Tag Archives | banks

5 Cs of Credit – How to Be More Credit Worthy

Are you credit worthy? Right now, is your credit good enough for a lender to give you a loan or line of credit today? If your answer is no or if your not sure of your answer, take a look at the 5 Cs of Credit. This 5-point checklist allows loan officers to easily determine if you are going to be good for their banking business. Although, banks don’t strictly rely on only the 5 Cs of Credit, it’s good to know where they start.

But first, what are the 5 Cs of Credit?

5 Cs of Credit

The 5 Cs of Credit include cash flow, collateral, capital, character, and conditions.

5 cs of creditCash Flow

The bank need to know that your company can generate (and has generated) enough cash flow to pay off the debt. To increase your chances of getting approved for a loan, display how you have paid off debt before, had consistent cash flow, and plan to pay off debt in the future. Remember, cash is king. Because of that, this is one of the most important Cs.

If you need to improve your cash flow, download our free 25 Ways to Improve Cash flow whitepaper. Get approved for that loan!

Collateral

Unfortunately, some companies fail. Regardless of whether the company fails or not, the bank wants to make sure that it can be paid. The bank looks for sufficient collateral to cover the amount of the loan as the secondary source of repayment. This C allows the bank to cover all their bases because at the end of the day, they just want to be paid.

The bank wants to make sure it is protected if you cannot repay the loan. As a result, the bank will look into your savings, investments, and/or property.

5 cs of credit

Capital

Capital is a huge sign of commitment. One of the reasons why the bank looks at capital to approve a loan is to confirm that the company can weather any storm and ensure that the owner will not just walk out any day. The bank needs to know that there is a significant commitment, that being an investment, from the owners of the company.

Character

One of the suggestions we give to clients when developing a banking relationship is to take their banker out to lunch. This provides an opportunity for the banker to assess your character. What are they looking for? Integrity, honesty, respect, and other virtues reflect a good business person who will stick with their commitments in the good times and the bad. Sound character is critical in business. The banks want to feel safe when doing business with you.

Indicators of character include credit history and stability. The biggest question asked is, “will you be able to repay the debt?”

Conditions

With any business, there are external factors that could impact the company’s success. Therefore, the bank looks for conditions surrounding your business that may or may not pose a significant risk to your ability to succeed (and pay off your loan). If there is high risk, the banks will be more cautious when approaching you. But if the risks are small and do not impact any of the 5 Cs of Credit, then the bank is more willing to offer a loan.

Ask yourself: can you repay the debt?

Why do banks follow the 5 Cs of Credit?

In short, banks follow the 5 Cs of Credit to mitigate any risk related to loaning to a company. The risk a bank incurs from lending money to companies can be managed by assessing different areas of credit. Although not every bank uses this list, it’s safe to assume that when approaching a bank, you need to address each of these factors.

Relationships

Business deals with people; therefore, it is critical for the management (especially the owner/CEO/CFO) to have a good relationship with their banker. Imagine a random person coming into your office to ask for a $350,000 loan. Because you have no relationship with them, you don’t know how honest they are, if they have integrity, how willing they are to pay back the loan, how they do business, etc. Because there are a lot of unknowns, the risk increases dramatically.

Trust between a bank and a company is developed when you have proven that you are able to pay off your loans, have long-lasting relationships with customers, vendors, suppliers, etc., and alert the bank if your projections are a little off.

5 cs of creditWhat Lenders Look For

Lenders look to reduce their risk. They are willing to provide loans that may not have the highest return over risky loans with high returns. Areas of risk include the amount of credit used, the number of recent applications for loans, how much the company makes, and available collateral.

To start the process of applying for a loan, address areas that need to be fixed before the application, explain any red flags that your banker might raise, and prove you are credit worthy.

How to be More Credit Worthy

Creditworthiness is a valuation method banks use to measure their customers, your company. Although there may be slight differences between personal and business credit scores, it is a good start to improve your personal credit score. If you follow the same guidelines in your business, the company’s creditworthiness will increase.

Be more credit worthy by:

  • Paying bills on time
  • Pay more than just the minimum amount required
  • Manage credit card balances
  • Limit or manage the usage of debt

In addition to addressing the factors that directly impact your credit score, take a look at the 5 Cs of Credit. If you find yourself lacking in any one of those areas, make it a goal to increase your creditworthiness in that area over the next quarter. If you have decided to start tackling the first “C” – cash flow – download the free 25 Ways to Improve Cash Flow whitepaper. Make a big impact today with this checklist.

