Accountants can play a vital role for their clients when it comes to helping them understand the credit options available to them and how they can prepare a solid finance application. Accountants are an integral part of how we support their SMEs clients. They tend to be SMEs’ most trusted advisors as they understand the business and its needs.
They can help SMEs navigate the complex landscape of finance and can support the businesses in developing business plans and forecasts required to make the case for the finance application.
When considering the type of finance, the most important thing is to establish what the business needs the money for and what finance solutions could work for them. For example, if the money is needed for an asset, a five-year loan may be a good solution. If it’s for cashflow, then an overdraft, which can be arranged privately and externally to the business’ bank, might be more appropriate.
The first port of call should be the business’ bank as they understand the business and tend to have cheaper rates. If the business is eligible, they will be able to lend under the current Government emergency loans schemes including the Coronavirus Business Interruption Loan Scheme (CBILS) or the Bounce Back Loan Scheme (BBLS). The only issue with taking this route is that banks are currently inundated with applications so the pace may be a bit slower for any business looking to secure funds more quickly.
The British Business Bank has also accredited a number of alternative finance firms such as Funding Circle and Assetz Capital to deliver the coronavirus business interruption loan scheme.
These lenders have more flexible criteria, require less information and tend to process applications faster than banks. Their interest rates are higher, however if the business applies under the government schemes, the government is covering the interest for the first 12 months after which it may be able to refinance at a better rate when stability has returned to the markets.
Conventional lenders, outside of the government schemes, are still available but are more cautious. They may request different types of security including personal guarantees. Their rates will be higher than bank finance but the application should move substantially faster. Among these lenders, there are also several regional funds.
Once you have identified what the money is needed for and have explored the options available to the business, it’s time to start building a solid application.
So, what are the main elements that make up a strong finance application which SMEs need to consider when preparing for finance? At Choice Business Loans, we often compare credit applications to a three-legged stool: affordability, credit score and security. All three legs need to be as equal as possible when submitting a finance application.
The first leg is affordability. Lenders need to see that the business has a strong history of generating income. This will give them some reassurance that it will continue to generate a similar income in the future. Projections can be a useful way to demonstrate growth but they need to be backed up by past numbers.
A key metric used by lenders to determine affordability is the company’s earnings before interest, taxes, depreciation, and amortisation (commonly abbreviated EBITDA). After deducting all current financial obligations and after taking into consideration the current finance cost, lenders need to be able to see a surplus.
This surplus varies from lender to lender and is often dependent on the other two factors: credit score and security which leads us to the next leg, the company’s credit score.
The credit score shows to lenders that the business behaves responsibly with credit which includes paying bills on time or not bouncing payments due to insufficient funds showing in the bank account statements. Depending on the lender and/or the type of business, the company director’s personal credit score and the way they conduct business can also play a part in the decision making process. Every time an application is submitted, the director’s score goes down slightly so it’s worth avoiding multiple applications within a short period of time.
The third main element that lenders examine is security which provides them with a safety net. If the business cannot repay the finance, lenders need to be able to recover their funds. Security could include a charge on assets, personal guarantees from the director or having the right to take over receivables of the firm. The level of security varies is based on the perceived risk of the loans and can also contribute to shaping the interest of the loan.
And last but definitely not least, the current economic and socio-political environment. This plays a big role in finance applications. The global pandemic has led governments to intervene in markets while many lenders have stepped back from offering finance and the overall credit conditions are stretched.
It’s important to show lenders if or how the current situation has affected the business’ industry. If their industry has not been greatly affected by the outbreak then they will have more options available but if it has, it’s important to show lenders how the business is adapting and how it intends to recover and make a profit. This could include reviewing and adjusting forecasts and adjusting the business plan to indicate how the business will bounce back and make a profit again.
It’s worth noting that the concept of this three-legged stool applies mostly to companies looking to secure finance from High Street Banks in which case they will need a firmly built stool with three equal legs.
Borrowers who don’t fulfil those requirements need to keep an open mind and explore the market fully to identify lenders who will be willing to work with them to find a solution. Some lenders will forgive a poor credit record as long as they have suitable security while others will flex the degree to which affordability (or trading history) is required.
Others can be flexible on the type of security or, for the right business, will lend without any. When it comes to effective credit planning, businesses need to be aware of the options available to them on the market and understand what will work for their needs.
Sean O’Farrell is Managing Director of long-established finance brokerage Choice Business Loans which helps businesses access traditional forms of finance, as well as alternative ways of raising finance such as peer-to-peer lending, crowdfunding and private lenders.