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Using Key Indicators as a Using Key Indicators as a Tool to Communicate with Tool to Communicate with
Your Lender Your Lender
… or, How to Keep Your … or, How to Keep Your Loans in Place in 2007Loans in Place in 2007
Jeff BaldwinJeff Baldwin Emma Shinn Emma Shinn
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Multiple Choice Quiz:Multiple Choice Quiz:
1. When your banker asks you for 1. When your banker asks you for your plan, the best approach in your plan, the best approach in communicating with your banker communicating with your banker is to:is to:a.a.Give them a plan, and make it look Give them a plan, and make it look
really good really good
b.b.Give them a plan that is so confusing Give them a plan that is so confusing they won’t be able to tell how well you they won’t be able to tell how well you are doing are doing
c.c.Don’t give them anything Don’t give them anything
d.d.None of the aboveNone of the above
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Multiple Choice Quiz:Multiple Choice Quiz:
2. When you are about to miss your 2. When you are about to miss your plan, the best approach in plan, the best approach in communicating with your banker communicating with your banker is to:is to:a.a.Act like everything is going to be okay Act like everything is going to be okay
and you will catch up in December and you will catch up in December
b.b.Present so much detail he won’t be able Present so much detail he won’t be able to figure out what is going on to figure out what is going on
c.c.Don’t say anything and hope it will get Don’t say anything and hope it will get better better
d.d.None of the aboveNone of the above
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Communicating with Your Lender
Topics include … Topics include …
1.1. Builder Financing 101 … a few Builder Financing 101 … a few basics about capital basics about capital requirements and sourcesrequirements and sources
2.2. The Lender’s Point of View … The Lender’s Point of View … your capacity to service debt your capacity to service debt
3.3. Key Indicators Used by Lenders … Key Indicators Used by Lenders … how they evaluate your healthhow they evaluate your health
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Builders often need financing for:Builders often need financing for: Work in processWork in process
Spec inventorySpec inventory
Other working capitalOther working capital
Land acquisition and Land acquisition and development development
Other fixed assets, ventures or Other fixed assets, ventures or investments investments
1. Builder Financing 1011. Builder Financing 101
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Capital Requirements and Sources
How will the funds be used?
How much financing is
needed?
What collateral is available?
How quickly is financing needed?
What sources of financing
provide funds for this
purpose?
Who provides financing of this size and
duration?
REMEMBER! Don’t finance
long-term assets with short-term
debt!
What sources of financing do/do not require
collateral?
What sources are most easily approachable?
REMEMBER! Investors take a long time to
decide!
Ask yourself the following questions:
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The answers to these The answers to these questions will help you target questions will help you target the right sources and types of the right sources and types of financing …financing …
And avoid the common mistake And avoid the common mistake of financing a long term need, of financing a long term need, such as land development, with such as land development, with short term borrowingshort term borrowing
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Three Important StepsThree Important Steps
1.1. Know your requirementsKnow your requirements::– Purpose, size, timingPurpose, size, timing
2.2. Determine the appropriate type and Determine the appropriate type and source of financingsource of financing::– Work in process or other working capital loanWork in process or other working capital loan– Construction loansConstruction loans– Land acquisition & development, or other Land acquisition & development, or other
“project” loans“project” loans– Other capital investmentOther capital investment
3.3. Present a business plan which Present a business plan which demonstrates that cash flow will service demonstrates that cash flow will service the debtthe debt
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Demonstrate Your Strategic Thinking Process
Strategic Strategic DecisionsDecisions
Detailed PlanningDetailed Planning
Financial PlanFinancial Plan
Management Management PlanPlan
Production PlanProduction Plan
Analysis Analysis Business PlanBusiness Plan
Market DefinitionMarket Definition
Competitive Competitive AnalysisAnalysis
Market Market SegmentationSegmentation
ProductsProducts
Operating Operating ResultsResults
Financial Financial ConditionCondition
Cash FlowCash Flow
Market TargetingMarket Targeting
Market Market PositioningPositioning
ManagementManagement
Sources of Sources of FundsFunds
Users of FundsUsers of Funds
MarketingMarketingProgramsPrograms
ProductionProduction
Management & Management & StaffingStaffing
Revenue & Revenue & ExpensesExpenses
Market PlanMarket Plan
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Provide financial projections thatProvide financial projections that::
Demonstrate your “strategic” thinkingDemonstrate your “strategic” thinking
Demonstrate sound execution strategiesDemonstrate sound execution strategies
Are consistent with your business planAre consistent with your business plan
Are supported by key assumptionsAre supported by key assumptions
Identify the key revenue and cost drivers Identify the key revenue and cost drivers
… … and include and include the key the key
performance indicatorsperformance indicators
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2. Lender’s Point of View…
In order to obtain the most appropriate financing, the builder needs to understand the concerns of the lender.
