CAMPARI PART VI – “R” is for REPAYMENT

If you just joined the series, click here to read the Introduction to the CAMPARI framework.

No Bank is going to lend to any business unless it can see exactly how the debt will be repaid. In this part of the assessment process, the Manager reviews the forecasts, which are included in the Business Plan. The forecasts are the primary source of information to demonstrate that the loan or overdraft can be paid back. However, it’s not just a case of looking at the figures and accepting them at face value – there are many questions to ask (just as you would expect!).

 

Has Your Ability To Repay Been Demonstrated?

In order to ensure that the amount borrowed can be repaid, the Cash Flow Forecast and Profit And Loss Forecast contained in the Business Plan are analysed. If you have requested a loan repayable each month, your forecasts should show that you can afford the repayment. If you have requested an overdraft limit your Forecast must show that you can cover the interest.

One point to be aware of about Cash Flows and overdrafts is you do not have to show that you will be repaying it within 12 months; it’s not unreasonable to have an overdraft limit in place for a number of years. Remember that the limit is financing your turnover and as long as you are making sales, you may need your limit. However, your Forecast should be shown that any interest charges can be easily covered.

It’s human nature to be over optimistic at times, especially when asking for money, and so neither the Cash Flow nor Profit and Loss Forecast will be taken at face value. To safeguard against a zealous entrepreneur, the Bank will spend time taking the forecasts apart and testing the assumptions behind the figures. There are a number of key issues, which are looked into.

 

Questions Applicable To the Profit And Loss and Cash Flow Forecasts

  • Does the projected increase in sales look realistic?
  • On what basis are sales going to increase? Have contracts for new sales been signed or is there a confirmed future order book?
  • Has an improvement or deterioration in the general economic scene been taken into consideration?
  • Is there a dependency on a limited number of customers or products making the business vulnerable?
  • Have stock requirements been accurately assessed? On what basis have the requirements been worked out?
  • Is the business dependent on materials or stock being delivered on time? If so, how has that risk been addressed?
  • If sales are projected to increase and additional workers are required, has this been factored into the costs?
  • If new borrowing has been requested, has the loan repayment and interest charge been included?
  • What interest rate has been assumed in the calculations?
  • Does it look as if all overheads have been included (the Manager can refer to previous Audited Accounts to check this)?
  • Have the stock costs and overheads, which would be expected to increase when sales go up, been increased as well (refer back to the section on fixed and variable costs)?
  • Are the monthly opening and closing balances correct?
  • Do all the figures add up (it’s surprising how often this is not the case!)
  • Is there a margin of error or safety built in as regards paying interest or the loan repayment? If your loan repayments come to say N4,900 per annum and your projected profits are forecasted to be N5,000, before finance costs, then you don’t have much leeway for things to go wrong. Sales could be N1,000 less than you thought, or your cost of raw materials could be higher and this is enough to plunge you into loss. Very little margin of safety between projected profits and interest costs or loan repayments can be dangerous and will be seen as a weakness

 

Questions on the Cash Flow Forecast

  • What terms of credit (for both sales and purchases) have been used? Are they similar to the previous year? If not, why not?
  • The forecast will only show the estimated balance at the end of the month; is there likely to be a higher peak during the middle of the month?
  • Does it show all proposed capital expenditure, new loans agreed and drawn down and any money introduced by the Directors?

The overriding area for consideration is whether the forecasts look reasonable, are they consistent with what the business owner has told the Bank and, if the business is already established, how it has performed to date. If there are any areas, which need clarification then expect to be called in again so the issues can be resolved.

Once satisfied that the Forecasts and their assumptions are fine, and serviceability is proven, then this section of the assessment process will be considered as a key strength of the application.

 

What Is Your Previous Repayment Track Record Like?

Although the issue of how your Bank account has been run was considered under the Character aspect of the process, it is also a valid part of the Repayment assessment. If you have been banking with your Bank for some time and have had previous loans, then your repayment track record in meeting your payments on time will be considered. The same goes for any overdraft limits you may have had; have the limits been respected?

I mentioned earlier that if you bank elsewhere, the Manager would request copies of your statements and ask the same questions. The way you have operated your account is a good indication of your ability to repay in the future and so will be considered as either a strength or a weakness. If you struggled to keep up with your last loan repayments, or you constantly exceeded your limit, then this will not put you in a good light.

 

Is The Repayment Term Acceptable?

In asking for a loan to purchase for example a vehicle for the business, the term, or length of the loan has to tie in with the life expectancy of the vehicle. It’s no good purchasing a vehicle that will only last for 4 years and at the same time ask for a loan repayable over 10 years. By the time you need a new vehicle you will still be paying for the old one! The repayment period has to tie in with the expected life of the asset being bought. The only exception to this is buying a building and repaying that loan over 15 or 20 years, which is reasonable.

 

Is There A Secondary Source Of Repayment?

Bankers are a pessimistic bunch – they will look for a secondary source of repayment in case all else fails! The question they will ask themselves is, “What is the alternative way out for the Bank if the business collapses and some of the debt is still left behind?” You would not be expected to cover this in your Business Plan – explaining how the Bank can get its money back if the business goes belly-up will not come across as a positive statement!

The answer to this question is usually the security being offered and we will consider this in more depth later.

 

Your Personal Income and Expenditure

I have said before that for a small business (a one-man band), the Bank is looking to you as the person who will ensure the debt is repaid; they are lending to you as an individual, not the business. They will therefore want to know what your personal financial situation is.

They may ask you to complete a personal income and expenditure statement, which will detail your in-goings and outgoings. Ideally this should show a surplus each month.

 

What Do The Audited Accounts Reveal?

We have already examined the key points, which the Bank will look for when reviewing a set of Accounts. All the key ratios will be considered and then an overall assessment given as to whether the past accounts are a strength or weakness. As you will know, when you invest in any financial product, there is also a health warning which says, ‘past performance is not a guarantee to future performance’. The same applies to Audited Accounts.

Whilst your Accounts may show exceptional or even poor performance, it does not mean that this will happen again in the future. Your Business Plan, and the reason for your request, may be aimed at putting right your poor performance or even capitalising on your past successes. However, the Bank still needs to consider past performance because it’s a representation of how you manage your business.

Your Balance Sheet is also the foundation of your business. It supports your day- to-day financial needs and is the basis of where your business is going in the future. The ability of your financial position to support your future plans cannot be ignored, so the Bank, in assessing your request, will ask how your past and current performance rates – a strength or weakness?

If you are a start up then obviously you will not have Audited Accounts and so to prove that you can service your interest or repayment the Bank will concentrate on your forecasts and the other information you have provided. In Nigeria, however, start-ups usually are not supported by Banks. We advice other sources of funding.

 

What Do The Management Accounts Reveal?

When reviewing Audited Accounts I mentioned that the one disadvantage of relying on Annual Accounts to assess business performance is that the information is out of date. On average, it can take 6 to 9 months for a business to have its accounts prepared and a lot can happen in that time. To overcome this disadvantage the Bank may ask for more up to date information in the form of Management Accounts.

If you keep monthly or quarterly trading figures then this in its self is a strength; it shows that you have up to date information on performance and as a result you can spot and respond quickly to any potential problems. For any business, just relying on the annual accounts to see if they are making a profit, is not an ideal situation. If this is the case then it would be considered a weakness.

If monthly or quarterly figures are produced then they will be analysed in the same way as annual figures. The same issues are considered, trends assessed and compared to the annual accounts.

To your success!

Olanrewaju Oniyitan






Comments