Knowledge is one thing, insightful knowledge is different game ball game

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Introduction
As an entrepreneur you think and see the business world differently. You see reward where
others see massive risks. You see opportunity where others see the potential for failure. You see
banks as resources for capital where others see frustration and risk avoidance. This primer is
designed to help you take the mystery out of lending and to some degree business financial
management. It will allow you to think strategically and eliminate some of the hassles associated
with borrowing money and managing your banking relationship.
Greg Washington

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Fact: Most business loan requests are denied before they get to a banker’s desk!
The Land of Denial
The usual suspects for loans being denied are as follows:
 Insufficient collateral
 Insufficient cash flow
 Management inexperience
 Industry risks
 Personal credit of business owners
Your loan request can also be delayed because of miscommunication between you, your banker,
your accountant and financial advisor. This is what I call “credit choke points” because they
effectively choke off the flow of information between the credit decision makers (your banker)
and you. This is also known as “volleyball banking” because information is lobbed back and
forth without any real progress. You must be aware of how your bank processes loan requests. If
you submit a complete loan proposal, your bank should be able to process it relatively quickly.
Credit Choke Points
Outdated or
inaccurate
financial
info.
statements
Accountant
has not yet
prepared
data
Borrower
not specific
in credit
request
Organizational
Changes
cause
changes
Bank credit
policies and
procedures:
Experience
level of
banker

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II. How to Avoid the Land of Denial
During my career in banking, particularly in commercial lending, I developed a feel for business
owners who didn’t have a financial strategy. It can be summed up by their failure to answer what
I call, The Final Four, which are the following questions:
 Is your business ready to borrow?
 How much do you need to borrow?
 How are you going to use the money?
 How are you going to pay it back?
Once you began to formulate a strategy prior to going to your bank, you will understand that
there is nothing magical or mystical about borrowing money. So where do you begin in your
capital quest? You can start by answering the Final Four questions above and also the following
questions that tell you if you’re ready to borrow
Are You Ready to Borrow?
The questions below are designed to help make an assessment of how ready you are to borrow
1. How frequently do you review your business’s financial statements?
____ yearly
____ quarterly
____ monthly
2. Did you file an extension for your corporate taxes last year?
____ yes
____ no
3. Does your banker and/or CPA annually review your business’s financial condition?
____ yes
____ no
4. Have you completed a personal financial statement?
____ yes
____ no
5. Do you access your bank account information online?
____ yes
____ no

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If your answers to the majority of these questions are “yes” then you are an offensive borrower
who’s on the way to securing a loan. If most of your answers are “no” then you are a defensive
borrower who needs to make adjustments. You always want to be an offensive borrower or move
in that direction.
A borrower on the offensive:
 prepares quarterly financial statements;
 establishes banking relationships prior to needing financing;
 files corporate and business tax returns in a timely manner;
 understands his or her business’s strengths and weaknesses; and
 prepares compiled accrual-based statements.
A borrower on the defensive:
 uses tax returns in lieu of compiled financial statements;
 consistently files tax returns late;
 is frequently in financial crisis; and
 is unfamiliar with his or her business’s critical financial issues.
What type of loan do I need?
You can’t get what you want if you don’t know what you need. Before you go to the bank know
what type of loan your business requires. Your loan may fall into either or the two types of
business loans:
Short-term borrowings are usually lines of credit. The bank disburses funds through a line of
credit on an as needed basis up to a predetermined limit. The borrower may borrow and repay
repeatedly up to the limit within an approved time frame (usually one year). A borrower can use
a short-term loan for purposes such as financing a seasonal buildup in accounts receivables or
inventory. The bank will expect this type of loan to be repaid after its purpose has been served.
Short-term loans are generally repaid in less than a year from the liquidation of the current assets
that are financed (e.g., receivables and inventory).
Long-term borrowings are usually represented by a formal agreement to provide funds for more
than one year. Most loans of this type are designated for an improvement that will benefit the
business and increase earnings (e.g., the purchase of a new building that will increase capacity or
a machine that will make the manufacturing process more efficient and less costly). Long-term
loans are usually repaid from profits over a period of years and are used to support long-term
assets such as buildings, machinery and equipment, furniture and fixtures, vehicles, and building
improvements.
Your firm may need both short and long term capital. Once you have determined how you will
use the funds, you will be able to identify the appropriate type of loan for your business. The
Sources and Uses of Capital Statement presented below illustrates this process.

