loan might technically provide cash in every case.

But the commercial reason behind the borrowing is completely different.

Before applying, be able to explain:

• What are we buying or funding?
• How much do we actually need?
• What will the borrowing allow the business to do?
• How will the repayments be made?
• What happens if the expected benefit takes longer to arrive?

That discussion should happen before choosing the loan product.

If you are asking someone to lend money to your business, they are likely to want reliable information about how the business is performing.

The original lending guidance highlights accurate, up-to-date financials as one of the key ways to make a business easier for lenders to assess. Australian Government guidance similarly notes that lenders may ask for financial reports, cash-flow statements and forecasts as part of a business loan application. (Boma Marketing; business.gov.au)

That can include:

• profit and loss
• balance sheet
• cash-flow information
• tax returns
• BAS
• current debt
• forecasts
• bank information
• other supporting financial records

The exact requirements vary by lender and loan.

But the principle is straightforward:

Your accounts should reflect what is actually happening in the business.

If the financial statements say the business is profitable but the balance sheet contains large unexplained accounts, overdue tax and unreconciled balances, the next conversation becomes harder.

There is a difference between useful current financial information and pretending every business has perfectly real-time accounts.

For a finance application, the information needs to be recent enough to give a reasonable view of the position.

That may mean making sure:

• bank accounts are reconciled
• sales are recorded
• major expenses have been entered
• payroll is current
• debtors and creditors are accurate
• loan balances reconcile
• ATO liabilities are understood
• shareholder or director loan accounts have been reviewed
• unusual transactions have been investigated

If the accounts are several months behind, start there.

Getting the loan is only the first part.

The business then needs to make the repayments.

Australian Government guidance recommends understanding the maximum repayment a business can afford and using cash-flow information to assess whether the business can support the proposed borrowing. (business.gov.au)

This is where a forecast becomes useful.

Suppose a business wants to borrow $500,000 to open another location.

The question is not simply:

Can we make the loan repayment today?

We also need to consider:

• setup costs
• additional wages
• rent
• stock or materials
• marketing
• working capital
• interest
• loan repayments
• tax
• the time it takes for the new location to reach expected sales

The existing business may comfortably support the debt now.

That does not automatically mean it can support the debt and everything else the expansion requires.

One useful exercise is to put the proposed finance into the business forecast before applying.

Ask:

What does cash look like with the repayment included?

Then go further.

What happens if:

• revenue is 10% below forecast?
• the new location opens two months late?
• another employee is needed?
• a major customer pays slowly?
• interest costs are higher than expected?
• the business also needs to fund a large tax payment?

The point is not to create the most pessimistic forecast possible.

It is to understand how much room the business actually has.

A proposed loan does not sit by itself.

The lender — and the business owner — needs to consider the existing commitments of the business.

That might include:

• equipment finance
• vehicle loans
• property debt
• business credit cards
• overdrafts
• existing business loans
• ATO payment arrangements
• shareholder loans
• other finance commitments

Looking only at the repayment on the new loan can make the decision look easier than it really is.

Imagine the proposed facility requires another $8,000 each month.

On its own, that may appear manageable.

But the business may already have:

• $20,000 of monthly finance repayments
• a significant tax liability
• large supplier commitments
• increasing wages
• owner distributions

The question becomes:

How much total financial pressure are we adding to the business?

That is the more useful conversation.

A profitable business can still have difficulty meeting repayments.

Profit and cash are not the same thing.

Cash can become tied up in:

• debtors
• stock
• equipment
• loan principal repayments
• tax
• growth
• owner drawings

That means a lender may want to understand not only whether the business makes money, but how money actually moves through it.

Australian Government guidance describes cash-flow statements as useful for understanding money coming into and leaving the business and for forecasting whether future obligations can be covered. (business.gov.au)

For the owner, that matters just as much as it does for the lender.

A loan approval is not useful if the repayments leave the business permanently short of cash.

If profit and cash tell two different stories in your business, our guide to reading a balance sheet explains where the difference usually sits.

Borrowing too little can create a problem.

Borrowing too much can also create a problem.

Before applying, work through the actual requirement.

For an equipment purchase, that might be fairly straightforward.

For an acquisition or new location, the number may need to include much more than the purchase price.

For example:

You might need to fund:

• fit-out
• bond
• initial rent
• equipment
• recruitment
• wages
• marketing
• initial stock
• professional fees
• working capital

If the fit-out costs $300,000, it does not necessarily follow that the funding requirement is $300,000.

The business might need significantly more cash before the location becomes self-supporting.

That should be modelled before the finance application.

Historical accounts explain where the business has been.

For some borrowing decisions, the forecast is what helps explain where the business is going.

If the borrowing is intended to create additional revenue, capacity or profit, show how.

For example:

“We want to borrow $250,000 for equipment” is less useful on its own than understanding:

• what the equipment does
• what capacity it adds
• what additional revenue may result
• whether new staff are required
• the expected gross margin
• the cash required
• the repayment
• the expected financial position afterwards

The forecast should not be built simply to produce the answer needed for the loan.

It should reflect the assumptions the owners actually believe are reasonable.

A lender is not only interested in annual profit.

The balance sheet can help show:

• cash
• debtors
• stock
• assets
• existing loans
• tax liabilities
• supplier balances
• owner loans
• equity

Two businesses making $500,000 profit can have very different financial positions.

One might have:

• $700,000 cash
• low debt
• current tax liabilities
• customers paying quickly

The other might have:

• $80,000 cash
• $1.5 million of debt
• $400,000 owing from customers
• $250,000 owing to the ATO

The profit number may be identical.

The capacity to take on additional debt may not be.

An ATO liability does not automatically mean finance is impossible.

