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The Relationship Between Financial Management and Loan Underwriting

Posted on October 28th, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

In my previous article, “Securing a Small Business Loan Revisited,” I went over the phases of approaching a bank for a small business loan, wherein I made this observation: “In recent articles I’ve also talked about the importance of using an appropriate method of accounting, budgeting, and strategic financial planning. The reasons these activities are important are twofold: 1) managing your business’ growth, profitability, and cash flow; and 2) obtaining outside financing as and when needed.  This article revisits some earlier articles I’ve written on the topic of obtaining bank financing, but the two objectives are very closely intertwined, as banks first and foremost want to know if you are addressing reason number 1.

What I was referring to above was a section on the topic of Understanding the Lender’s Underwriting Criteria from another article, that concludes with this statement:

“Even a brief examination of these points suggests the need for you to do your homework before making a loan request, because an experienced loan officer will ask probing questions about each of them. Failure to anticipate these questions or providing unacceptable answers is damaging evidence that you may not completely understand the business and/or are incapable of planning for your firm’s needs.” (Securing a Small Business Loan – Part III: the Application)

The point is, the lender wants to know how you manage your business financially, because that has a direct bearing on if and how your loan can be repaid.  So exactly what ARE some of the things (experienced) lenders are looking at, and why:

  • Profitability:  A business that has historically lost money, and is continuing to lose money, is on its way out of business.  The lender’s loan cannot be repaid, nor can it prevent the business from failing in the long run.
  • Debt Service Coverage:  The adequacy of existing (NOT projected) profit and cash flow to fund both existing and proposed loan payments.
  • Balance Sheet Leverage:  The amount of debt in the company in relation to its net worth. The more debt the company has, the more susceptible it is to swings in sales, profit, and cash flow, particularly for a company that has thin margins to begin with.
  • Liquidity and Turnover Ratios:  The ability of the company to fund day-to-day operations through internally generated cash flow.  A negative net working capital position can jeopardize the business’ ability to meet payroll, pay suppliers when due, make loan payments on time, and fund many other short-term cash needs.
  • Sales Growth:  The faster the business’ growth, the more cash flow that is consumed by “permanent” increases in working capital.  This is due to the cash required to support the related increases in accounts receivable, inventory, labor costs, and so on, that far exceed the company’s internally generated profit and cash flow – until the growth levels off.  This type of funding need can bankrupt a company if it goes unchecked, and most “traditional” banks are usually not staffed and equipped to provide this specialized type of financing.
  • Funds Management:  The proper matching of sources and uses of funds. For example, the funding of major capital expenditures out of cash flow, or with short-term debt, can severely cripple a business financially, the same as poor liquidity can as discussed above.

If you need assistance in better understanding the above issues, see below articles for more information.  Or, if you need help with working with a lender, just give us a call.

Related Articles:

Securing a Small Business Loan: Winging It

The Effect of Operating Losses On Cash Flow

The Difference Your Method of Accounting Can Make

The Ratios: Which Are the Most Important?

The Relationship Between Turnover Ratios and Cash Flow

The Effect of Sales Growth On Cash Flow

The Effect of Funding Fixed Assets Out of Cash Flow

Case Study: The Risk of Sales Concentrations


Securing a Small Business Loan Revisited

Posted on October 22nd, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

From time to time I receive emergency requests from clients who need to provide financial information to a bank, but they are months behind getting us the information we need to complete their financial statements.  In recent articles I’ve also talked about the importance of using an appropriate method of accounting, budgeting, and strategic financial planning. The reasons these activities are important are twofold: 1) managing your business’ growth, profitability, and cash flow; and 2) obtaining outside financing as and when needed.  This article revisits some earlier articles I’ve  written on the topic of obtaining bank financing, but the two objectives are very closely intertwined, as banks first and foremost want to know if you are addressing reason number 1:

Step 1: Establishing a Banking Relationship

At some point, most small businesses owners will visit a bank or other lending institution to borrow money. Understanding what your bank wants, and how to properly approach them, can mean the difference between getting your money for expansion and having to scrape through finding cash from other sources. Unfortunately, many business owners fall victim to several common, but potentially destructive myths regarding financing, such as:

  • Lenders are eager to provide money to small businesses.
  • Banks are willing sources of financing for start-up businesses.
  • When it comes to seeking money, the company speaks for itself.
  • A bank, is a bank, is a bank, and all banks are the same.
  • Banks, especially large ones, do not need and really do not want the business of a small firm. Read More

Step 2: Positioning

Walking into a bank and talking to a loan officer will always be something of a stressful situation.  Preparation for and thorough understanding of their evaluation process is essential to minimize the stressful variables and optimize your potential to qualify for the funding you seek.  Read More

Step 3: The Application

Lending is the essence of the banking business and making mutually beneficial loans is as important to the success of the bank as it is to the small business. This means that understanding what information a loan officer seeks–and providing the evidence required to ease normal banking concerns–is the most effective approach to getting what is needed by the lender.  Read More

Related Articles

Securing a Small Business Loan – Winging It

The Effect of Operating Losses on Cash Flow

Larry’s Debt Repayment Strategies, Inc.

