Financial Reports and Lending Decisions

There are several things I would want to know before lending money to anybody. One of these is the audited financial statements for the past three years. The reason I want to see the audited financial statements is because the auditing process ensures the reliability and truthfulness of the statements. Statements that are unaudited are simply not worth the paper they are printed on – the auditing process will uncover irregularities, and I\\'m going to need that in order to lend money. Furthermore, the auditor\\'s report puts a stamp of approval – knowing that a professional auditor has signed off on the financial statements is an important part of the process of ensuring that I am making my decision to lend or not lend based on sound information about the financial condition of the company (Crawford, 2018).

On the surface, the information that Jason provided seems fine enough. I would not make the decision based on these numbers alone, but in theory a current ratio of 3.1 points to a company that is solvent. That asset turnover is improving is also a positive sign, in terms of the cash conversion cycle. If net income and EPS are up, that is also good, though as a creditor I\\'m much more concerned with free cash flow and whether my debt is subordinated – but it is definitely a good sign that these numbers are going in the right direction. However, there are definitely some other things I would need to know.

One is that the financial statements will tell me the raw numbers. It is not actually relevant that net income is up if Jason\\'s financials are based on a lemonade stand and he\\'s borrowing to buy diamond-mining equipment. We have to know if the company can specifically handle borrowing the dollar figure that it is asking for, and that is not something that these particular numbers can tell us. This is what is known in banking as capacity.

The second thing I need to know is the collateral, or capital, that the business has. In other words, I need to be able to secure this loan somehow. It might be able to secure it against whatever equipment Jason is buying, but maybe I cannot. It is important to know, if I am lending to a small or medium-sized business, what assets that business has against which I can secure my debt investment (Kiisel, 2013).

Hayes (2018) notes that there are several other ratios that can help determine the financial health of the company. Three ratios that would also be important are the cash ratio, the accounts receivable turnover and the inventory turnover. The cash ratio is important because it highlights how much cash the company has to meet its obligations – the current ratio can be distorted by high values for inventory that won\\'t be sold, or accounts receivable that are unlikely to be received.

This is also why I want to know the inventory turnover and accounts receivable turnover. These actually tell me more than the asset turnover. The inventory turnover should be healthy – the company should be able to move its inventory at a regular pace. The accounts receivable turnover should also be healthy – the company should be able to collect from its customers. Let\\'s put in this way - if it is moving inventory but not getting paid for that, this is something that would concern me as a banker. If it\\'s not even moving inventory, that also worries me. These are the sorts of ratios that can help to truly define just how health the company actually is.

So at this point, I\\'ve asked for the full financial statements, some other ratios, and I need to know things like free cash flow, capacity, and collateral. I also in this case would need to know more about Jason\\'s character (Kiisel, 2013). Many bankers lending to small business want to know that the company has a management team that it can place faith in, that it can trust that the people running the company are not only honest in their dealings but capable of executing the plans that they say they are going to. If Jason is looking to borrow equipment on an 8-year time frame, that is a long time frame for a small bank. That time frame therefore has to align with the equipment that\\'s being bought, and Jason\\'s business will need to have a fairly long track record of success, not just a couple of years, otherwise lending for such a long time frame is incredibly risky for my bank.
At present, I have to say that I would not lend to Jason. The reality is that I don\\'t have the financial statements. I have unaudited ratios provided by the person who is asking me for money. Even if those numbers are taken at face value, there\\'s no sense of how they align with the dollar figure being requested, what the dollar figure will do to the financial health of the company, what the company wants to do with that money, whether I think it can do that, or any of the other variables. There is zero chance I\\'m lending based of four back of envelope numbers – they are worth less to me in making this decision than a chocolate chip cookie recipe. At least I can do something with a cookie recipe. I can\\'t do anything with these numbers as they are presented.
One things a banker has to always remember is not be badgered into making a decision where there is data deficiency. The question of would I recommend approval is premature at this stage – get me some real data, some real operational information, audited financial statements, and then a thorough assessment can be performed. No thorough assessment, I won\\'t even look at the application, much less render a decision on it.


References

Crawford, C. (2018). The importance of audited financial statements of a business firm. Your Business Retrieved March 15, 2017 from https://yourbusiness.azcentral.com/importance-audited-financial-statements-business-firm-17757.html

Hayes, A. (2018). Ratio analysis: Using financial ratios. Investopedia. Retrieved March 15, 2017 from https://www.investopedia.com/university/ratio-analysis/using-ratios.asp

Kiisel, T. (2013) The five Cs of small business lending. Forbes. Retrieved March 15, 2018 from https://www.forbes.com/sites/tykiisel/2013/11/05/the-five-cs-of-small-business-lending/#719ed0c9555a