How to Be More Credit Worthy, 5 cs of credit

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Why do most startups fail?

why most startups fail

Right now is the time of innovation – kickstarters and new types of marketing campaigns are popping up everywhere. You might have an idea yourself, regardless of whether you’re a Millennial, Generation X, or even a Baby Boomer! So how do you know if your idea is a good one?

As I have mentioned in previous posts, I am an adjunct professor at the University of Houston Wolff Center for Entrepreneurship. In one of our first classes, we discussed an interesting topic: the survival rate of a new business, and why most startups fail.

According to Fortune, 9 out of 10 new businesses fail. The number one reason for why most startups fail was not having a product that serves the market. I asked the students this question, and now I’ll ask you… Do you think a good product is enough to survive in the market?

Top 5 Reasons Why Most Startups Fail

The answer to that question is no. A number of factors play into why most startups fail. Here are a few:

#1: People don’t need it!

The number one reason for the failure of a business is creating a product for a market that doesn’t need it. The first thing you should do, before you spend all of your cash on producing and prototyping your product, is market research. Who is your customer? How many customers are out there? How much are they spending on a product that serves a similar function? If you can’t answer all of these questions about your idea immediately, then maybe this isn’t the best business to invest in.

 #2: Cash wasn’t King

Where are you spending your money? Research shows that 29% unfunded startups fail because they ran out of money. We can assume that they spent the money on research and development, marketing, salaries, and other overhead expenses. How did they run out of cash in the first place? Because the financial leaders overlooked important, and possibly tedious details.

Also consider that different businesses see profits at different times. You may go 5 years without seeing a dime. Or maybe it’s the other way around –  some startups might skyrocket after a couple of years. But do they have enough cash to keep them afloat? Looking ahead is always important when you manage your finances. Like gas in a jet, cash is the fuel to keep your business running. Cash is king.

Even if you aren’t starting a new business, taking a look at your company as a whole is always a good idea when making big decisions. Download our free Internal Analysis whitepaper to learn how!

#3: Lack of a Quality Team

why most startups failObviously when you start a company, you want the best staff you can build. However, most startups can’t afford “the best of the best.” There may be certain skills that you need, tasks that need to be done quickly, but your staff simply cannot keep up.

Let’s say your team has all the skills you need, but they don’t communicate or work well with others. You’ve just invested your money in a team that could fall apart. It’s better to a have a team that learns the skills and has a positive attitude, versus a skillful team with a negative attitude. In this case, quality is defined by the talent in the person, not just the skills they bring.

#4: No Competitive Advantage

On top of marketing research, you also have to conduct competitive research when you start a business. What makes your company unique? In a way, a condensed competitive scope may indicate that your product is needed. What you have to figure out is how to make your brand more attractive than your competitor’s.

This means more than just “being the cheaper alternative.” The intellectual property itself has to have that secret sauce… which also means that you answer your customer’s problem better than your competition.

#5: Poor Pricing

Poor pricing is another reason why most startups fail, so don’t underestimate the power of smart pricing.

The Startup Roadmap

Solve a Problem > Build a Good Team > Research/Develop the Idea >

Financial Projections > Look for Funding > Develop Product >

Disrupt a market.

This is a general roadmap of a startup. Typically, it takes 3 years to be successful in an industry. Think about it – when you apply for a job, they look for people with 3+ years experience. Why? Because they have 3+ years experience in a skill set. The interviewee knows how to navigate a problem and has practiced solving it. Same goes for a business.

Why Banks Turn Startups Away

The research pwhy most startups failreviously mentioned shows data for companies that have been around 3-5 years. I like to think that after you pass the first three years, things get easier for your company. For example, banks need to see at least 3 years of financial statements. You may not need profits for all three years, but you should be trending upward by year three for banks to consider investing in your business.

Banks turn away companies less than three years old for multiple reasons. One is that new or small businesses are more risky than larger businesses. Post-recession, banks have to be more strict with who they lend to. Banks also earn less profit on smaller loans. If you think about it, banks underwrite a $5 million loan for the same cost of underwriting a $50,000 loan. It makes more sense to focus on the larger loans, with a less risky business.

Conclusion

Although it seems like everyone around you is looking for that next big idea, really think through your next venture. Do you have a market, cash, and a good team? What is your competition like? And finally, what is your pricing strategy? If you create a roadmap and make financially sound decisions, your startup should already look better than most.