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Source of Funds Amount Use of Funds Amount
Bank
Owner
$215,000
$60,00
Leasehold Improvements
Information System
Line of Credit – Bank
Owner
$150,000
$25,000
$40,000
$60,000
Total $275,000 $ 275,000
III. How Banks Review Loan Requests
Banks are in the business of assessing and managing risk. A loan request represents risk.
Banks must be correct at least 98.9 percent of the time when they loan money to businesses. The
losses associated with loans gone bad can be significant. A business closes its doors, jobs are
lost, and the owner may suffer significant and irreparable financial and emotional loss. Typically,
when a loan loss occurs, 9-10 new and profitable loans must be created to offset the loss.
Bankers realize that their clients’ time is not exclusively devoted to pouring over financial
statements and analyzing business finances. This is why banks need to obtain as much
information about borrowers as possible. It is impossible to assess risk without useful financial
information, such as business financial statements, personal financial statements, personal tax
returns, business tax returns, and related documents.
In order to determine risk, banks review loan requests in the following three ways:
 Automated Review. Banks use this type of review for loan requests
typically less than $100,000. Banks generally require borrowers to submit
a one-page loan application. They also may request personal and/or
business tax returns and a personal credit report. This type of lending
request is usually processed within 24 to 72 hours. Banks typically charge
an annual fee for the use of the loan. A borrower may renew this type of
loan every year by submitting business and personal tax returns and an
updated credit report (obtained by your bank).

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 Centralized Review. Banks use this type of review for loan requests
typically between $100,000 and $250,000. (Note: these amounts vary by
bank.) Banks applying this level of review generally require the past two
year’s business and personal tax returns, a personal financial statement
from anyone who owns more than 20 percent of the business, and interim
business financial statements no more than 90 days old (this may include a
profit and loss statement, balance sheet, and an aging of accounts
receivables and accounts payables.)
 Judgmental Review. Banks use this type of loan review for loan requests
in excess of a certain dollar amount, usually greater than $250,000. This
type of review requires borrowers to provide information similar to that
required under centralized review. However, it may be prudent for the
owner to have accrual-based financial statements for two or three years.
Loans of this size are generally assigned to a commercial banker who
manages and monitors the relationship more closely. Companies
borrowing at this level may have other needs such as cash management
and/or investments that are handled by a commercial lender.
Under centralized and judgmental review, the bank may assign a credit analyst/underwriter to
review your information. The bank will make its decision based on its own internal credit criteria
and render a decision to the borrower. Although banks underwrite credit differently, they all
make credit decisions based on the information noted above. Additionally, you may be required
to submit the following information as well:
Amount of Loan Information Required
 Completed loan application
 Most recent personal and/or business
tax returns
 Past two years business and personal tax returns (or
business financial statements)
 Most recent business financials (no less than 90 days old)
 Most recent agings of accounts receivables and payables
 Completed personal financial statements
 Completed loan application
 Supporting documents as defined by bank (articles of
incorporation, insurance certificates, bank account
statements, appraisals and environmental reports)

