If We Build It, Will They Come?Posted on July 30th, 2017
Outsourced Accounting Department, Inc.
Recently I was asked by a banker to prepare a set of projections for a loan they were considering for one of their customers. The owner wished to expand his facility to increase sales, and wanted to borrow a large amount of money to purchase a new building. From the point of view of the owner, the purpose of the projections was to create a business plan the banker asked for. However, from the point of view of the banker, the unspoken purpose of the projections was to determine if the business could repay the loan.
The banker’s real question here is, “What if” they DON’T come? In other words, how solid are the revenue forecasts, and what happens if they don’t materialize? Can the business still absorb the payments on the new debt? Understanding this, rather than jumping into creating a fluffy business plan, I put on my CFO hat and prepared a preliminary set of projections based on the business’ existing sales pattern and cash flow.
To illustrate, below is the sample company I’ve used in my last few articles. I’ve now made the assumption that the company borrows $1.8 million to buy a new building. It’s also assumed that its sales forecast for the rest of the current fiscal year is NOT affected by its expansion into its new facility (i.e., the owner’s expected sales growth from expansion into its new facility is based purely on speculation, NOT on any firm sales orders).
Note first on the company’s P&L the doubling of interest expense from July on. Then look at the Cash Flow Statement. For the entire year, the projected “Cash Flow After Debt Service” is a negative $252,000 (rounded). Now, look below at the projected “Over Advance” of $241,000 for the year. Obviously, no bank is going to (knowingly) lend more money to a business to help it pay back its existing loan. So, all this number indicates is that without an immediate boost in sales, this deal does not work.
The question now is, does either the owner, OR the bank, want to risk that this game plan will not work? Hint: First, banks are not investment houses, and therefore, are traditionally risk averse. So the only remaining question is, what is the owner willing to risk if he is “lucky” enough to get his loan approved?
Again, this is the importance of financial planning. It’s always best to think these things through before incurring the time and expense of going through a loan application process only to get your loan turned down, or worse yet, getting your loan approved only to end up in bankruptcy or out of business.