Preparation Is Key to Getting Financing

Now that we are halfway through the calendar year, I thought it would be a good idea to take a look at how a manufacturer should get prepared for its fall spending.

The cycle of machine tool purchases pretty much repeats itself on a yearly basis, and by this point in the year, many shop owners have a pretty good idea of what their equipment needs will be for the fall.

Most have visited an open house or a tradeshow and have moved beyond the inquiry stage to the point where they may already have a quote in hand for a new piece of equipment. This means now is the time to start thinking about how the purchase should be financed.

What They Think

With that in mind, I thought I’d give some insight into what a financial institution looks at when reviewing and approving applications for the financing of machinery.

The first thing any lender will review is what is actually being financed.

When it comes to machine tools, anyone with industry knowledge knows that a good, brand-name machine tool has an excellent resale value.  Because a lender’s first concern is exit strategy in the event a deal goes badly, it wants a comfort level knowing the asset can be resold with relative ease to recover a significant portion of the loan. In addition, lenders that concentrate in a particular industry have in-house specialists who provide internal evaluations for the equipment, so they will understand the transaction.

Machine tools in today’s market typically have good resale values, and since the investment is significant, the borrower usually has already done their due diligence with respect to the quality of the equipment as well as service and technical support from the equipment’s seller.

How Much?

A question I normally get right at the beginning of the process is something along the lines of “How much money can you get for me?”

The answer to that question is really found in the company’s equity box, which determines how much financing is available.

Essentially, there will be a review of the company’s working capital and cash flow to determine if the borrower can pay its current loans and expenses before adding anything new.

Another factor looked at is the debt-to-equity ratio, a financial ratio that indicates what proportion of equity and debt the company is using to finance its assets. A high debt-to-equity ratio indicates more creditor financing (bank loans) is used than investor financing (owner/shareholder).

Last, retained earnings, the profits retained by the company that are reinvested in its core business and are not paid out as dividends, as well as tangible net worth, the sum of all the tangible assets (cash, equipment, property) minus any liabilities, are examined.

All of this information can be found in the financial statements of the borrower.

I always recommend to my clients that they use a registered accountant from a reputable accounting firm.  The difference in the quality of the report is significant. Plus, a well-prepared report will provide much more comfort to the potential lender.

There is also the ancillary benefit of talking to an expert who can give guidance on how a transaction should be handled from an accounting perspective and advise on how to minimize the tax implications.

Financial Statements

The three types of financial statements are: notice to reader, review engagement, and audited.

The larger the financing request is, the more detailed the financial statements must be.  Also, internally prepared statements, called interims, for the current financial year may be required if the accountant-prepared statements are more than six months old.

Most of my clients use QuickBooks or Simply Accounting to generate interim statements. They are fairly easy-to-use software packages that keep track of the current year’s performance.

Credit Report

The next area for review are the commercial and personal credit reports.

All lenders require a commercial report, the most common ones being from Equifax and Dun & Bradstreet (D&B) as well as PayNet, which is a service that deals exclusively with leasing companies and shows how a company pays its current leases.

Personal reports are necessary when the application includes a guarantee from ownership. These reports provide a significant amount of information about the borrower, including how long it has been on file, the number of trades, how much credit it has been extended by either credit card companies or banks, and, most important, its repayment history.

These reports also provide information about any legal or collection issues.

It is important for any applicant to know what information is in their credit report so if there has been any negative activity, it is shared upfront with the lender. This way there are no surprises, and an explanation is provided with the original submission.

Once all of this information has been collected, a write-up is prepared that details the type of business, age, experience of owners, and industry, along with a justification of why the equipment is required and what the potential benefits will be to the bottom line once it has been installed.

This write-up, along with all the financial and commercial information, then is evaluated to determine if the application is approved, declined, or structured.  A structured approval is an approval for less than 100 per cent of the total request. It means the deal is approved, but it requires a deposit or additional collateral (existing equipment) to lower the transaction size and, in turn, mitigate the risk.

I realize I have covered a lot territory here, but if you are trying to secure funding for equipment, it is very important to not only understand the process, but also to use a good accountant who can prepare a quality set of statements.