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Eventually, an officer of the bank has to sign-off on every loan request. Banks will use the
following procedures to make decisions on loan approvals under the centralized or judgmental
review methods:
 Credit Committee. A loan officer presents your loan request and business
information to his or her peers and senior lenders for discussion and a
decision to approve, decline, or adjust your request is made. Your original
lending officer will inform you of the final decision.
 Multiple Signature Approvals. The decision to approve, decline, or
approve with modifications, will be made by several officers. Two to four
bank officers will review, comment and/or sign off on your loan request.
Your original lending officer will inform you of the bank’s decision.
Once an approval is granted, you may receive a proposal letter outlining the conditions under
which the bank will lend you the money. Note that a proposal is not a commitment to lend.
Money will only change hands when you have satisfied the conditions indicated in the proposal
letter.
V. Personal Financial Information
Your business is legally structured to shield you from personal liability. However, in many cases,
your personal financial condition impacts your ability to borrow. Personal financial information
plays a critical role in the approval of your loan. This is true for the vast majority of privately-
owned firms. Personal credit scores and personal financial statements also impact lending
decisions. There are exceptions, of course, but generally, an individual who owns more than 20
percent of a business will be asked to submit a personal financial statement and a personal credit
report will be obtained. The following factors of your personal financial life will impact the
bank’s loan decision:
 Your personal credit history/credit score
 The quality of your personal financial assets
 The level of your personal financial liabilities
Credit Score A credit score less than 700 may be a problem.
Know your credit score beforehand.
Personal Assets Quality counts: cash, stocks, bonds and homes
are best. Personal property (e.g., cars, jewelry)
has little value.
Personal Liabilities Less debt is best; reduce unsecured loans, (e.g.,
credit cards).
If you have a solid credit score, minimal liabilities, and high quality personal assets, you are in a
good personal financial position. The best way to exclude your personal financial life from your
business life is to build a strong financial foundation for your business.

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An exceptionally strong business has the following attributes:
 Superior management
 Superior business net worth
 Strong sales trends
 Strong gross margins
 Strong cash flow
 Strong profits and business assets with solid market value
Only your banker will be able to tell you if your firm is strong enough to forego a personal
guaranty.
VI. Business Financial Statements
You get only one chance to make a good first impression. Your financial statements are your
business’s calling card in the banking community. If you manage your business through
monthly bank statements and year-end cash-based tax returns, you weaken your chances of
borrowing. Tax returns can be used to make a loan decision based on the dollar amount of the
loan and the method that the bank uses to review loan requests. However, tax returns are cash-
based and reveal only a limited amount of information about a company’s financial condition.
Accrual-based statements present a more complete picture of a business’s financial status.
Bankers speak the language of accrual accounting. If you provide the bank with accrual-based
financial statements you are ahead of the game. Below are examples of a both cash-based and
accrual-based balance sheets.
Cash-Based Balance Sheet
Current Assets Current Liabilities
Cash $ 25000 Mortgages, notes, bonds
payable < 1 year
$ 18105
Other Current Assets 12300 Other Current Liabilities 7896
Buildings & Other Depreciable Assets 135000 Loans from shareholder 17350
Other Assets 12685 Mortgages, notes, bonds
payable > 1 year
115368
Capital Stock 1000
Additional Paid in Capital 15628
Retained Earnings $9638
Total Assets $184,985
Total Liabilities and
Shareholders Equity $184,985
Cash-based financial statements give you a picture of profits but do not show you total cash
flow. They provide only a limited perspective of the business’s financial condition. Tax returns
will show a cash-based balance sheet.

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Accrual-Based Balance Sheet
Current Assets Current Liabilities
Cash $ 25897 Deferred Income $ 18105
Accounts Receivable 135698 Accounts Payables 27896
Inventory 38598 Notes Payable – Bank 17350
Prepaid financing fee, net 12685 Accrued Wages 5368
Total Current Assets $212,878 Total Current Liabilities $68,719
Long-term Assets Long-term Liabilities
Property & Equipment Long-term debt - Bank 118935
Transportation Equipment 119878 (less current maturities) (19638)
Leasehold Improvements 15987 Net long-term debt $99,297
Office Equipment 11895
(less accumulated depreciation) (115089) Shareholders Equity
Net Property and Equipment $32,671 Common stock 1000
Retained Earnings 76533
Total Equity 77533
Total Assets $245,549
Total Liabilities and
Shareholders Equity $245,549
Accrual-based statements give you a total picture of a business’s financial condition and show:
 the amount of money you owe to suppliers (accounts payables)
 the amount of money customers owe you (accounts. receivables)
 the cost of fixed assets such as office equipment, vehicles, land, and
buildings
 the amount of money invested in a business (owner’s equity, loans from
the owner to the business)
 the amount of money withdrawn from a company (e.g., dividends and
distributions)
 the amount of taxes owed but not yet paid (e.g., sales taxes and payroll
taxes)
 the wages earned but not yet paid to owners and employees
 the amount of money owed but not yet paid to creditors
Most bankers rely on accrual-based financial statements to make significant lending decisions.
compiled basis. A good accountant will be familiar with the types of accounting methods (see the
table below) and financial statement options that provide the best advantage for your business.