But it should be understood.

If the business owes tax, know:

• how much
• what the liability relates to
• whether lodgements are current
• whether a payment arrangement exists
• whether the business is complying with it
• what cash is required going forward

Do not prepare a borrowing forecast that ignores the tax already sitting on the balance sheet.

It is still a commitment of the business.

If tax debt is part of the picture, our taxation work can help you understand the position before a lender asks about it.

Credit history can also affect borrowing.

Moneysmart explains that lenders use credit information when assessing whether to provide credit, and a higher credit score generally indicates a lower perceived level of credit risk. Factors recorded in credit reports can include existing credit products, applications and repayment history. (Moneysmart)

Before a significant finance application, it can be worth understanding what is on your credit report.

Look for:

• incorrect information
• old facilities that should have been closed
• missed repayments
• defaults
• multiple recent credit enquiries
• unusually high credit limits

Do not fall for businesses promising that they can simply “repair” legitimate negative credit information. Moneysmart specifically cautions that paying a credit-repair company may not improve your credit score. (Moneysmart)

If there is an error, deal with the error.

If there is a genuine repayment issue, understand it and address the underlying problem.

A lender may ask why something changed.

That is normal.

For example:

Why did profit fall last year?

Perhaps the business deliberately hired ahead of growth.

Why have debtors increased?

Perhaps a major customer changed payment terms.

Why is there a large director loan account?

That needs to be understood.

Why did revenue increase 40% but cash decline?

Perhaps growth required additional stock and working capital.

A change in the numbers is not automatically a problem.

An unexplained change can be.

The owners should understand their own financial statements well enough to explain what has happened.

Comparing the numbers against the prior year — and against businesses like yours — is often where those explanations start. See our guide to business and financial benchmarking.

Australian Government guidance notes that business-loan documentation varies, but a lender may request items including business plans, financial reports, cash-flow statements, financial forecasts, lease agreements and personal financial information. (business.gov.au)

Depending on the finance and lender, your application pack may therefore include:

• recent financial statements
• current management accounts
• business tax returns
• BAS
• cash-flow forecast
• profit forecast
• existing finance details
• purpose of the proposed borrowing
• asset purchase or sale documentation
• lease information
• personal financial information where required
• details of proposed security or guarantees

Do not send a pile of reports without understanding what they say.

A good finance application should tell a coherent story.

Depending on the finance, a lender may ask for security or a guarantee.

Australian Government guidance recommends understanding what assets may be offered as collateral and who may be required to guarantee a business loan before applying. (business.gov.au)

This deserves attention.

If an owner or director is being asked to provide a personal guarantee or offer personal assets as security, understand the implications before signing.

Accounting advice, finance advice and legal advice may all have a role depending on the arrangement.

Do not treat the security documentation as paperwork to sign after the “real” loan decision has already been made.

The original article notes that business funding can come from traditional banks as well as alternative or non-bank lenders. Australian Government guidance similarly recommends comparing loan products and considering both banks and non-bank lenders. (Boma Marketing; business.gov.au)

Different facilities can have different:

• interest rates
• fees
• security requirements
• repayment structures
• loan terms
• flexibility
• application criteria

The cheapest headline interest rate is not automatically the best finance arrangement.

Consider the overall terms and what the facility needs to achieve.

Where lending advice or credit assistance is required, work with an appropriately licensed finance professional.

Finance discussions are generally easier when the business has time to prepare.

Waiting until cash is almost exhausted can reduce the options available.

If you know that in the next 6–12 months you may:

• purchase equipment
• open another location
• acquire a business
• buy commercial property
• undertake a major fit-out
• increase working capital

start looking at the numbers earlier.

That gives you time to:

• clean up the accounts
• prepare forecasts
• understand debt capacity
• review cash
• deal with outstanding issues
• speak with lenders or brokers
• decide whether borrowing makes commercial sense

The finance application should be one of the final steps.

The decision about whether the business should borrow comes first.

Imagine a business wants to purchase $600,000 of new equipment.

The owners expect the equipment to increase capacity and reduce subcontractor costs.

Before looking for finance, we would want to understand:

• current revenue and profit
• current cash
• existing debt
• tax liabilities
• expected equipment deposit
• proposed repayment
• interest cost
• expected savings
• additional revenue
• maintenance and running costs
• whether additional staff are needed
• what happens if the additional work takes longer to arrive

The question is not simply:

Can we get $600,000?

It is:

That is what should be worked out first.

A useful pre-application review would cover:

• Financial records — are the accounts current and reliable?
• Profitability — is the business making enough money to support the proposed debt?
• Cash flow — can the business meet the repayments while continuing to pay everything else?
• Existing debt — what is already being repaid?
• Tax — are liabilities understood and lodgements current?
• Forecast — what does the business look like after the borrowing?
• Purpose — can we explain clearly what the money is for?
• Amount — are we borrowing enough to fund the entire decision, rather than just one part of it?
• Credit — are there credit-report issues that need attention?
• Security — what guarantees or assets may be required?

If those areas are understood, you are in a much better position to have the finance conversation.

The goal is not simply to make the business look good enough to a lender.

The goal is to make sure the borrowing itself makes sense.

Finance can give a business:

• capacity
• equipment
• property
• working capital
• the ability to acquire something it could not otherwise purchase

It also creates a commitment.

Before adding that commitment, understand what the business looks like afterwards.

If you are considering a significant business loan, acquisition, equipment purchase or expansion, speak with us before the application is submitted.

We can help work through the current financial position, cash flow and forecast so you understand what the business can reasonably support.

Where you need lending or credit advice, we can then work alongside the appropriate finance professional.

Talk to our team before making the next major financial commitment.