Cash Flow Expressed as Asset-Based Borrowing Availability




Three Most Common Budgeting Errors

Posted on October 15th, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

When it comes to creating a budget, it’s essential to estimate your spending as realistically as possible. Here are three budget-related errors commonly made by small businesses and some tips for avoiding them.

  1. Not Setting Realistic Goals. It’s almost impossible to set spending priorities without clear goals for the coming year. It’s important to identify, in detail, your business and financial goals and what you want or need to achieve in your business. And a major category to consider is the impact of sales growth.  An unrealistic forecast here will not only give you a false reading of your future funding requirements, but also discredit your business plan with prospective lenders right from the start.

As a case in point, a while back I was working with a client to put together a business plan to assist him in obtaining financing for his company.  I started the process by asking him to forecast his sales for the remaining 3 quarters of the year.

After struggling with it a few days, he came back with a spreadsheet indicating six percent sales growth in the second quarter, nine percent in the third quarter, and twelve percent in the fourth quarter.  And my immediate response was, “OK, now write in the margin, ‘ha, ha.’” (we had that kind of humorous relationship).

“Now here is what I really want to know: What are your customers going to buy from you?  And if you don’t know, call them and ask them.” (In his line of business his customers would know this). When he finally did obtain this information, the projected sales growth far exceeded his initial guess, having major implications for the amount and type of financing he was going to need to fund this growth. (See Testimonials under “Growth Funding”.)

  1. Underestimating Costs. Every business has ancillary or incidental costs that don’t always make it into the budget–for whatever reason. A good example of this is buying a new piece of equipment or software. While you probably accounted for the cost of the equipment in your budget, you might not have remembered to budget time and money needed to train staff or for equipment maintenance.

In addition, you also need to make sure you’ve arranged financing for the purchase of the equipment with the appropriate source of funds, usually long-term-debt.  If you neglect to do this and instead purchase the equipment out of cash flow, you can jeopardize your company’s ability meet payroll, pay suppliers, or basically, to operate.

  1. Failing to Adjust Your Budget. Don’t be afraid to update your forecasted expenditures whenever new circumstances affect your business. Several times a year you should set aside time to compare budget estimates against the amount you actually spent, and then adjust your budget accordingly.

In QuickBooks, there is a budget feature that allows you to create reports with such a comparison. You can project your Profit and Loss as well as your balance sheet and cash flow.  However, projecting your balance sheet is the tricky part, as changes in accounts receivable, inventory, and accounts payable, are a function of your sales growth and turnover ratios , and QuickBooks does not do this for you automatically (nor do most other business plan and projection software programs I’ve seen).

So, I use the QuickBooks budget feature for the Profit and Loss portion only so that I can compare my actual operating results with my original budget. I then export that to EXCEL to be incorporated into a more advanced projection model I use (sample) that can forecast the above balance sheet changes based on historical or expected turnover rates, and in turn, the funds needed to support those changes. I then update the projected data with actual operating results each month so that I can forecast the company’s cash requirement through the end of the year and beyond.

Budgeting and forecasting is not easy for most small business owners who are usually not accounting oriented and have “better things to do” with their time. So as I’ve stated in previous articles, if you need help with it, consider contacting a financial professional.

Related Articles:

Strategic Financial Planning vs. Crisis Management

The Risks of Misinterpreting Your Financial Statements

The Effect of Sales Growth on Cash Flow

The Importance of Cost Accounting in Financial Planning

Analyzing the Components of Cash Flow

The Relationship Between Turnover Ratios and Cash Flow


The Risks of Misinterpreting Your Financial Statements

Posted on October 7th, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Many small business owners I’ve known view their financial statements as something that is only needed for tax purposes. However, to ignore or misinterpret what your financial statements are telling you, and then not utilize that information to forecast where your business is headed, can be a recipe for major disappointments, or worse, a future financial disaster.

