Bank Operating Line of Credit and Letters of Credit

 by: Jay Chatterjee  

 

 


Banking - Business Loan Application 

Operating Lines of Credit and Letters of Credit 

You are probably wondering what a series on business banking essentials is doing on a natural health website. 

Well, stress caused by financial worries will eventually adversely affect your health. Many business owners operate under constant financial pressure, and this series on commercial banking and commercial finance will arm them with the knowledge that they need to deal confidently with diverse business situations, and with their bank managers. Knowledge is comforting, it is the fear of the unknown that is stressful. 

How can I help you? I obtained my Chartered Accountant designation (I'm retired now) in Australia. Upon moving to Canada, I worked for a wholly owned Canadian subsidiary of an American bank. Over time, I rose to become the Senior Vice-President responsible for the commercial finance division. This division granted flexible operating lines of credit, which included letters of credit for importers. In this career, I encountered numerous different types of businesses including trading, manufacturing and importing. 

This is not intended to be a detailed accounting or banking course. I have put together the essential information you need in order to give yourself the best chance of succeeding in your business. I shall tell you what your bank manager would like to hear from you at your meetings. I shall tell you the early warning signs that your business needs positive action. 

These comments are not for retail business; they apply to wholesalers, importers and manufacturers. 

To cover the vast amount of banking information, even in thumbnail format, I shall break it down into various segments. Some will apply to your business, others may not. I am intentionally phrasing the segments in very simple layman's terms. I would advise you to discuss my advice with your accountant, or even your banker, before you decide to act on it. 

This first segment deals with the initial loan application. It is assumed that you are applying for an operating line of credit, which may, or may not, include letters of credit. The actual loan within the line of credit will fluctuate at different times, depending on the cashflow, but the bank will put an upper limit which you cannot exceed without special authorization. The limit of the operating line of credit is determined by the bank after evaluating various aspects of your business, including your equity in it. 

There is certain basic information that the financial institution requires in order to make the decision to finance your business. You must come to the appointment with the bank armed with this information, ideally accompanied by your accountant who prepared the information package. 

" Financial Statements for the past three years 

" Pro forma financial statement for the year to date 

" Cashflow projections for the current year 

" List of aged accounts receivable 

" List of aged accounts payable 

" Summary of inventory 

From the above documents, the bank will ascertain whether your business was profitable in the past, and whether it appears to be profitable this year. 

The cashflow projections will show how high the financial involvement will peak at, and how well the loan will be collateralized at any given time. 

The accounts receivable list will disclose the quality of the customers and whether a significant percentage of them is delinquent. 

The accounts payable list will reveal whether your business is up-to-date with its payments to suppliers. 

The inventory summary will show the nature of the inventory and give an indication of whether it can be sold readily. 

In addition to examining the above documentation in detail, be aware that a credit check will be done on the business to ascertain if there is any outstanding litigation, and as to its creditworthiness. 

Knowing all this, be sure to have satisfactory explanations for any aspects that may appear detrimental to the bank. 

It is important to keep in mind that the ideal customer for an operating line of credit, as far as the bank is concerned, is one who: 

" Is profitable 

" Needs the credit to finance profitable growth 

" Does not require too high a loan/equity ratio 

" Has adequate collateral to cover the loan at all times 

" Has collateral that can be liquidated easily 

" Has excellent credit rating 

Your strategy? When making the loan application: 

" stress the good value of the assets that support the equity of the business. 

" Point out that the inventory is current, or can easily be sold. 

" Explain that your accounts receivable are up-to-date and that delinquent receivables have been provided for. 

" If you have unencumbered fixed assets, point out that there is additional collateral for the bank in them. 

" Advise the bank that you have adequate fire insurance to protect the assets, and personal life insurance that could be used to protect the bank, if necessary. 

" Recognise that the banker looks to collateral to repay the loan if the business fails. The banker is not really interested in intangible assets, such as goodwill, even though they could be very valuable.