Short Term Loans and Lines of Credit Disadvantaged Business Enterprise (DBE) Supportive Services Program The contents of this training course reflect the views of the author who is responsible for the facts and accuracy of the data presented herein. The contents do not necessarily reflect the official views or policies of the State of California or the Federal Highway Administration. This course outline does not constitute a standard, specification, or regulation. Business Credit Preparation Financial Documents Lenders Evaluating Loan Applicants Business Credit Cards Business Loans Letters of Credit Business Leasing Account Receivable Financing Inventory Financing Agenda 2 Business Credit What is Business Credit Financial Instruments Exchange Transactions Promise to repay at some later date Leveraging Business Credit Establish and maintain good credit history. 3 1
Business Credit Leveraging Business Credit Companies, banks and other lenders may examine your business credit to determine your creditworthiness Once vendors or lenders do extend you credit, it s critical that your payments are prompt. Vendor payment reports are one of the best ways a business can improve its credit history. 4 Preparation Obtain and Review Personal and Business Credit Reports and correct any errors on it There are three credit reporting agencies: Experian, TransUnion and Equifax. Check all three A copy of your credit report is available from all three credit reporting agencies at no charge, once per year, per individual at www.annualcreditreport.com 5 Preparation Business Licenses & permits: Depending on your city and state, you may be required to have certain business licenses and permits. Opening a business checking account is an important first step toward separating your personal credit from your business credit profile. Look for lower minimum balance requirements and lower transaction costs when evaluating a business checking account agreement. 6 2
Preparation Once you have established a credit rating for your business, you must also monitor it for accuracy. Check your credit report quarterly to ensure that it contains no errors. If you find there are errors or discrepancies on your credit report(s), contact the credit reporting agency/agencies directly about resolving the issue(s) It is strongly recommended that you stay current on all personal accounts (i.e; no late payments, collections, tax liens) prior to approaching a lender. 7 Financial Documents Getting Organized Tax Returns: A lender will ask for 1-3 years of personal and, if applicable, business, federal tax returns. Tax returns are the key determinant of an entrepreneur s and/or business historical financial position, assets, liabilities, and profitability. Prior bank statements, personal and business (if applicable), will provide a history of how monthly cash flow is managed. 8 Financial Documents Getting Organized Year-to-date financial statements, or interim financials, will provide information on business performance at any given time. They will typically be requested to measure the performance of a company before the end of its fiscal (or tax) year. It is important for all businesses to keep up-to-date and accurate financial records especially when applying for a business loan. 9 3
Financial Documents Getting Organized Plan your startup company by writing a business plan, or at minimum, a strong executive summary. Existing businesses can write a strategic plan, revise their existing business plan or, executive summary. 10 Lenders Conventional Lenders Conventional lenders typically have stricter lending criteria where collateral and an above-average credit scores are required. They offer a diverse selection of credit-score driven products. Banks are primary examples of conventional lenders. Typically, less documentation is required and decision time on a loan request can be much shorter than for an alternative lender. 11 Lenders Entrepreneurs seeking financing for their startup or existing businesses should visit their local bank first. Banks offer a diverse range of financing products and ancillary services. They also have strong referral networks which include a listing of alternative lenders (including community lenders) within the area. Above average credit scores required 12 4
Lenders Alternative Lenders Alternative lenders are non-banking institutions. They include for-profit companies such as venture capitalists that provide advances to businesses based on future sales, invoices, contracts, receipts, and non-profit community lenders and microlenders that provide nontraditional financing, loans and/or grants. Alternative lenders have more flexible lending criteria than conventional lenders (e.g., banks). For example, collateral may not be required, or credit scores may not matter as much as the overall credit history. Many are not-for-profit institutions that lend limited dollar amounts to businesses operating within their region. 13 Lenders The application process can be more document-intensive than a bank, and the turnaround time on a loan decision may be longer. Applicants have to show that with the infusion of loans and grants, their business will remain at the break-even point or become more economically successful. Borrowers Must Be Thoroughly Organized and Prepared. 14 Evaluating Loan Applicants 4 C s of Credit Capacity: are you able to repay the loan? Capital: what are you worth? Conditions: what external factors impact your business, and how? Character: will you repay the loan? 15 5
