How to Borrow from a Bank – How a Bank Manager Assesses Your Case


In an attempt to improve the communication between the bank manager and the small businessman the ways that a case for finance for a business should be pre­sented to the bank. Problems arise in this area mainly as a result of both parties having insufficient knowledge of how each other’s businesses really operate. If this knowledge or communication gap is to be effectively bridged we should discuss the other fac­tor in the equation: how does the bank manager assess the case for finance presented and what criteria does he apply in this appraisal?

It is difficult to give a definitive answer to these questions as, although the bank manager is concerned with factors (which by definition can only pertain to history) the most important factor to be considered is the future trading potential of the business The bank manager, therefore, has to test the assumptions made in the compilation of the future trading plans in such areas as the market potential of the products and profitability levels, etc The conclusions which are drawn will be based on the bank manager’s judgement of the probability of the successful fulfil­ment of the plans. It can be seen, therefore, that the decision to lend or not to lend is not based upon any easy scientific formula. The areas in which judgements are made fall within five main categories, which are outlined below.

 Bank Manager Assesses  Case

Management

This is a vitally important area both in terms of the people and the function. The bank manager will wish to be assured that the management comprises persons of integrity, who are respon­sive to and aware of the need for change and have the appropriate skills in terms of marketing, production, finance and personnel. In addition, he will assess the quality of the management infor­mation and control systems. This includes such areas as budgeting, cash flow forecasting, profit and loss reporting, pur­chasing, costing and pricing. The bank manager’s assessment in this area will be a major influencing factor in his decision whether to lend.

Products

The bank manager will also wish to discuss with the small busi­nessman the nature of the company’s products and their position in the market place generally. The questions which he will ask include:

(a) Is demand for the products declining, static, or rising?

(b) Are the products competitively priced?

(c) Is the quality of the products appropriate in relation to the market that is sought?

(d) What are the implications of any change in product mix on volume and profit?

(e) Are the existing and proposed sales levels well spread in terms of customer mix?

Prospects

In this category, consideration will be given to the influences of technological and environmental change which may affect the future of the business. This will be coupled with an assessment of the availability of the resources necessary for the successful filfilment of the various sales and profit targets of the business. An appraisal will, therefore, be made of the position regarding the supply of raw materials and labour, and of the adequacy of premises, plant and machinery.

The capital base

In general terms the capital base comprises share capital, capital reserves and revenue reserves (the profit and loss account), less any intangible assets such as goodwill. In this article, we can­not outline in detail the position regarding deferred taxation, but, depending upon various factors, this reserve is often in­cluded as part of the capital base of the business.

Having ascertained arithmetically the size of the capital base, a review will then be undertaken of the nature and quality of the asset structure of the business. This is important, as certain assets could either be under- or overvalued, and this would ob­viously affect the size of the capital base. Alternatively, the busi­ness may have a relatively high investment in fixed assets which may affect the working capital position. It is difficult to generalise in the latter area, as any assessment of the asset struc­ture, and indeed of the business itself, must be related to the type of industry in which it operates.

It is usual for bankers to relate the size of the capital base of the business to the level of borrowed money required. This will include both bank facilities and finance available from other sources. This is known as the gearing relationships. As a ‘rule of thumb’, the bank manager will tend to look for not more than a 1:1 relationship between the capital base and the level of bor­rowed monies. However, this should not be seen as a definitive guideline, and in some cases he may wish to see the gearing relationship at a lower level than 1:1. Equally, however, where a business has strong management, good products and a growing market, good budgetary control, and above average profitability levels (both historic and projected) giving adequate interest cover, it would not be unusual to see a gearing relationship somewhat m excess of 1:1 being acceptable.

Working capital surplus

The working capital of the business is ascertained by deducting the current liabilities (creditors and bank overdraft, etc) from the current assets (stock and debtors, etc). An assessment of the nature of the working capital surplus is undertaken by using ratio analysis. This will reflect underlying trends in terms of in­vestment in debtors and stock and the bank manager may well wish to review the controls in these areas. For example:

1. Are the debts being collected at a reasonable rate or are there monies outstanding in excess of the normal terms of trade?

2. Is stock turn satisfactory or is a proportion of the stockholding unsaleable?

This is an important area as the continuing circulation of cur­rent assets is the life-blood of the business. Any check on the circulation will affect the liquidity of the business and thus its ability to survive.

Conclusion

As a result of making an appraisal of the case presented to him in these five equally important categories, the bank manager will be able to assess the degree of risk that the bank runs in lending money to the business. If the risk is considered reason­able, the bank manager will be prepared to lend, though his assessment in this area may occasionally result in security being requested.

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About the Author: Marie Mayle is a contributor to the MegaHowTo team, writer, and entrepreneur based in California USA. She holds a degree in Business Administration. She loves to write about business and finance issues and how to tackle them.

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