Ever feel uncomfortable when you meet with your business banker because you’re not on top of the key business finance terms?
Below are some of the key terms explained and a note on why they are important to bankers.
Knowing how bankers approach lending decisions can save you time and money when seeking finance.
- Loan to Valuation Ratio (LVR)
This ratio is the loan amount as a percentage of the value of the security for the loan.
This maximum LVR (expressed as a percentage of the market value of the property) varies between different types of properties and between lenders. For example, the maximum LVR for residential properties is usually 80 per cent but for commercial properties it is often 70 per cent. Mortgage insurance is not available for business loans so if a loan exceeds the maximum LVR, lenders will treat the excess as unsecured and adjust the price (rate) of the loan.
Lenders use LVRs rather than the market value as the maximum fully secured loan amount because valuing property isn’t an exact science and they need to allow for changing economic circumstances and changing property values.
- Risk margins
Unlike home loans, business loans are often expressed as a base rate plus or minus a risk margin. The risk margin reflects the level of risk a lender sees in a business and it will vary from business to business. It doesn’t mean the lender thinks it is a risky business (if they did they would not make the loan).
For lenders this is the level of debt a business carries compared to the level of the owners’ equity in the business. The higher the level of debt, the more vulnerable a business is to interest rate increases and the more dependent it is on the ongoing availability of debt to keep operating. Lenders prefer lower gearing, though in many small businesses there is little equity so gearing is often high. This is one reason why many lenders require security for small business loans but are more willing to lend unsecured to bigger businesses.
- Working capital
This is current assets less current liabilities. Current items generally require payment within the next 12 months. Lenders look for the amount of and changes in the level of working capital as a way of seeing how “liquid” a business is. That means how comfortably the business can meet its current liabilities from the current assets it has on hand. Businesses need working capital, usually in the form of an overdraft.
Debtors are the people who owe your business money. They occur when you sell goods or services and allow the purchaser to pay later. Debtors are an asset as they will eventually pay you cash.
Creditors are people to whom you owe money. They are a liability as you will pay them cash.
An ‘aged’ listing of debtors or creditors shows how much is owed and to whom. This means you can see the number of days your debtors or creditors have been outstanding. Most accounting software packages will produce these reports. Lenders look at these reports to make sure businesses are not allowing long standing debts to accumulate and are paying creditors in a timely way. Late payment of creditors can be a sign a business is having cash flow problems or could be creating a poor reputation.
You can now impress your business banker by throwing in a financial phrase or two next time you meet! Got a term you don’t understand. Let me know in the comments section below and I’ll explain it for you.
Fiona Smith is a Greater Building Society Business Banking Specialist. Fiona has more than 15 years experience in financial services and a Graduate Diploma in Management. The Hunter-based Greater recently won the Roy Morgan Customer Satisfaction Award for Best Building Society for a record breaking 16th month in a row. It offers business banking as well as home loans and other financial services to customers across NSW and South East Queensland.