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ECONOMIC PERSPECTIVE:•Domestic and foreign influences •Regulation and policy•Technological change •Market / customer expectations
INDUSTRY PERSPECTIVE:•Industry life cycle•Industry benchmarks•Competitive pressures•Capacity (supply and demand)
OPERATIONAL PERSPECTIVE:•Management•Processes and controls•Production efficiencies•SWOT analysis
Sources: Government publications and bank policy
Sources: Internet, databases, regional news services and industry specific publications
Sources: Business plan, site visit and meetings, industry expertise
Banks usually consider the big picture …Capacity to Service Debt
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ECONOMIC PERSPECTIVE:•Federal deficit •Interest rates•Market expectations
INDUSTRY PERSPECTIVE:•Mortgage defaults•Sales decline•Inventory levels
OPERATIONAL PERSPECTIVE:•Management experience•Cycle times•Inventory levels: land & WIP
Currently, there are Red Flags at all levels …
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When you ask lenders about theWhen you ask lenders about thecurrent environment: current environment:
“… “… what do you look at for home what do you look at for home builder loans that is different from builder loans that is different from the pastthe past?” ?”
Many respond with two words:Many respond with two words:
Staying PowerStaying Power
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How do lenders evaluate “Staying How do lenders evaluate “Staying Power”?Power”?
Debt to equityDebt to equityLiquidity, i.e., current ratio and working Liquidity, i.e., current ratio and working capital capitalComponents of working capital, i.e., Components of working capital, i.e., inventory, specs, etc. inventory, specs, etc.
Note that all of these are balance sheet Note that all of these are balance sheet indicators – which many builders ignoreindicators – which many builders ignore
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One thing has not changed …
The single most important factor in the bank’s decision to lend, is the company’s …
Capacity to service debt
Lender’s often evaluate this by looking at several key indicators.
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Key indicators are criteria that help to evaluate the financial condition, or health, of a company.
These criteria include both financial ratios and other signs that point to the health - or sickness - of a company.
3. Key Indicators Used by Lenders
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Key Financial Indicators
Lenders examine key indicators related to these areas:
Liquidity and financial stability
Balance sheet and capital structure
Turnover of assets Cash Flow Operating performance
– Return on assets– Return on equity– Benchmark to industry
standards Sales trends
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Key Financial Indicators
Definitions of the most common financial ratios:
DefinitionRatioCurrent Ratio
Asset Turnover
Debt to Equity
Net Profit Margin
Return on Assets
Return on Equity
Current Assets / Current Liabilities
Sales / Total Assets
Total Liabilities / Net Worth
Net Profit / Sales
Net Profit / Total Assets
Net Profit / Total Equity
2020
Key Financial Indicators
The primary financial ratios used :
RatioRatio BestBest OkayOkay Red FlagRed Flag
Debt to EquityDebt to Equity < 2.5< 2.5 ~ 4.0~ 4.0 > 7.0> 7.0
Current RatioCurrent Ratio > 1.5> 1.5 ~ 1.2~ 1.2 < 1.0< 1.0
Net Profit to SalesNet Profit to Sales > 10%> 10% ~ 4%~ 4% < 0< 0
Gross Profit to Gross Profit to SalesSales
> 25%> 25% ~ 20%~ 20% < 15%< 15%
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Key Financial Indicators
The secondary financial ratios used:
RatioRatio BestBest OkayOkay Red FlagRed Flag
Return on Assets Return on Assets > 25%> 25% ~ 10%~ 10% < 5%< 5%
Asset TurnoverAsset Turnover > 3> 3 ~ 2~ 2 < 1< 1
Inventory TurnoverInventory Turnover > 2> 2 ~ 2~ 2 < 2< 2
Specs to Total Specs to Total InventoryInventory
< 10%< 10% ~ 25%~ 25% > 50%> 50%
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Key Financial IndicatorsOther financial ratios sometimes used:
RatioRatio BestBest OkayOkay Red FlagRed Flag
Operating Operating Expenses to SalesExpenses to Sales > 12%> 12% ~ 16%~ 16% > 20%> 20%
Revenues to Revenues to Working CapitalWorking Capital > 10> 10 12-1412-14 > 17> 17
Months of Interest Months of Interest CarriedCarried > 24> 24 1818 > 18> 18
Profit on EquityProfit on Equity > 50%> 50% 25-40%25-40% < 15%< 15%
Percentage of Percentage of Profit DistributedProfit Distributed > 50%> 50% ~ 50%~ 50% > 70%> 70%
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When bankers are concerned about the When bankers are concerned about the accuracy and reliability of financial accuracy and reliability of financial statements provided by a company, they statements provided by a company, they often consider other indicators:often consider other indicators:
• Track record of meeting sales and delivery Track record of meeting sales and delivery commitments commitments
• Cash balancesCash balances• Credit history and terms that suppliers are Credit history and terms that suppliers are
offeringoffering• Supporting evidence that tax payments and Supporting evidence that tax payments and
payroll obligations are currentpayroll obligations are current• Sales prices and trends Sales prices and trends • Sales pace and trendsSales pace and trends• Reputation among competitors, creditors, and Reputation among competitors, creditors, and
within industrywithin industry
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Footnote: Footnote:
Your lender is likely to have their Your lender is likely to have their own criteria – talk to them to find own criteria – talk to them to find out what they are looking for.out what they are looking for.