It was early spring; the temperatures were much warmer than normal as the banker walked down the sidewalk to talk to see his customer. Harold knew his banker was coming, he just could not figure out why. His line of credit was in good shape and he had not missed a loan payment in years. Harold thought the banker was making a courtesy call – WRONG.
Harold soon found out that this was going to be one of the worst days of his life. His banker had come to tell him that his line of credit and the $325,000 equipment loan was being called. Harold had 30 days to find other financing. If you haven’t had the opportunity to experience this, it is like being hit (unexpectedly) by a truck, it is a demoralizing experience.
What Harold did not realize is that the banker had been reviewing the profit performance of Harold’s business for the last 18 months. And there wasn’t any (profit). The banker had been looking at the monthly financial statements each month, whereas Harold didn’t give them much thought. The company had cash in the bank, were paying their vendors, payroll and making the bank payments; Harold was not concerned until today. Don’t fall into this trap.
Here is an easy way to tell if your company is making enough money to keep your banker happy (and if your banker is happy, you can relax), for the last 12 months:
1) add up the interest expense on your line of credit,
2) add up all of your payments on term debt (principal and interest)
3) Add: a) net profit, b) deprecation expense, c) amortization expense and d) all interest expense (including your line of credit)
4) Add 1 and 2 together and divide that into 3, that numbers should be 1.25 or higher.
Example:
Last 12 months interest on line of credit. $ 60,000
Payment on trucks (P&I) $ 36,500
Payments on Equipment Loan (P&I) $ 37,500
Total $134,000
Profit $100,000
Depreciation $ 72,500
Interest $ 83,400
Amortization $ 0
Total $255,900
Calculation $255,900/134,000 = 1.91
In this example, the company has adequate debt service capacity to service all of the principal and interest payments that company has due. It is in pretty good shape because its debt service coverage ratio is greater than 1.25:1. There are many indicators that indicates the health of a company; but it is an important one.
This is one indication you should evaluate quarterly or at least semi-annually from your financial statements. Your banker is looking at this and so should you.
Having trouble with your banker or your company’s financial performance? Call me for an objective discussion on what you can do to increase the financial performance of your company and your personal net worth.
