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A
Guide to Banking and Finance
How to approach
financial institutions?
>>Just like any other businesses when you get referrals from
the others, it is generally easier and less stressful to have your
friends and business associates introduce familiar financial institutions
to you.
If you do not know anyone who can refer a financial institution
to you, you can consult bank branches where you maintain personal
bank account. The branch manager will generally be glad to refer
you to their commercial departments when their marketing professional
will approach you to identify your financing needs.
Should I
choose banks or financial companies?
Whether to choose banks or finance companies depend upon your needs.
With the current development in the commercial finance sectors in
Hong Kong, there are increasingly more finance companies that are
providing professional financial services that can compare with
banks. Many commercial finance companies have started to provide
many new and more innovative financing that is not available in
banks.
The difference between obtaining financing from banks or finance
companies is becoming smaller and smaller. The most important factor
for you is to decide who is providing the most suitable financing
solutions for your company.
What do financial
institutions look for in granting loans to commercial enterprises?
Since financial institutions are risk averse, they would only finance
companies that they deem are of low risks. Of course, each financial
institution has a different way to evaluate risks and has different
degrees of tolerance of risks.
Generally speaking, financial institutions would evaluate the following
areas before deciding whether to grant credit facilities to a commercial
enterprise:
i) Management
ii) Acceptable financial conditions
iii) Collateral Value
iv) Sound and feasible business and plans
v) Positive outlook of industry
vi) Clean litigation records
- Management
Management is
the key to the success of any organization, regardless of its size.
Therefore, a financial institution will evaluate management to ensure
they have the ability to operate the company in ways that the company
that repays loans.
Some of the
key questions that you, as managers, will be judged by financial
institutions.
i. Is the management
competent and knowledgeable about their business?
ii. Is the management experienced in the business?
iii. Is the management committed to the business?
iv. Does the management/shareholder(s) have the resources to support
the business in the event of business difficulties?
v. Is the company too dependent on one or two key individual(s)
in relation to the size of the business?
If you have a new company, you should highlight the background and
experience of the key managers from their previous companies. You
should be emphasizing on the track records of these key managers.
A brief biography
of key managers is suggested. The biographies should contain the
following information:
a) Full name
of key managers
b) Titles and their area of responsibilities in the company
c) Age
d) Working experience and highlight past accomplishments
- Acceptable financial conditions
Financial statements
are basically one of the most important piece of information used
by financial institutions in evaluating a company's credit standing.
It is because decision-makers in a financial institution "Do
not generally" know SME personally. Financial statement is
an "Objective" report card of your business and it separates
between "Dream" and "Reality " of a SME.
Having financial
statements prepared and audited by an external auditor on a timely
basis will help financial institutions know your financial conditions
more clearly and objectively. This is especially important during
the current liquidity crunch in Hong Kong.
If your fiscal
year is March 31 and today is September 1, 1998, your audited financial
statements as of March 31, 1997 will be too "Old" and
financial institutions would not be able to ascertain your financial
condition in 1998.
If you are in
need of heavy financing support from financial institutions, you
can consider having your external auditor prepare your financial
statements twice a year. With better and more timely reporting,
you will be able to win stronger support from your financial institutions.
Some of the
areas on the financial statements that are important to financial
institutions are:
1. Stability
of revenues, gross margin, operating margin and net profits;
2. Amount of profits in relation to the size of your business;
3. Amount of cash flow in relation to the fixed obligations;
4. Amount of capital or commitment from shareholders;
5. Amount of debts borrowed from outside (both banks and suppliers);
6. Amount of short-term assets in relation to short-term liabilities,
i.e. working capital.