Speaking of making financially sound decisions, check out our free Internal Analysis whitepaper to assist your leadership decisions and create the roadmap for your company’s success!

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Banks are Restructuring Troubled Loans

With oil prices the lowest they’ve ever been in recent memory, business owners and financial analysts are predicting either an economic downturn, or possibly another recession in oil producing states. Bad news for oil and gas companies? Maybe not… Recently, I spoke with several Houston area bankers and learned that there seems to be a general focus on how banks are restructuring troubled loans in the oil and gas industry rather than forcing these companies into a workout situation as in previous downturns. This particularly applies to those companies who were more financially fragile going into the crisis back in July 2014.

Banks are Restructuring Troubled Loans

According to a recent Wall Street Journal article, some analysts and investors say, “The time of reckoning has been pushed back restructuringseveral months as banks prove reluctant to turn off the taps.” Despite being in the 15th month since the peak of oil prices in July 2014, banks “have kept flowing, helping the [oil and gas] industry weather the market’s collapse.”

If you’re in any oil producing state or country, you’ve probably already felt the pinch. Unfortunately for some, the price of oil is predicted to stay at $40 for the next 9-21 months, extending the “crisis” to 24-36 months.

One of the questions that we’re dealing with today is to what extent this crisis will spill over to other markets. Companies adjacent to the oil and gas industry will likely be feeling the pain in the near future. The good news is that banks aren’t pressuring companies outside of the oil and gas industry to restructure their loans just yet.

(Questions that your banker wants to know the answers to… Click here to read more about it)

What Can I Do Now?

The key is DON’T PANIC! There are steps you can take, so it’s time to put on your thinking cap and be the trusted advisor your organization needs.

(NOTE: Want more tips on how you can be a trusted advisor? Check out our whitepaper How to be a Wingman!)

Sit back and look at your company as a whole in the market. By taking a wide view, you’ll be better able to see where the company is unnecessarily bleeding.

Three things are key in protecting yourself in an unstable market:

  • Be proactive
  • Cut sooner and cut deeper
  • Restructure

Be Proactive

If your company is on the “edge” of the oil and gas industry, be proactive! Since we’re in the 15th month and are expecting it to last up to 36 months, it’s vital that you start preparing now.

First, calculate the how long your company can lose money without running out of cash. If you haven’t acted yet (especially if you’re in the 5% closest to the oil and gas industry), you’ll most likely discover that you’ll run out of cash before this crisis is projected to end.

Start analyzing how your market is functioning, how your company is operating, etc. List all of the operating functions that are not necessary or could be dramatically improved. Ask yourself: what are you spending the preciously small amount of cash that you have on?

The advantage of acting now is to prevent panic (i.e. cutting thousands of jobs, angering stock holders, breaking debt covenants, etc.). If you’re trained, armed, and ready, then you have a much better chance of surviving this crisis than a company who walks on the battlefield completely unprepared.

Cut Sooner And Cut Deeper

Oftentimes in this twilight zone of a crisis, soft cuts are ideal because they don’t hurt as much. This results in further cuts happening down the line when you find yourself scrambling to find a solution.

When we say “cut,” we don’t always mean cut people. Put on your thinking cap and re-engineer your company. Just because you’ve done things a certain way for 20 years doesn’t mean it should stay that way for the next 20. Times change and so should your company.

Years ago, I had a client who was spending upwards of a quarter of a million dollars on advertising in Yellow Pages. He found himself in a pickle despite the fact that the market was ideal for his company. Even though it hurt, he cut his marketing from $250,000 to $50,000 and allocated the $200,000 to other more vital places within the company. Because of this reallocation of resources, he was able to save his employees and the company.

There are many ways to do more with less. More money spent does not always correlate to higher productivity or efficiency.

Reallocate your resources from the old company to the new.

Restructure

There are two sides to restructuring: either the bank restructures the loan or the company restructures its operations. In simple terms, restructuring is when significant changes are made in the operations, structure, or debt of a company to avoid financial harm and improve the business. This should provide greater efficiency, if done correctly.

The strength of your operations can either cause your ship to sink, or deliver you safely to the shore. Managing your cash flow is of the utmost importance. Prioritize what is necessary to continue operations. Analyze what can be and needs to be cut. Improve productivityProject your cash flows. Manage your cash flows from there.

Debt restructuring essentially provides two options: continue operations or liquidate. If you are able to maintain and increase cash flow while reducing expenses, then continue operations. The goal is to at least break even.

