Indirect Costs and Loan Conditions
Lenders will normally require your business to provide periodic
reports. The reporting requirements for a small business loan can vary.
Local community banks will most likely require quarterly and annual
financial statements from the business. They also may require an annual
personal financial statement and income tax return. Additionally, if the
loan is guaranteed by the businesses accounts receivable, monthly
reporting is typically required.
Not all banks require that a CPA prepare the documents. If a bank does
require it, they may be satisfied if the CPA only prepares the final
compilations. Depending upon the bank's staff and the amount of lending
done, banks vary on the degree of scrutiny given to the reports. Smaller
banks will seldom confirm the accuracy of these financial statements as
long as a quick review reveals no significant problems. The reporting
requirements are usually considered pro forma.
The bank/lender needs monthly statements for any loan secured by accounts
receivable. They need this because the accounts must frequently be "aged"
to assess their fair value and also because the loan-to-value amount is
continuously changing. For example, lets assume a bank gave you a working
line of credit for $30,000, secured by your accounts receivable. On
receivables that are under 60 days old, the bank has agreed to extend 75
percent of the value of those receivables. The monthly reporting on the
receivables is important so the bank can make sure the loan remains
secured by at least $40,000 worth of receivables under 60 days old.
Unlike small banks, conventional lenders usually include an assortment of
covenants and restrictions in the loan. Some banks may place restrictions
on the use of loan funds, require proper maintenance of business
facilities, and require adequate insurance coverage. They may also require
the maintenance of key financial ratios such as debt-to-equity ratio,
current ratio, and coverage of fixed charges ratio. Additionally, most
banks will require minimum working capital balances, place restrictions on
the amounts of dividend payments, restrictions on salaries, a restriction
on mergers and acquisitions, and place limits on further pledges of
assets.
Most smaller community banks are less demanding because they don't want to
and/or don't have the time and money to spend policing covenants.
Frequently, the covenants required by community lenders will limit the use
of financial ratios and will restrict the use of collateral as security
for any other loans.
A subordination agreement usually stipulates that corporate obligations
are a lower priority to the loan than the rights of shareholders,
officers, and directors. Defaulting on these terms will result in a
foreclosure on the secured assets. Nearly every small business commercial
loan allows the bank to "call" the loan due. This usually only happens if
the bank feels that the probability for repayment is seriously threatened
or degraded.
In addition to all of the requirements above, your lender may require that
you personally guarantee repayment of the loan with your own assets.
Return to The True Cost of Borrowing Money
© 2001 Missouri Innovation Center