Some of the ratio analysis is required in the process of comparing
one selected financial statement value to another, they are as follow
:
1. Average collection
period ratio (ACP)
2. Inventory turnover ratio
3. Average payment period ratio (APP)
4. Debt-to-total capital ratio (DTC) or Debt ratio
5. Financial burden coverage ratio
6. Return on investment ratio (ROI)
7. Return on Owner's equity ratio (ROE)
If your business is operating in a declining position in the past,
you should be prepared to discuss with financial institutions your
plan to reverse the declining trend. Preparing a financial projection
for the next 12 months would assist such discussion.
- Collateral Value
There are several
types of collateral that are valued by financial institutions in
granting credit facilities to SME. They are:
1. Real estate
2. Cash deposits
3. Public company shares
4. Accounts receivable
5. Plant and Machinery
Historically, real estate is used primarily to form the borrowing
base by many financial institutions. In other words, when real estate
prices are high, amount of credit facilities extended to SME increase.
After the currency crisis, real estate prices in Hong Kong drop
significantly resulting in subsequent drop and reduction of credit
facilities available to SME.
Given the current
instability, financial institutions have become more conservative
in granting credit facilities to SME based on real estate collateral.
You should not rely on real estate to be primary collateral for
your financing needs.
Cash deposit
is the most popular form of collateral but of course it is limited
by the amount of cash you have or are able to pledge to financial
institutions.
Public company
shares can be used to pledge to banks to secure financing. However,
given the current volatility of the stock market, it will be difficult
to expect financial institutions to attach generous values to shares
collateral in credit facilities to SME.
Accounts receivable
is an increasingly popular form of collateral supporting financing
for SME in countries like Hong Kong. You will be able to discount
or/and sell your account receivable to financial institutions in
exchange for cash advances. The former is called invoice discounting
and the latter is called factoring.
There are several
areas that you need to know in accounts receivable financing:
1. Whether you
have a large number of debtors.
The large the
number of debtors, the easier it is for you to obtain accounts receivable
financing.
2. Whether your
debtors are of good quality.
The better the
quality of your debtors, the easier it is for you to obtain accounts
receivable financing.
3. Whether your
products are subject to significant product disputes or returns.
The lower the
potential dispute in your products, the easier it is for you to
obtain accounts receivable financing.
Plant and equipment
is another form of assets that you can use to obtain financing.
Since a significant number of manufacturers in Hong Kong have relocated
to the PRC, such assets are becoming less important in securing
financing for SME.
However, you
are still able to raise equipment finance from some finance companies
or banks that are offering leasing and hire purchasing of equipment.
As you can see
above, you need to evaluate the type of collateral you have and
whether you are able to pledge such collateral to financial institutions
to secure financing.
- Sound and
feasible business and plans
Financial institutions
will make judgement on a business' ability to stay viable. You need
to convince financial institution on your ability to compete and
your business is a value-added business. In other words, your company
will survive to repay the loans they make to you.
Business plans should be achievable with the resources (technical,
financial, operational) you have. Usually, it is sufficient to explain
your plans for the next 12 to 24 months.
It should be
noted that the more feasible is your business plans, the lesser
the amount of collateral a SME needs to pledge to financial institutions.
Of course, such business and plans are expected to be reflected
on the financial statements you present to financial institutions.
- Positive
outlook of industry
Financial institutions
will evaluate the business trend of various industries and form
opinions as to whether the industry is in an up or down trend.
If your industry
is subject to significant negative media coverage, you should take
initiative in explaining to financial institutions you company's
position and how you prepare to weather such negative trend. It
is your responsibilities to differentiate your company in the eyes
of financial institutions.
- Clean litigation
records
Past incidence
could provide hints and indications of the future. This is how financial
institutions see companies with litigation records.
If you have
been involved in litigation, you should be pro-active in explaining
to financial institutions the complete background of the litigation
and steps you are taking to resolve them
What is the
Information required by financial institutions
Information required by financial institutions Though financial
institutions have different information needs, they generally require
the following information for assessing whether to grant your credit
facilities:
1. Audited financial statements for the past two to three
years
If you do not have the recent year audited financial statements,
you will require to submit internal financial statements. Depending
upon the date of your most recent audited financial statements;
you may need to submit the recent monthly internal financial statements.
