By SueCanyon | August 14, 2007
Lately, I’ve been getting many questions about what to put in a loan package. It seems as if the Small Business Administration once again has a great deal of money right now to back loans to small businesses, so there are many banks pushing their loan programs. So, even though there is a great deal more information on the subject of getting loans in my Profit Power Action Pack Series, I thought I would touch on some important factors now.There are three things you must know about getting loans.
1) Banks don’t want to know WHAT you do — they want to know that YOU know what you’re doing.
Read that again. They don’t want to know what you do, but to know that you know what you’re doing.
The only way they have to gauge whether or not you know what you’re doing is if your income statement and balance sheet are correct. Imagine sitting before an applicant for employment in your facility. Now, imagine saying to the nice young man, “Now, go home and get a haircut and come back and we’ll see if we want to hire you.” You would never do that, would you?
Now, imagine sitting before a loan officer who says, “Go home and put together a business plan and we’ll see what we can do.” This is their way of saying, “No” without actually having to say it. What they’re betting on is that you will give up on the idea because if you can’t get your books straight, how could you possibly put a decent bank presentation together?
So, the first thing you must do is get your chart of accounts straight, and entries booked in the right places. I cover this in great detail in the Action Pack.
2) They want to see three years’ tax returns and financial statements.
That means you will have to be in business for three years before you can get a loan. It also means that your tax returns must match your financial statements. A set of books that doesn’t match your tax returns makes bankers believe one of more of the following about your business.
First, the taxes are on the cash basis, while the books are on the accrual basis. It is possible to navigate this situation with a knowledgeable banker, but the figures must correlate somehow. If your tax accountant did his or her work properly, they should have a spreadsheet that you can include that would correlate the two. Without this correlation, you probably fit into the second or third situations, described below.
QuickBooks has the ability to run reports on either basis at any point in time, so even if you normally run on the accrual basis, you can get reports on the cash basis. The reverse is not so true. In other systems, it may be difficult or impossible to jump from one to the other.
Second, it may mean that your tax accountant has not given you the correct entries to adjust the books from one tax period to the next. This makes it appear that you aren’t willing to spend the money that should be spent on accounting … so… it is natural for the bank to assume that maybe you don’t have as much profit as the books show.
Third, your ‘bookkeeper’ doesn’t know how to keep books. This makes it appear that your tax accountant has not spent enough time teaching your bookkeeper how to make proper entries, or simply ignores the entries, and takes your raw data back to his office to create his own set of books for tax purposes. Most accountants are not in the business of teaching accounting, and in this case, you are wasting your money with the bookkeeper you have.
3) You must have been profitable for all three years, but more to the point, profitable enough that you can show that there is enough extra cash generated to make the payments.
They are trying to determine, “Does the business generate cash flow?” There are two important things to consider when looking at cash flow.
We must assume that you are profitable. (If that’s not the case, then you need the Profit Power Action Pack Series to get you there.) So, first, perform these calculations. Add up all the monthly loan payments you currently make for vehicles, equipment, your building if you are not renting, etc. Add to it the loan payment you will need to make for the loan you are applying for. Now multiply that total by twelve. Then add the depreciation back into your profit figures, because depreciation is a non-cash item. Do your three years of income statements reflect that you have made enough profit each of those years to cover the payments?
For example: Your profit plus depreciation for the last three years was $20,000, $22,000, and $30,000. Your payments add up to $8,500 per month, and you want to borrow another $150,000 to expand your business. At 9% for five years, this would require a payment of $3,113 per month. So, your total payments for a year would be $139,356! You can see that being profitable doesn’t always mean that you’re doing well. In fact, you’re currently in a negative cash flow position by over $72,000 even without the loan!
Now, maybe that $150,000 will allow you to bring in another $1 million in revenue, at $200,000 in profit. But remember, they don’t care what you’re doing, they want to know if you know what you’re doing, and only past history will give them that warm and fuzzy feeling that you can truly manage your business toward earning that $200,000 in profit.
The second thing to consider is that your tax accountant may have convinced you, or you are an owner who has decided on your own, that you should make as little profit as possible in order to avoid taxes. Perhaps many of your personal expenses have been put through your company that might pass an audit, but don’t really have to do with your business.
I don’t like paying taxes any more than you do, but to make your business look less than it really is, does yourself a disservice. There are those who are running a business and those who have purchased a job. This is one of the distinctions between those two. If your strategic plan requires you to be able to use other people’s money to grow the business, then you must plan to make profit and to pay taxes. If you just want a job a go to each day regardless of what happens to you, that will be worthless at the end of your working days, then by all means, stick to your strategy of paying as few taxes as possible.
Low profits means low retained earnings, which means low equity when you get ready to sell the business and retire. The choice is up to you.
The preponderance of the low-profit-thinking out there is what is causing the banks to have so much money to lend… they can’t find people who will qualify to borrow it. I am among a great many successful employers who are of the opinion that we should pay as little tax as possible, on as much profit as we can.
So, to recap, make sure your bookkeeper understands bookkeeping. Make sure your books conform to generally accepted accounting principles (GAAP) before you send them to the bank. Make sure they match your tax returns. Make enough profit to cover all of your loan payments, taxes, and then some. Write a strategic plan that encompasses all of your wants and needs for several years out. Stick to the plan, and when you’re ready your banker will likely give you the loan you request because he will know that you know what you’re doing.
To your success!
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