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Two Details Your Lender Is Asking About, and You Should Too

The bank's Female African american Mortgage Officers shake hands with customers to congratulate them after signing a housing investment loan agreement.

There are a lot of words to describe the current economic environment, uncertain is one of them. And while many companies may not be seeking new financing in the near term, there are a number of reasons a business owner and its lender will be having conversations soon if not already – 1) a renewal of an existing loan 2) terms were modified as a result of COVID-19 impact 3) quarterly or annual covenant or other performance requirements.

There are consistent themes emerging with lenders, so it is best to be prepared for the questions being asked, but it is just as critical in managing the business itself. While an overall assessment of the business is always key, there are two key lines of questioning where visibility is essential – monthly trending and liquidity.

Monthly Trends

The Lender

The value of timely, reliable monthly data is never more critical than in times of significant disruption. Lenders are diving in deep and scrutinizing monthly trends to understand what the impact of COVID-19 had on their customers. Results from one month to the next can provide key data that could lessen cause for concern from a lending perspective. They are not assuming just because numbers were great prior, that this will revert automatically. They are looking to see an upward trend after the economy has begun to re-open, and that the short-term trends can be explained by what is going on in the business.

Isolating the noise is essential as well. Lenders are partnering with their customers in a very active way, but they are still very mindful of risk. You may be in an industry with a gloomy near-term outlook, yet your business could be an outlier in a positive way. Disruption could create an opportunity to gain market share or purchase failing competitors for pennies. Being able to present a picture to the lender that demonstrates this strength could not only make the lender feel more comfortable, it could even result in additional financing if needed, being easier to obtain.

Lenders are asking questions around this to manage their risk and assess how much debt the company can support.

The Business Owner

For business owners, this detailed look at trends is crucial to make decisions. So first and foremost, every reasonable effort needs to be made to ensure that timely, accurate monthly data is available.

Do the trends make sense? Did payroll come back and not revenue as expected or was there any expected lag and revenue came back a month later. Are margins doing what they should be? The worst thing that can happen is to not have explanations for movement in numbers. With the world changing so quickly, having information to make quick, informed decisions is paramount. And this means your financials need to be accurate enough to form reasonable conclusions.

What is your business telling you versus the headlines? While lenders want to peer through the noise from a risk perspective, you want the same clarity to identify signs of an opportunity or challenges. Do the trends show that customers are buying where it may make sense to add more payroll? Or are results not yet there sustainably and cash needs to be conserved for another month or two. And just because the industry overall or even competitors are moving one way, your business may be telling you something different through its performance.

Liquidity

The Lender

The other key area lenders are seeking clarity on is liquidity. What is the company’s cash position now and in the future? For a lender, this is simple – can my borrower repay the loan they have? And one step further – can they do so today, tomorrow and 6 to 12 months from now. Of course the further out a projection goes, by nature, it will be less accurate. However, lenders are absolutely expecting some sort of cash flow forecast out 90 to 180 days and even a full year. Even a solid attempt at this will go a long way in providing confidence to your lender that you are monitoring cash and being proactive.

You are likely to be asked about some of the details behind expected cash flow as well. Are customers paying on time? How much of your payables are deferred save cash in the near term? How does cash change as the market improves?

The Business Owner

Cash is the lifeblood of your business. What does your runway look like? How do you know? What impact does it have for you if a key customer pays late? Do you have enough cash to add staff in 60 days? PPP money is likely spent, what is happening to your cash balances in the future as a result? How much cushion do you have? Businesses that cannot answer these questions are at risk of running out of cash without even knowing it.

Understand your options. Having a cash flow forecast on paper allows a management team to evaluate what happens if a key assumption does move around. If a key customer pays late and creates a $100,000 cash shortfall, what options could you move around to make that up? And remember, cash flow is about timing, so it could be accelerating other receivables, deferring payments to vendors, or waiting to hire until that customer pays its invoice. It is much easier to avoid a car accident when you can see out your car window up ahead and react. Looking forward into your cash flow is no different. And evaluating possible scenarios on paper adds confidence to decision making, even during chaotic times.

The bottom line is that businesses will be asked by a lender to provide this information at some point. By being proactive, you will be prepared, but more importantly, a deep look in these two areas on a regular basis could guide essential decisions that could avoid potential pitfalls, increase profits, and protect the business long term.