Jan 22nd 2013
By Mary Ellen Biery, Research Specialist, Sageworks
If one of your clients recently applied for business credit and was rejected, he or she isn't alone. A recent survey of banks and asset-based lenders found they had turned down more than a third of all businesses' applications for loans, according to Pepperdine University's 2013 Capital Markets Report.
Furthermore, many businesses wouldn't even attempt to seek funding because they believed their request would be rejected, according to a survey of privately held businesses in the same Pepperdine report.
How can you help a client whose business credit application was denied?
First, tell your client to try to find out why the application was denied. The Federal Trade Commission (FTC) says an applicant should submit a written request for the reasons of the denial within sixty days, and the creditor must give the applicant the specifics in writing within thirty days of the request. Tell your clients to approach their lender, and they may be able to resolve any issues. The Equal Credit Opportunity Act prohibits creditors from denying a loan based on reasons that have nothing to do with an applicant's creditworthiness, according to the FTC.
In the Pepperdine study, banks and asset-based lenders only rarely cited a company's size or economic concerns as the reasons for declined loans. The top reasons instead were tied to the quality of the business's earnings or cash flow, or to the fact that a company had insufficient collateral.
So the next thing clients can do if their business credit was denied is take a good look at their business and how it rates on the financial metrics that can best predict default - the exact scenario lenders want to avoid. One way to see how their firm stacks up against peers is through a business credit report.
Below are five financial metrics that Sageworks Inc., a financial information company, has identified as the best predictors of default, so if your client was denied credit, highlight these metrics as areas for improvement.
1. Cash to assets. This is a key measure of liquidity that provides an indication of how much flexibility a firm has to deploy cash or access liquid accounts in order to make good investments, according to Lawrence Litowitz, a partner at strategic advisory firm The SCA Group LLC. Two suggestions for your clients: manage your accounts receivable to ensure you're getting paid as quickly as possible and manage inventory to avoid tying up cash.
2. EBITDA to assets. Comparing EBITDA (earnings before interest, taxes, depreciation, and amortization) to a company's assets helps show how efficient the business is. Improving this metric often involves either raising revenues (without a similar increase in expenses) or cutting costs. Using customer suggestions and improved planning are a few ways to boost revenues. Urge clients to review overhead expenses, such as telephone and equipment, or revisit vendor contracts to seek expense savings.
3. Debt service coverage ratio. This is measured by comparing EBITDA to a firm's current portion of long-term debt and interest expense, so boosting EBITDA with some of the suggestions above could yield improvement in the ratio. One effective way to tackle the debt and interest side of this ratio is to cut expenses and apply the savings toward paying principal on the debt.
4. Liabilities to assets. This ratio indicates how much of a company's assets are financed through debt, as opposed to through profits from the business, so improving this metric is all about reducing debt. The Better Business Bureau recommends making the biggest debt payment possible each month, especially for credit cards, which typically carry high interest rates that otherwise accrue interest payable, another liability account.
5. Net income to sales. This is a fundamental measure of how profitable a business is. Cutting operating expenses can be a short-term way to boost this ratio, but it can also backfire, so remind your clients to tread carefully. For example, skimping on equipment maintenance could lead to more expensive repairs or replacements. Longer-term goals required to improve profitability involve lowering production costs and increasing higher-profit sales.
Running a successful business isn't a sprint, it's a marathon. In the same way, addressing issues that contributed to a credit denial may take months or even years. But in the long run, the efforts should help your client win not only a loan, but also create a more lucrative business.
About the author:
Mary Ellen Biery is a research specialist at Sageworks, a financial information company and provider of the Business Credit Report by Sageworks. She is a veteran financial reporter whose works have appeared in The Wall Street Journal and on Dow Jones Newswires, CNN.com, MarketWatch.com, CNBC.com, and other sites.