Evaluating Loan Applicants Working Capital Working capital is equal to current assets. Net Working Capital equals current assets less current liabilities The liquidity of current assets affects the terms and availability of short term credit The most liquid assets are cash, money market funds and account receivables 16 Evaluating Loan Applicants Other Factors Considered Judgments against your company Owner s investment in the business Direct or related experience in the industry of the business you plan to launch is highly recommended. This criterion holds most true for start-up businesses. Most alternative lenders will require industry experience before applying for a loan if the business is a start-up. 17 Evaluating Loan Applicants Use of loan proceeds. Provides details on how the loan money will be spent. It is recommended the start-up or expansion costs be known first to determine the amount the entrepreneur will be able to financially contribute and how much will need to be financed. 18 6
Evaluating Loan Applicants Short term creditors are ultimately concerned with a borrower s ability to pay its bills as they become due and therefore want to be assured that the business is liquid. Liquidity is a firm s ability to meet its maturing short-term (debt to be paid within one year) obligations. Poor liquidity may lead to higher cost of financing (credit risk) and inabilitiy to pay current obligations as they become due. 19 Business Credit Cards General Requirements Although some major credit card companies require that companies be in business for one-two years before extending credit, shop around and see if you meet the requirements for any business credit card. When you meet with the bank manager who specializes in small business credit cards, explain that you have been working to improve your business credit rating. 20 Business Credit Cards Many credit card companies require a Social Security Number to establish a business card. However, you may be able to work around this or use your Employer Identification Number (EIN) instead when applying for a business credit card. If you have established a good business credit history and the bank is friendly to small businesses, you are more likely to be successful in your endeavors. 21 7
Business Credit Cards Advantages of Business Credit Cards One of the advantages of business credit is that it is not negatively affected by adding more credit accounts. If you have the need and ability to maintain, consider opening a second business credit card account. Also different from personal credit, a business s PAYDEX score is not lowered when merchants check your business credit history or when you open more business credit accounts. 22 Business Credit Cards In business, a company s credit record is not considered established and solid by many, until it has at least five trade accounts, at least three credit cards, and at least two small loans fully paid off. 23 Business Credit Cards Choosing a Business Credit Card Look at your needs, choose a card that s right for you and learn the best way to use it. A fixed 0% introductory APR rate makes entertaining client, scheduling travel arrangements and buying office supplies even easier. Reward points. Annual fees 24 8
Business Credit Cards Credit Limits Do not get hung up on your business credit limit. Once you start using the cards regularly and paying for your purchases monthly, your limits should increase. After your company has been around for two years, you ll be able to more easily apply for a major business credit card. Having business cards and developing excellent habits to manage them, such as timely payments, can positively impact your company s business credit rating. 25 Business Credit Cards Do not get hung up on your business credit limit. Once you start using the cards regularly and paying for your purchases monthly, your limits should increase. After your company has been around for two years, you ll be able to more easily apply for a major business credit card. Having business cards and developing excellent habits to manage them, such as timely payments, can positively impact your company s business credit rating. 26 Business Loans Overview Principle (loan amount) usually $25K and up. Interest (prime +credit risk) Repayment Terms 90 days or longer Loan Fees (% of amount borrowed) are typically range between.05 5% Guarantees of Key Owner Must have a legitimate business purpose in order to secure the loan. In Business for at least two years. 27 9
Business Loans Types of Loans Available Secured Loans Secured by either personal or business assets such as inventory and A/R. Unsecured Loans Uncollateralized loans. Requires excellent business and personal credit ratings. Typically carry higher interest rates than secured type loans. Installment Loans- Fixed monthly payments of principal and interest. Tailored to meet seasonal working capital needs. Sample Bank Loan Request (see handout) 28 Business Loans Commercial Finance Loans - When credit is unavailable from a bank, the company may have to go to a commercial finance company, which typically charges a higher interest rate than the bank and requires collateral. Typically, the value of the collateral is greater than the balance of the loan and may consist of accounts receivable, inventories, and fixed assets. Commercial finance companies also finance the installment purchases of industrial equipment. 29 Business Loans Lines of Credit (Revolving) Under a revolving line of credit, the bank agrees to lend money up to a specified amount on a recurring basis. The bank typically charges a commitment fee on the amount of the unused credit line. Credit lines are typically established for a one-year period and may be renewed annually. 30 10