Ultimately, the company needs to make a decision about when to jump ship. If after researching and analyzing operations, structure, and debt you find that you cannot make $1 profit, then the best case scenario would be to liquidate.

 (Be mindful of Expense Restructuring when restructuring your company.)

It’s not every day that you’re given the opportunity to restructure your company to have higher productivity and higher efficiency, thereby a higher net income. Be proactive, make the necessary cuts now, and live to fight another day.

(NOTE: Want more tips on how you can be a trusted advisor? Check out our whitepaper How to be a Wingman!)

HOW TO BE A WINGMAN

Reference: Wall Street Journal’s “Oil Sinks Below $40 Amid New Signs of Glut”

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Banks are Restructuring Troubled Loans

See also:

What You Should Know About Breaking Debt Covenants

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Trade Finance

See Also:
Trade Credit
Trade Account
Exchange Traded Funds
Currency Exchange Rates
Currency Swap

Trade Finance Definition

Trade Finance is the movement of assets, transactions, or investments overseas into other markets. To ensure the safety of a purchaser or seller trade finance, banks often provide a needed service to make the transactions as meaningful and as safe as possible.

Trade Finance Meaning

Many transactions among a buyer and a seller result in a prepayment or purchase on credit. This, of course, depends on the terms of the sale. These activities are often more risky for a buyer (importer) or a seller (exporter) because of the international arena in which they operate.

Finance methods often include a bank in transactions to reduce the risk. For example, if a buyer purchases goods on credit, then the seller may want to reduce its overall risk in the receipt of payment by using a trade finance bank. The bank would take part in the transaction by putting up a contract. Whereas, the bank will pay the seller and leave the buyer to pay the bank for the transaction of the goods. If a prepayment occurs, banks can assist in the documentation of the goods to be shipped. This ensures that the buyer is actually purchasing the goods it has paid for.

trade finance

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Private Placement

See Also:
Convertible Debt Instrument
Common Stock Definition
Preferred Stocks
Hedging Risk
Treasury Stock

Private Placement Definition

The private placement definition is the process of raising capital directly from institutional investors. A company that does not have access to or does not wish to make use of public capital markets can issue stocks, bonds, or other financial instruments directly to institutional investors. Institutional investors include the following:

You do not have to register private placement issuances with the Securities and Exchange Commission (SEC). In addition, you do not have to provide a detailed prospectus. The issuing company and the purchasing investors negotiates the terms and conditions are negotiated. You cannot trade private placement securities on public markets, but they can be traded privately among institutional investors after they have been issued by the issuing company.

A private placement is in contrast to a public offering, which is issued in public capital markets, requires a detailed prospectus, must be registered with the SEC, and can be traded by the investing public in the secondary markets.

Advantages and Disadvantages of Private Placement

The primary advantage of the private placement is that it bypasses the stringent regulatory requirements of a public offering. You have to conduct public offerings in accordance with SEC regulations; however, investors and the issuing company privately negotiate the private placements. Furthermore, they do not have to register with the SEC, do not require the issuing company to publicly disclose its financial statements, and ultimately avoid the scrutiny of the SEC.

Another advantage of private placement is the reduced time of issuance and the reduced costs of issuance. Issuing securities publicly can be time-consuming and may require certain expenses. It forgoes the time and costs that come with a public offering.

Also, because the investors and the issuing company privately negotiate private placements, they can be tailored to meet the financing needs of the company and the investing needs of the investor. This gives both parties a degree of flexibility.

Now, let’s look at the disadvantages of private placement. The main disadvantage of private placement is the issuer will often have to pay higher interest rates on the debt issuance or offer the equity shares at a discount to the market value. This makes the deal attractive to the institutional investor purchasing the securities.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

Private Placement, Disadvantages of Private Placement, Private Placement Definition
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Private Placement, Disadvantages of Private Placement, Private Placement Definition

 

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External Sources of Cash

See Also:
Angel Investor
Categories of Banks
Commercial Paper
Common Stock
Convertible Debt Instrument
Venture Capital

External Sources of Cash

In another article, I told you about Sue and generating cash from sources within her business. I will not detail her entire story at this time, but will tell you that we were successful in obtaining external cash allowing her to grow the business with the piece of mind of a constant and predictable cash flow.

We need to make sure we are all talking about the same thing when we hear or see the phrase “external sources of cash”. So, today I am going to define external sources of cash, and in the future, I will share situations where the different types are best utilized.