2. Collateral
information
Depending on the type of collateral that will be pledged to financial
institutions for credit facilities, you will be required to submit
the following collateral information.
3.Real
Estate - Contract of sale of real estate, address of real
estate, size of real estate, purchase price and current market value,
and outstanding mortgage or installment loans.
4.Accounts
receivable - Information of outstanding accounts receivable
such as debtor's aging report and names and addresses.
5.Public
company shares - evidence of purchase of shares, purchase
price and current market price
6.Plant
and equipment - Contract of purchase of plant and equipment,
type of equipment, serial number, and location of equipment.
7. Information
of production facilities -Information of production facilities
in China if you have a manufacturing base in China. This includes
operating license, joint venture contracts, and approval from the
local Government offices.
8. Information
of current orders - Information of current orders on hand
including purchase order, letters of credit and etc.
What is the
Typical approval process ?
To plan when you need to start discussion with financial institutions,
you should have some understanding of the approval process. The
following summarizes the typical approval process of a financial
institution for a revolving credit facility.
1. Discuss with financial institutions to identify your financing
needs (Typical length of time: 1 day)
2. You submit the above information to financial institutions for
review (Typical length of time: 5-30 days depending on whether enough
information is provided and whether real appraisal needs to be performed)
3. Physical visit to China production facilities, if applicable
(Typical length of time: Typically occurs simultaneously with the
step (2) above)
4. Verbal or written confirmation of type and amount of facilities
(Typical length of time: 1-2 days after step (2) is completed)
5. Financial
institutions go through internal approval procedures (Typical length
of time: 5-15 days depending upon the amount of facilities)
6. Execute legal documents (Typical length of time: 2-5 days )
7. Activation of facilities (Typical length of time: 1-2 days after
step (6) above )
Conclusion
Obtaining financing is a lengthy and complicated process. Understanding
how financial institutions "Think" will allow you to react
and respond appropriately. As a SME owner, you should view managing
financing relationship as important as managing customer relationship.
Being proactive and maintaining company transparency are keys to
success in building a long term and supportive financing relationship
with whatever financial institutions you will be working with.
Appendix:
Outline of information required for financial institution
Bundle of information you should plan on submitting to financial
institutions include the followings:
A. Business
Plans
1. Introduction
Purpose and amount of financing needed. How would you use the funds?
2. How much do you need to borrow and what will you do with it ?
Is your borrowing for capital investment or meeting your working
capital requirement?
Have you prepared a financial projection in support of your borrowing
requirement?
Does the financial projection indicate that the borrowing would
lead to an improved financial performance?
3. Company description
What is the business?
What are the products/services?
Where is the manufacturing operations and what is the current stage
of development of the production base?
Who are customers?
What is the uniqueness of the business, i.e. any patent, proprietary
technology and etc? In other words, how do you survive in the market?
4. Market analysis and description
What is the targeted industry and its outlook in the next 12 months?
Who are the competitors and what are their comparative market positions?
What is the regulatory environment in Hong Kong and customers' countries,
if products are for exports?
5. Description of current management
Who are the key managers of the company?
Describe their working experience, and academic background and accomplishments.
6. What is the development plans in the next 12 months?
7. Conclusion
B. Current financial statements
1. Description of current financial situations
How profitable is your business?
Any balance sheet, income statement and cash-flow statement included?
Do you use ratio analysis to assess your financial performance?
How often do you prepare financial statements?
Do you prepare budgets for different functional areas of your business?
How do you monitor the cash flow of your business? Do you have a
cash flow budget?
C. Audited financial statements
1. Directors report
2. Clean report
3. Profit/Loss account
4. Balance sheet
5. Notes to the financial statements
D. Collateral
information
1. Real Estate
2. Accounts receivable
3. Public company shares
4. Plant and equipment
Updated
till 27-May-2004
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