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.

There are hundreds of businesses in central Indiana in this predicament, so I decided to do a little research and come up with some guidelines of what it takes to get the attention of a lender in this “NEW” economy.

• Credit score of the owner of 720 or better.
• Decent payment history with vendors
• Debt service coverage ratio of 1.25:1.
• Debt to worth ratio 2:1 or lower
• A history of profitability
• At least 2 years in business
• Accurate financial statements

PROFITABILITY is the primary ingredient that impacts 5 of the 7 requirements listed above. In any economy, it is critical for management to keep focused on profitability. It is critical that the company work to a profit plan. It impacts if the owner gets compensated adequately and regularly; it determines if vendors get paid in a timely manner; it is one of the largest components in cash flow; it grows equity (which impacts the debt to worth ratio); and the longer the history of profitability, the more likely the company is stronger financially and as an added bonus – worth more.

And lastly, a word about accurate financial statements – although this seems like a no-brainer; it is a problem with many companies. Financial statements are the report cards that everyone outside your organization evaluates to see your performance as a manager.  If the information is inaccurate, it reflects negatively on your ability to run your company.  Accurate statements prepared on the “accrual” basis are the first step in managing a company well and getting your bankers trust.