There are two sources of external sources cash for businesses: lenders and equity investors. I will begin with the least costly.


Download The 25 Ways to Improve Cash Flow


1st Source of External Cash: Lenders

Always remember that borrowing, no matter what the sources, will be less costly than equity. There are two classifications of lenders to discuss. However, within the classifications there are various sub categories. First and by far the least costly is traditional bank financing. What I am talking about here is when the bank takes all of the financial risk on your loan. Examples of these loans would be traditional lines of credit, loans for equipment, and building loans. Additionally, banks offer other products when they do not take all the risk and these products are more costly. Examples of these products are Small Business Administration (SBA) loans, equipment leasing, and factoring. Later in the series we will discuss the various differences in the lending philosophy of banks and different types of banks such as state vs. national, and community vs. multi state.

The second types of lenders are what I will call alternative lenders. Probably a term you may not be familiar with, but include such companies as asset based lenders, accounts receivable lenders, factoring companies and hard money lenders. These lenders take greater risk in their lending activities than banks. The reasons alternative lenders may be a better source than banks vary on a case by case basis. In future articles, each one of these will be discussed with examples and stories.

2nd Source of External Cash: Equity Investment

The second type of external cash for a business is equity investment. This by far is the most expensive cash or capital a business can acquire. You may be asking “why is this most expensive… I don’t have to pay it back”. Well, the answer is you are sharing part of your profits each year for the growth cash with your partner, and then upon the sale of the business, you share the return on equity with the partner.

Understanding the two different external sources of cash is critical because each or all may be needed in your business’s situation. For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

External sources of cash

External sources of cash

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Categories of Banks

See Also:
Bankers’ Language is Financial Jargon
Finding the Right Lender
Funding Source Versus Lender
How to Manage Your Banking Relationship
Interest Rate
Is it Time to Find a New Bank?
Commercial Bank

Categories of Banks

In another article, I told you the story about Robin’s company needing to perform due diligence on her lender. I made a reference to categorizing lenders into four groups, big market, middle market, small market and those in it for the money. I said I would share details of that conversation this week.

Robin asked me to explain which banks are in each category. I started by telling her that what she was about to hear was developed by a banker who has over twenty five years of banking experience.

Big Market Lenders

Big market lenders are the giant banks we all know, such as, JP Morgan Chase, Wells Fargo, Bank of America, etc. They have every banking and personal financial service known to mankind. They are located on almost every street corner in Houston and in most cities in America. Very good at all retail and financial services and loans over 20 million dollars. They will do smaller loans but you must fit precisely into their lending policies. Personal customer service is limited. If you are approved, you will normally deal with the internet or 800 numbers at regional service centers.

Middle Market Lenders

Middle market lenders are the ones most of us have heard of which include Comerica, Wachovia, Compass, etc. These banks follow the bigger lenders in the retail and financial services they offer. They really like loans from 5 million to 20 million dollars, but will do smaller loans. The advantage they have over big banks is their lending policies are a little more flexible, but not very much. If dealing with a human loan officer is important to you, these lenders are more involved than the big market lenders. But again, you will normally deal with a regional service center or the internet.

Small Market Lenders

Small market lenders normally are made up of banks that cover a region or a single state. Lenders you will recognize in this category are Frost, Sterling, Amegy, Regions, etc. These banks will have most of the retail and financial services offered by the bigger banks. They are very good with loans ranging from 2 million to 10 million dollars. The major advantage they have over larger lenders is their lending policies are more flexible and they have a better appreciation of local industries. Another difference is they still maintain and provide personal customer service. However, this customer service may vary between branches because it depends on the people running the branch. They have the capability of internet banking and 800 numbers, but you normally still deal with your local lending officer.

Local Community Banks

The lenders that are in the business for the money are the local community banks. Normally these lenders have five or fewer branches and the bank president is an owner.

They do not have all the retail and financial service capabilities of the larger lenders. These banks are very good at loans between 250 thousand and 3 million dollars. Most have limited internet capabilities, but will normally provide the customers with very good personal service. In this category, if they want your business they will try to make their lending policies fit your needs. A possible disadvantage in this category is the bank president may have a history of starting the bank and building the bank to sell to the larger banks. Many times, the bank president has built and sold several previous banks, so be ready to change banks with the president.

Robin summarized this discussion by saying “So I should evaluate the needs and values I have within my business and deal within the category that fits.” I agreed. To learn more financial leadership skills, download the free 7 Habits of Highly Effective CFOs.

categories of banks

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