In the last quarter of 1987, a company in, let's say, the framus business had the best quarter in its history.
Sales were up by more than 20 percent and, more importantly, the company was highly profitable. Management's forecast of framus sales for the first quarter of 1988 was very optimistic.While January was a little soft, February came back strong and March looked like it would be gangbusters. Imagine management's shock when the company's bank would not increase its line of credit.
The company needed the increased line of credit to support its higher level of sales. The time between the purchase of raw materials and the shipment of goods - when the receivable could be expected to be collected - was only about 120 days.
The bank should be thrilled, management surmised. After all, the money borrowed to pay for raw materials, labor and overhead during those 120 days benefitted both the company and the bank.
So why would a rational banker - who also is anxious to make a dollar - refuse to lend more money?
There is a very good reason. The banker is in the business of assessing risk. If such judgments are correct, the bank makes money and so does the banker. If too many loans become uncollectible, the bank loses money and the bankers involved had best update their resumes.
If the loan is not made, the banker need not worry about its collectibility. It always is safer not to make a risky loan.
On the other hand, any banker who fails to make a loan to a company that eventually succeeds, in spite of being turned down, loses money. No banker consciously wants to lose money.
The idea, then, is to understand how the lender decides whether the company can reasonably expect to succeed.
Before going to the bank with a loan request, it is important to understand the factors that influence bankers when they make credit decisions. The banker will look at the company's management, history, industry and current and expected financial positions.
The most important aspect is management - its members' credibility, ability to manage and ability to deal with change.
The lender wants comfort that the financial forecasts prepared by management are achievable and not overly optimistic (forecasts rarely are pessimistic). A history of unattained goals does not bode well.
A company's history implies longevity. The longer a company has survived, the longer it is likely to survive.
The survival rate for American companies is not good. Nearly 80 percent of all new companies fail before they are five years old. Nearly half do not last for two years. Bankers generally do not fund start-up companies, investors do.
The company's business is important, too. Some banks like the framus industry because they have some expertise in it, while others do not understand it and, therefore, do not include such companies in their portfolios.
Current financial position will show whether the company is financially sound and whether the bank should view itself as a lender or investor. A company can show equity generated either from earnings or investors, and hopefully both.
Our framus company did not consider all of this when it went to the bank. Many prior forecasts had been missed by a wide margin. Therefore, the bank did not have a lot of confidence in the next projection.
A good quarter, or even a good year, does not ensure long-term success. The presentation of the quarter was made orally; the full-year statements actually showed a loss.
What could management have done? It could have:
- Prepared quarter-only financial statements that compared the current quarter to the comparable prior-year quarter.- Prepared financial statements through February and the latest 12 months, which would have reflected a profit.
- Presented a statement of assumptions that reflected management changes in reaction to the marketplace and restored the lender's confidence in management.
Remember, the format of the presentation is as important as the content. Don't get caught like the framus company did - so busy trying to get the next sale that it did not pay attention to the adequacy of its financing until it was too late.
Scott Pickett is with Emerging Business Services, Coopers & Lybrand.