23 May Inside Your Banker’s Mind
When it comes time to renew your line of credit you might be wondering, what’s my banker thinking?
For bankers, everything about your line of credit is analyzing any changes in risk. The financials tell a story about what happened in the business this past year. But more importantly your banker will ask you the “why” questions to determine if the risk of your line of credit changed positively or negatively in the past year.
Here are the 4 things they’re thinking about:
Profitability-Why did profit go up or down last year? There are 3 moving parts in your income statement: revenue, gross profit and operating expenses. If revenue and profits were up, that’s a good sign. If revenue and profits were down, you’ll likely get questioned about that heavily, especially in a favorable economy where most industries are expanding. If operating expenses are increasing as a percentage of revenues, that’s another area you’ll likely get questioned about.
Liquidity– Banks love to see a lot of cash on the balance sheet. After all, profits don’t pay back loans, cash does. That gives them comfort that there’s another source of repayment for their loans. If you had a profitable year, but cash went down, then you’ll likely get questioned about where that cash is. If you’re growing, then that cash will be sitting in accounts receivable to be collected. If it isn’t there, then your banker will likely ask about how much you pulled out of the company last year.
Asset quality– Your banker will calculate your accounts receivable and inventory turnover. The calculations are revenue/AR balance and COGS/inventory. To come up with number of days outstanding divide both numbers in to 360. If you’re turning either faster or slower, you’ll likely be asked for an AR aging to see if there are any receivables over 90 days outstanding. Also, your banker will ask about any stale inventory that may need to be written off.
Leverage– Your banker cares about how much they’re investing in your business in the form of debt and how you’re investing in the form of shareholder’s equity/net worth. If you’re taking on a majority of the risk, that gives your banker comfort in extending credit. However, if your bank and vendors are taking on a disproportionate share of the risk (greater than 80%), then you may get push back from your banker about leaving more money in the company. A leverage ratio of somewhere between 3 or 4-1 debt to equity is where your bank could start bringing this issue up.