Business Loans The bank typically charges a commitment fee on the amount of the unused credit line. Credit lines are typically established for a one-year period and may be renewed annually. You can determine if the preferred line of credit is adequate for your company's present and immediate future needs by considering the current and expected cash requirements of the business. 31 Business Loans You should use a line of credit if the company is working on large individual projects for a long time period and will obtain minimal or no payments until the job is completed. The disadvantages of lines of credit relate to the collateral requirements and the additional financial information that must be presented to the bank. 32 Business Loans The advantages of a line of credit are that it offers easy and immediate access to funds during tight money market conditions and it enables the company to borrow only as much as it needs and to repay immediately when cash is available. Banks also may place restrictions on the company, such as setting a ceiling on capital expenditures or requiring a minimum level of working capital. 33 11
Business Loans When the company borrows under a line of credit, it may be required to maintain a compensating balance (a noninterest-bearing account) with the bank. The compensating balance is stated as a percentage of the loan and effectively increases the cost of the loan. A compensating balance may also be placed on the unused portion of a line of credit, in which case the interest rate is reduced. Use lines of credit to provide seasonal working capital, purchase inventory, finance receivables, take advantage of trade discounts and manage cash flows. 34 Business Loans SBA Loans The Small Business Administration (SBA) has created a program of government-guaranteed loans designed to help give small businesses that may not otherwise qualify for credit get the funds they need. SBA loans make it possible to qualify businesses more easily and provide them with more flexible terms than conventional loan options, letting you preserve working capital for other expenses. 35 Business Loans Qualifying for an SBA loan is easier than qualifying for other loans. First, the SBA allows higher loan-to-value ratios. Depending on your loan request, you may be able to borrow upto 100% of your financing needs. SBA loans can help growing businesses purchase or renovate real estate, acquire fixed assets such as heavy machinery or specialized equipment, or supply working capital for ongoing financing needs. 36 12
Business Loans SBA s microloan program provides loans of up to $50K to help small businesses. SBA loans are for businesses that are owner-operated; for profit; organized as a sole proprietorship, corporation or professional partnership; within the size guidelines designated by the SBA; unable to secure other credit under reasonable terms. 37 Business Loans SBA Express / Patriot loans available for amounts up to $350,000; available as a line of credit or term loan; designed to provide easy access to working capital and fund equipment purchases; loans in excess of $100, 000 secured by business or personal assets; fixed or variable rates not to exceed 6.5% over prime rate; maximum term of 7 years; fully and partially amortizing payment options; SBA fee doe apply to all loans. 38 Business Loans Conclusion Discuss your loan package with your bank representative to ensure it s complete before submitting it. 2012 Federal Reserve Bank of New York Small Business Borrowers Poll found that 63% of loan applicants in 2011 were able to get at least part of the credit they sought. 39 13
Letters of Credit General A Letter of Credit is a letter from a commercial bank guaranteeing that a buyer s payment to a seller will be received on time and for the correct amount. Letters of credit make it possible to reduce risk (of nonpayment) when you buy and sell around the world. To pay on a line of credit, banks only verify that shipper (seller) has performed in accordance the trade agreement. 40 Letters of Credit Sample Letter See Handout 41 Business Leasing Operating Lease Operating Lease Month to month - The company leases property that is owned by the lessor, who may be the manufacturer of the asset or a leasing company that buys assets from the manufacturer to lease to others. The lease payments under the contract are typically not adequate to recover the full cost of the property. Operating leases usually contain a cancellation clause that allows the lessee to return the property prior to the expiration date of the agreement. The life of the contract is less than the economic life of the property. 42 14
