James knows that at some point, many businesses will need money to accelerate the growth of the business. For most small businesses, there comes a time when the money needed to accelerate the growth of the business exceeds the money coming in from sales. Around this time, the small business is required to borrow in order to reach its growth potential.
When applying for finance, it's in your best interest to make your business as attractive as possible to the lender. This means that you have to share the story of your business with the lender, and you need to make sure that they believe in your vision for where the business is headed.
There are a couple of key things that lenders are looking for when reviewing an application for finance, and understanding this ahead of time can put you in the box seat for creating a strong application.
1. Ensure your financials are up to date
Not having your financial reports up-to-date can make applying for a loan harder than it should be. If you’re a new business, your trading history may not be long enough to prove to a lender that your business will be able to continue generating revenue and safely repay the loan.
Having your financial records up-to-date shows a lender that you're serious about keeping the business on track, and you're using accurate data and reporting to help you paint a clear picture of what's happening. If you haven't updated your financials, you might find that your business' financial records from 18 months ago aren't doing justice to the growth that you've worked so hard to achieve in the meantime. If your accounts are more than two years out of date, you need to book an appointment with your accountant as a matter of priority.
Ideally, the trend across the years is positive or steady, and you should have an explanation ready for any dramatic changes. If there's a good reason why there have been drastic changes or seasonal cycles, prepare your explanation ahead of time so that you're not caught out when the lender asks the question.
2. Tidy up your balance sheet
Most small business owners fully understand what 'Profit and Loss' is, but the Balance Sheet is often neglected.
It's time to change that.
The Balance Sheet and Profit and Loss work together to show the complete financial health of your business. The Balance Sheet is so important because it shows what your business owns and what your business owes.
I often see shareholder loans to the business classified as 'current liabilities', which means that the business expects to pay this back within 12 months. The bank will take all current liabilities into account when assessing the loan, and perhaps this should be reclassified as a non-current liability.
Ask your accountant to review the balance sheet and ensure that things have been correctly classified.
3. Ensure your tax lodgements and payments are up to date
Every request to provide financial information for business finance includes a “12 month summary of the client’s integrated client account with the ATO.”
In case you haven’t heard, the Integrated Client Account is the running tally the ATO keeps of all BAS/IAS lodgements and payments. It shows the bank whether you have:
- Lodged your BAS on time. It shows the date you lodged a BAS.
- Whether you pay your BAS on time. It shows all payments you make and whether you’ve been charged interest by the ATO for being late.
- Whether you have a large outstanding debt with the ATO.
Before you approach the bank, make sure you have lodged all your BAS and your tax returns are up to date.
Note: BAS stands for Business Activity Statement and IAS stands for Instalment Activity Statement
4. Know the Key Performance Indicators the banks are looking for
The lender asks for your financial statements because they can extract an extraordinary amount of information from them.
Banks are looking for profitability and financial stability. They will take out some key numbers, enter them into a spreadsheet (or another system) and it will generate a few key ratios as well as how they compare to their allowable range.
Here's a quick guide to these ratios:
- Gross Profit Margin = Gross Profit / Total Sales
- Net Profit Margin = Profit Before Tax / Total Sales
- Current Ratio = Current Assets / Current Liabilities
- Debt Service Coverage Ratio = Net Operating Income / Total Debt Service
- Total Assets
It’s always helpful to have somebody on your side, such as a relationship manager or a trusted advisor. If you're struggling to find time to cover off on your financials while also running the business, seek out a trusted advisor to help you be proactive on this front.
You may also find it useful to compare your business to the industry through some publically available sources such as the ATO small business benchmarks to see how you stack up.
Alex is the co-founder and CEO of Valiant Finance. He brings a wealth of experience from his time as a banking consultant at McKinsey, and has a background in Business and Law.
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