Understanding what banks look for part 2

Seeking finance can be a daunting task, even for the most confident business owner. But, with careful planning and a clear view of what the banks are looking for, the burden of obtaining finance can be greatly reduced.

Put simply, your bank is looking for three things – information, security and experience, and the first place they will look is at your financial statements.

Our three part series looks at the core components of your financial statements from the perspective of a typical bank.   In part one we looked at the balance sheet, now we turn to the profit and loss statement.

Profit and loss statement

Financial institutions will typically want a minimum of the last two to three years’ profit and loss statements.

Whilst strong profits are a good indicator, the bank will often delve deeper into what is behind the profit result.  Firstly, they will look at the fundamentals of the profit and loss statement considering items such as rent and wages relative to business turnover.

Banks often use data on industry benchmarks to assess expenses and overheads relative to comparative businesses.  They will inspect the business’ gross margin, closing stock figures, sales and turnover and compare them to industry standards and comparable businesses.

They will also view whether revenue has been increasing in order to understand if the business has been growing or contracting over the previous few years.  Declining revenues will often require an explanation whilst rapidly increasing turnover will be important to the bank in understanding funding requirements for the business’ growth prospects.

For an owner operated business a financial institution will scrutinise the shareholders’ and/or directors’ full take home pay.  It may be that profit is high but the directors are drawing minimal wages.

Conversely profit may be on the low side but closer inspection reveals that the owners are drawing large wages, salary sacrificing into superannuation and are provided with a number of salary packaging items such as cars etc. In this respect the business may be very profitable but the owners are choosing to draw out the profits.

Typically the bank will look at the EBITD (earnings before interest, tax and depreciation) and add these outgoings to prior years’ profits to determine anticipated cash flow to repay a loan.

Part three of ‘Understanding what Banks look for’ examines the cash flow report.