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CPAs and Small Business Lending: A Perfect Match?

May 17th 2016
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Accessing capital to fuel growth or fund other initiatives is one of the biggest challenges faced by many of your small business clients. Within their circle of advisors, their CPA may be in the best position to help them determine whether or not a small business loan would facilitate growth or put their business under stress.

Understanding the Numbers
Because most entrepreneurs don’t jump into small business ownership excited about the ins-and-outs of the accounting process, as their accountant, you’re in a unique position to help them better understand, in financial terms, the health of their business and determine whether or not an influx of borrowed capital is a good way to help them take their business to the next level.

I once spoke with a lender who said, “If I understand more about the financial health of a business by looking at the financial reports than the business owner, I’m not going to approve a loan.”

Successfully leveraging borrowed capital to facilitate business growth requires a thorough understanding of the value it will add to the business – as well as the costs. Here are five pretty straightforward questions that should be considered before one of your clients should seek financing:

  1. Is there a clear purpose for the loan?
  2. Has the business owner identified how much capital he or she requires?
  3. Has your client identified any potential return on investment (ROI)?
  4. Does the business owner have the cash flow to support the periodic payment frequency?
  5. What does the business owner’s business and personal credit profile look like?

Is There a Clear Purpose for the Loan?
Loan purpose is an important question. Is the need a short-term need, like purchasing inventory or bridging a seasonal cash-flow gap? Or a longer-term need, like purchasing a new building or expensive manufacturing equipment? A purchase like equipment that can be depreciated over several years might not be the best fit for a short-term loan; likewise, it might not make sense to purchase quick-turnaround inventory with a longer term.

Understanding loan purpose will also help you understand the urgency of the need. A traditional small business loan might not be the best choice if your client needs funds right away to take advantage of a growth opportunity, like ramping up to fill a new contract.

Has the Business Owner Identified How Much Capital He or She Requires?
“As much as I can get,” isn’t the best answer. Once you and your client understand the business need you’re trying to meet, you’ll be able to articulate just how much capital makes sense to meet that need. Most lenders appreciate a borrower who knows exactly how much capital they require.

You understand: There are costs associated with borrowing, and it might cost too much to borrow more than what is required to meet the need.

Additionally, most traditional lenders would prefer to lend $500,000 or $1 million, rather than $40,000 or $50,000, while other lenders specialize in loan amounts closer to $50,000. Understanding the loan amount will help you advise your clients to look where they have the best opportunities for success.

Has Your Client Identified Any Potential ROI?
I’m of the opinion that borrowed capital should offer some value to the business – if possible, in the form of a positive return. If an ROI can be identified, it will help you determine how much the borrower can afford to pay for borrowed capital. For example, purchasing quick-turnaround inventory that will provide increased profits if purchased at a discount might make it possible to justify a higher cost of capital than other business needs.

Additionally, lost opportunity costs associated with a longer loan approval process just might be too high – even if the costs of the funds are lower. An identified potential ROI will help make those decisions.

Does the Business Owner Have the Cash Flow to Support the Periodic Payment Frequency?
Many lenders are turning to more frequent periodic payment schedules than monthly. This can help reduce “lumpy” cash-flow needs at the end of the month and spread the cash-flow requirement over the entire month. It also helps borrowers and lenders identify potential problems earlier than a monthly repayment schedule.

Small business owners who have a consistent stream of cash flow throughout the month are better able to accommodate a more frequent periodic payment schedule than those who typically rely on the end of the month. Depending upon the nature of the business’ cash flow, a daily or weekly payment schedule could be easier for a business to accommodate than a single monthly payment.

For short-term needs and short-term loans, a more frequent payment schedule is very common. Nevertheless, many nonbank lenders that offer longer-term loans often include a more frequent periodic payment than monthly.

What Does the Business Owner’s Business and Personal Credit Profile Look Like?
Although a business owner’s personal credit score is not the best indicator of business creditworthiness, to one degree or another, most lenders consider personal credit score when evaluating a potential business loan. It’s generally understood that a bank, for example, would prefer a personal credit score of 700 or better, but will sometimes go as low as 680. The US Small Business Administration threshold is typically 650. Many online lenders will go lower, provided the business is healthy.

There are situations where a healthy business could have a strong business credit profile despite an owner’s weak personal credit score. And many of those businesses that are turned down at the bank because of a weak personal score are considered good customers by a number of lenders that more heavily weigh business health and profile when evaluating business creditworthiness.

A Match Made in Heaven?
Most small business owners make their first stop at their local bank when looking for a loan, only to be turned down because they’re not asking for enough, they’re looking for the wrong type of loan, or their credit profile doesn’t meet the bank’s rigid requirements. A small business loan could make sense for a lot of these businesses.

Because their CPA is in a position to understand the financial health of a business (sometimes even better than the small business owner), the accountant is in a position to offer insightful, thoughtful, and relevant advice to help that business owner make sound decisions regarding his or her business. For most businesses, I’d consider that a match made in heaven.

Related article:

How to Advise Clients on the New World of Small Business Financing

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