Helping Clients With Financing

There are several important ways a CPA can help clients get financing.  In this article we will describe some of them and address how CPAs can advise clients on the risk of personal guarantees.

1. Lenders often require a business plan and cash flow projections based on   realistic expectations. An example of how to develop realistic expectations of future revenue is to survey customers to ascertain the probable orders they will place, and to evaluate them in relation to past orders. Evaluate events that account for significant increases in future orders compared to the past.
   
   Taking the simplistic approach of assuming next year’s overall revenues will increase by, say, 10 percent will not do it.

2. Lenders will want to know what the funds are being used for and will want to see projections that support the ability of the company to repay the debt. The debt service ratio, the percentage of predicted funds available divided by the principal and interest deductions may be a critical factor to the lender.

3. CPAs can also help the borrower determine the cost of the loan, and to evaluate the implications of loan covenants such as prepayment penalties, requirements that limit owner withdrawals, and maintenance of minimum financial statement ratios such as total debt divided by net worth of the business.

4. Personal guarantees of the loan by owners of private companies are often required. CPAs can advise clients on the risk associated with them (explained later in this article).

5. There are a myriad of types of business loans.  Both the lender and the borrower’s CPA can be helpful in explaining them, and in guiding the borrower towards the most appropriate kind of loan for it’s circumstances. Here are three typical types of loans:

1. Seasonal loans:  The borrower is able to pay the loan back when inventories and receivables decline after a seasonal surge in business, and this pattern is typically repeated from year to year. It is generally easier to obtain than a term loan used to provide permanent working capital, so long as the increases in inventory and accounts receivable during the busy season are consistent with past experience. Absent a sudden deterioration in the demand for the company’s products, there should be minimal risk that the company will not be able to pay the loan on the due date.  Therefore, there is minimal risk to the guarantor(s).
2. Term loans, which are generally paid back from cash generated by net income, are a different story.  Here you almost always need a business plan and cash flow projections as described above. A borrower must have considerable strength to qualify for a term loan.   Personal guarantees may be important more as a demonstration of ownerships’ confidence than as a secondary source of payment. There may be somewhat more risk in giving a personal guaranty of a term loan than a seasonal loan simply because regardless of ownerships’ confidence in the business, changes in the economy, markets, and competition are more likely to occur when the loan will be outstanding for several years.
3. Accounts receivable financing is popular for companies that do not have the financial strength to qualify for unsecured seasonal or term loans.  Lenders who finance receivables (and sometimes inventories and equipment) use those assets as collateral for their loans and monitor them closely.  Because the monitoring controls the amount of the loans outstanding in relation to the value of the collateral, loan covenants are sometimes not as strict.  And so long as the lender is adequately protected by the value of the collateral, there is minimal risk to the guarantor.

A brief review of what lenders look for is helpful to CPAs in advising their clients:

1. Management continuity: The borrower needs to provide evidence that management strength is not dependent on one person.  There must be capable management in the wings. And of course the borrower’s integrity and past history are critical.
2. Lenders are also concerned if there is:
1. A concentration of business with a small number of customers or a dependence on one product.
2. Large owner compensation and benefits that are unlikely to be reduced in response to a decline in business.
3. Questionable quality of accounts receivable as measured by aging and bad debts.
4. Low quality of inventories as measured by turnover and obsolescence.
5. Potential need to replace equipment or upgrade it to remain competitive.

A final thought: A reputable CPA can be a very important source of comfort to a lender.  CPAs belong to a profession known for its devotion to high standards of financial reports, integrity, and ethics.  Companies that use CPAs and rely on their advice are therefore likely to be accorded a higher level of respect.