By Robert A. (Bert) Talerman
Just like the individuals who run them, businesses depend on key relationships in their efforts to sustain, evolve, and grow. These relationships include those with customers (without customers, there is no business), employees, vendors, attorneys, accountants, bankers, and other key advisors. I’m going to focus on the importance of the commercial banking relationship.
To some, the commercial bank can be viewed merely as a place to deposit their money, process transactions, and borrow funds. However, a good commercial banker wants for the business all the same things that the business owner desires for their business – financial strength, profitability, growth, and the achievement of identified financial goals. It only works when the business owner achieves their financial goals and is successful in a safe and sound manner. The right commercial banker for the relationship is one who is viewed by the business owner as a trusted financial partner.
Good commercial bankers want to understand your business and should explain how the banking part of the transaction works. Banking services are no different than any other product or service that a business owner utilizes and acquires, although the case could be made that banking services are one of the essential services for long term success – safe storage of funds, processing of transactions, the availability of loans, and generally facilitating commerce. Invite your banker to your business and show them how it works, explain the supply chain, what makes you unique, your short term and long term goals, your challenges.
This should be an ongoing part of the commercial banking relationship. Furthermore, your commercial banker is bound by various confidentiality requirements so your information cannot be shared with others outside the bank. Equally important, ask your commercial banker about their business and make sure you understand the products and services that you are using. Again, your banking services are an essential part of how you run your business and you need to and want to understand what is involved.
Additionally, it is beneficial for you to understand how the bank makes loan decisions and what ratios are important in that process.
One of the key factors in making loan decisions is a variety of key ratios that commercial bankers take into account.
The ratios used to determine creditworthiness should not be a mystery to the business owner. These ratios are essentially measures of financial capacity that are equally as important to the business owner as to the banker. Fundamentally, bankers care first and foremost about cash flow and the ability to repay a loan. This should be no different than your primary concern – the ability of your business to generate the necessary cash to pay all your bills including the principal and interest of your loan, with a surplus for you. When this works comfortably, you are able to continue to grow your business. The term that bankers use here is “debt service coverage”, generally defined as the ratio of the cash that is available after you have paid all your business expenses and taxes, divided by the interest and principal on all your loan obligations. Banks generally look for a 20 percent to 25 percent surplus here, so that there are funds left over for future investment.
Two other key things bankers look for are “liquidity,” generally defined as cash on hand, and “net worth,” generally defined as the difference between assets and liabilities. Cash on hand is important because it is how everything is ultimately paid for and it provides flexibility. Having more assets than liabilities is also important; the more assets that are actually owned, the less of a financial strain it puts on the business operation. Discussing these ratios with your banker will help you as you plan for the future.
While the ratio discussion above may be somewhat simplified, the key issue for businesses, just like individuals, is balancing the amount of cash the business generates against the amount it needs to meet its obligations, future investment, and savings. Just like individuals, businesses cannot survive with too much debt and have to make difficult choices about where to deploy their resources. Working closely with your commercial banker, your trusted financial advisor, will make it easier to manage the finances of your business.
Remember that your relationship with your commercial banker is like any other relationship: it will go through ups and downs, and it requires effort on the part of both parties to make it effective and rewarding. Make it a priority to understand the finances of your business and make your commercial banker a part of that journey.
Robert A. (Bert) Talerman is First Executive Vice President and Executive Lending Officer at Cape Cod Five Cents Saving Bank. He can be reached at (508) 247-2142 or rtalerman@capecodfive.com.