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Accounting Methods What It Does Pros Cons
Cash Basis
Revenue is recorded
only when cash is
received and expenses
are recorded only
when cash is paid
Easy to do Does not recognize timing
differences or income
recognition and expenses
accrued; ignores matching
principle, Non-GAAP
Accrual
Provides the most
complete and
comprehensive
information of a firm’s
financial activities
Bankers and
investors can
rely on this
information to
legitimately
assess financial
(credit) risks
Quality of statements are a
function of accurate
information passed on to
accountant
The type of accounting statement that a business uses is dependent upon the accounting method
the business uses. The table below identifies the available types of accounting statements.
Types of Statement What It Does Pros
Compiled Reports information
taken from the books of
clients taken as accurate
and factual;
compilations are used
by bankers and
creditors
Accrual-based statements
Financial and credit risks can be legitimately analyzed
Reviewed Reports financial
information with a
degree of diligence
absent from compiled
statements; CPA
assesses firm more
thoroughly and
statements are more
detailed and precise
than compiled; prior
year analysis of
numbers
Accrual-based statements
Quality of information is enhanced by analytical tests by
accountant
Viewed as stronger than compiled and provides more
notes and diligence
Audited Reports information in
the most exhaustive,
comprehensive, refined,
and complete manner
possible
Accrual-based statements
Assumed to be the most superior means of
communicating financial information to the market

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Talk with your accountant and banker to determine the accounting method and type of financial
statement best suited for your business objectives. You may find it difficult to reveal your firm’s
financial condition to a bank but its’ a part of financial due diligence. This is the point where
your financial interests may clash with the expectations of the bank you’ve chosen. The various
scenarios in which these separate interests typically clash with banks are described as follows:
 Scenario 1: Your desire to manage your tax liabilities by reducing your
firm’s profits may result in an unfavorable credit decision by the financing
source. Banks do not finance companies that generate small profits, losses
and demonstrate marginal net worth. Profits and solvency show an ability
to repay a debt obligation.
 Scenario 2: Your business is growing fast causing its expenses to outpace
its profits. Losses during a growth phase are not uncommon. To avoid this
pitfall, you must manage your business’s growth. If you fail to do so, your
financing options will be limited.
 Scenario 3: Your business is experiencing financial hardship. Sales are
declining, cash inflows are significantly behind cash outflows. Banks
rarely lend in this scenario. Once your business gets financially stronger
and obtains stability, you can pursue a more traditional lending
relationship with a bank.
 Scenario 4: Your business is doing fine and growing, but you need to
know how to borrow money to finance that growth. You need to know
how much to borrow, whether to lease or buy, and how to determine the
best payback method. Additionally, you want to ensure that you do not
severely impact cash flow, the balance sheet, or the income statement.
Depending on which scenario your business is in, then you can make decisions about your
financial management style and how to position your business to secure capital. The financial
market place for small business owners pursuing capital is quite crowded so you must choose
your banking source wisely. Additionally, you can conduct an interview with potential financial
suitors and ask them the following questions:
 How does the bank approve a loan request?
 How do you currently renew existing loans?
 Who are the key decision makers for loan approval?
 How long will it take you to approve my loan?
 How have any organizational changes impacted your approval process?
These questions will further refine your financial strategy as you pursue capital.

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Conclusion
Borrowing money is not an easy task. But with some diligence and guidance it’s not as difficult
as you might think. Your firm may be at a stage in its life cycle where one of the above scenarios
applies due to industry factors, the general economy, or inadequate business funding. Analyze
the issues that drive your business’s profitability and solvency and obtain quality financial
information. This is critical to your success as your business grows and requires more capital to
expand. If you have any questions regarding this information please reach out to me on Linked-
in or at gwashington11994@kellogg.northwestern.edu