I have written numerous articles that touch on this topic in one way or another. Here “in a nutshell” are the financial risks that you could be exposing your business to:

  • Loan Application Declined – You get turned down for a business loan because your tax return is showing a “loss,” when your business is actually profitable. (See topics on “accrual vs. cash basis accounting,” and “establishing lender relationships”).
  • Taxable Income vs. Operating Losses – Your tax return indicates you are making a “profit,” but your business is actually losing money. As sales decline, cash flow may temporarily increase due to declining accounts receivable and inventory.  But eventually, all of your cash is drained out of the business due to the underlying losses until it, and maybe you, are bankrupt. (See topics on “accrual vs. cash basis accounting,” “profit vs. cash flow,” and “turnover ratios”).
  • Past Due Loan Payments – You’re defaulting on loan payments even though your tax return is showing a profit. (See topics on “accrual vs. cash basis accounting,” “loan repayment,” “cash flow,” and “income vs. cash flow”).
  • Profit but No Cash– Your financial statements are showing a profit, but your checkbook doesn’t reflect that and you’re running out of cash.  Possible causes are rapid sales growth, or your receivable collections, inventory purchases, or accounts payable, are poorly managed, or sources and uses of funds are not properly matched. (See topics on “sales growth,” “sales concentrations,” “turnover ratios,” “cash management,” “asset-based borrowing availability,” and “matching of sources and uses of funds.”)
  • Inability to Sell the Business – Over the years, you’ve done a great job of minimizing (or avoiding?) taxes. But then when you’re ready to retire, on paper, your business isn’t worth anything in the eyes of prospective buyers. (See topics on “exit strategies,” “accrual vs. cash basis accounting,” “financial planning” and “budgeting.”)

Related Articles:

For more information on these topics, browse our blog articles (including in the archives off to the right) in our website at  To better understand the difference between our firm and other accounting and bookkeeping firms, view these articles specifically:

The Difference Between Your CPA and a Controller: M-1

Why Outsource Your Bookkeeping?

 The Opportunity Cost of Being Your Own Bookkeeper

The Importance of Cost Accounting in Financial Planning

Posted on October 1st, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Can you point your car in the direction you want to go, step on the gas, and then sit back and wait to arrive at your destination?

Not quite. You can’t let your business run on autopilot either and expect good results. Any business owner knows you need to make numerous adjustments along the way – decisions about marketing, pricing, hiring, investments, and so on.

So, how do you handle the array of questions facing you?  A critical part of the decision-making process is financial planning, of which a major component is cost accounting.

Cost Accounting Helps You Make Informed Decisions

Cost accounting reports and determines the various costs associated with running your business. With cost accounting, you track the cost of all your business functions – raw materials, labor, inventory, and overhead, among others.

Note: Cost accounting differs from financial accounting because it’s only used internally, for decision making. Because financial accounting is employed to produce financial statements for external stakeholders, such as stockholders and the media, it must comply with generally accepted accounting principles (GAAP). Cost accounting does not.

Cost accounting allows you to understand the following:

  1. Cost behavior. For example, will the costs increase or stay the same if production of your product goes up?
  2. Appropriate prices for your goods or services. Once you understand cost behavior, you can tweak your pricing based on the current market. (Sample Price/Volume Analysis.)
  3. Budgeting. You can’t create an effective budget if you don’t know the real costs of the line items. (Sample Budget.)

Is It Hard?

To monitor your company’s costs with this method, you need to pay attention to the two types of costs in any business: fixed and variable.

Fixed costs don’t fluctuate with changes in production or sales. They include:

  • rent
  • insurance
  • dues and subscriptions
  • equipment leases
  • payments on loans
  • management salaries
  • advertising

Variable costs DO change with variations in production and sales. Variable costs include:

  • raw materials
  • hourly wages and commissions
  • utilities
  • inventory
  • office supplies
  • packaging, mailing, and shipping costs

Cost accounting is easier for smaller, less complicated businesses. In QuickBooks, you have the ability to perform “Job Costing,” which is a fairly simple method of associating the related costs to specific customer sales.  This is great for service based companies, or those buying and reselling a single product or products.  The trickier part is getting the costs and revenues into the same accounting period, which QuickBooks does not do FOR you.  At this point manual accounting adjustments are required.

If your product has component parts that make up the final product, you have “Inventory Assemblies” which is a quite a bit more involved in QuickBooks.

Either way, you first need to understand these costs before you can plan your business and make informed business decisions. The more complex your business model, the harder it becomes to assign proper values to all the facets of your company’s functioning. If you’d like to understand the ins and outs of your business better and create sound guidance for internal decision making, consider getting help from a financial professional to set up a cost accounting system that fits your business model.

Related Articles:

Strategic Financial Planning vs. Crisis Management

The Effect of Sales Growth on Cash Flow 

Case Study: The Risk of Sales Concentrations