Business Leasing No liability is recorded on the books of the lessee at the commencement of the lease agreement term. Capital lease This type of lease usually does not provide for maintenance services. It is non-cancellable, and the present value of future rental payments equals to purchase price of the equipment leased. The life of the contract approximates the life of the property. 43 Business Leasing True Tax Lease Get 100% financing for new and used equipment, including some soft costs, plus low monthly payment terms, and postpone your decision to purchase the equipment until the end of the lease. 44 Business Leasing TRAC Lease (Terminated Rental - Adjustment Clause) A lease for new and used commercial trucks, tractors, vans and trailers that let you borrow the entire purchase price, including some soft costs, and get lower monthly payments with a guaranteed purchase option at the end of the term. 45 15
Business Leasing Advantages of Leasing No immediate cash outlay is required. Business leases let you finance the entire purchase price, including up 20% for soft costs of business equipment or commercial vehicles. Leases require little or no down payment, so you keep more of your own money while still ensuring your business has the equipment it needs to operate. 46 Business Leasing You can take advantage of low monthly payments and several end-of-term purchase options that give you the flexibility you need to make the right financing decision. Leasing is a satisfactory way to meet temporary equipment needs and provides flexibility in operations Usually there is a purchase option that allows the company to obtain the property at a bargain price at the expiration of the lease. This allows the flexibility to make a purchase decision based on the value of the property at the termination date. 47 Business Leasing The lessor's expert service is available. Leasing typically imposes fewer financing restrictions than are imposed by lenders. The company's obligation for future rental payment need not be reported on the balance sheet if the lease is considered an operating lease. However, capital leases must be stated in financial statements. Leasing eliminates equipment disposal costs. Leases may be available as a line of credit. 48 16
Business Leasing Disadvantages of Leasing Higher costs in the long run than purchasing the asset; the lessee does not build equity. The interest cost of leasing is typically higher than the interest cost on debt. If the property reverts to the lessor at termination of the lease, the lessee must either sign a new lease or buy the property at higher current prices. Also, the salvage value of the property is realized by the lessor. The lessee cannot make improvements to the leased property without the permission of the lessor. 49 Account Receivable Financing Using Receivables for Financing A/R serve as security for the loan as well as the source of repayment. Receivables are at least $25,000 Sales are at least $250,000 Individual receivables are at least $100. Customers are financially strong 50 Account Receivable Financing Factoring of A/R involve the sale of accounts receivable to a bank or finance company without recourse. The finance company assumes all credit and collection risks Remissions by customers are made directly to the factor Cost of factoring (Commission) 51 17
Account Receivable Financing Advantages of Factoring Advantages of factoring are that it offers immediate cash, reduces overhead because the credit management process is performed by the factor, and it strengthens the company s balance sheet. Disadvantages of Factoring Disadvantages of factoring include both the high cost and negative impression left with customers as a result of the change in ownership of the receivables factored. 52 Account Receivable Financing Assignment of Receivables In an Assignment (pledging) arrangement, ownership of the accounts receivable is not transferred. Instead, receivables are given to a finance company with recourse. 53 Account Receivable Financing The finance company usually advances between 50 and 85% percent of the face value of the receivables in cash; your company pays a service charge and interest on the amount(s) advanced and any resulting bad debt losses and continues to collect customer remissions. 54 18
Account Receivable Financing Advantages to Assignment of A/R The assignment of A/R has the advantaged of providing immediate cash, making advances available on a seasonal basis, and avoiding negative customer feelings. Disadvantages to Assignment of A/R Disadvantages include the high cost, managing the A/R collection process and the bearing of all credit risk. 55 Inventory Financing Using Inventory for Financing Typically takes place when the company has completely used its borrowing capacity on receivables. Requires marketable, nonperishable, and standardized goods that have quick turnover and are not subject to rapid obsolescence. 56 Inventory Financing Amount financed is about 75% of value of raw materials and finished goods. The drawbacks of inventory financing include the high interest rate and restrictions place on inventory. 57 19
Thank you! Questions & Answers Evaluation Survey Link will be emailed to you after this class Upcoming Classes Register today! Check www.dbe-advantage.com Emails will be sent to you soon 58 Business Development Program Business Plan Development One-on-One Mentoring Free Technical Assistance Certificate upon Completion of Program Teaming/Partnering Access to Recorded Webinars Access to Valuable Business Resources Custom Level Bid Matching For more information: Visit: www.dbe-advantage.com Email: dbesupport@gcapservices.com 59 20