March 01, 2012
With the economy brighter than it was a few years ago, your dealership may be considering applying for a loan to make some improvements at your store — or other investment in your business. But banks and other lending institutions have long memories, and they may be reluctant to lend significant sums to auto dealerships unless they consider the risks to be minimal. Here are four suggestions for convincing a lender that your business is creditworthy.
First, strengthen your balance sheet. Inventory is a prime source of collateral. You should have a car on the lot for each item on your floor plan loan. Some dealers keep a private stash of vehicles for their personal use or use their floor plan loan as a credit line — either is a major faux pas in the eyes of modern financiers.
Lenders also look at your days-in-inventory ratio. Order the bare minimum stock to keep yourself afloat and identify slow-moving vehicles. Discounts and auctions can help you move metal, if needed. Consider returning extraneous parts inventory to the manufacturer; some offer refunds (or at least credits).
Then turn to your income statement. Lenders like profitable businesses. Strong inventory management can help you lower variable costs, such as storage and interest expenses. But fixed expenses — including equipment leases and payroll — should also be pared back where possible.
Before meeting with your lender, assemble a package of relevant documents, including three years of financial statements and tax returns, detailed lists of used and new vehicles, business plans, and the dealer-owner’s personal financial statements.
Then learn to “lenderspeak.” Know what common terms — such as “debt coverage,” “accounting payback” and “debt-to-equity ratio” — mean, as well as the adjustments the lender customarily makes when evaluating your financial statements.
Lenders, for instance, often use the debt-to-equity ratio to gauge a business’s financial leverage. This ratio is equal to long-term debt divided by equity. Lenders typically use data from the prior fiscal year in the calculation, and they consider lending to a business with a higher debt-to-equity ratio to be risky, especially in times of rising interest rates.
Also important is “debt coverage ratio,” the amount of cash available to service interest and principal on outstanding obligations. Lenders generally are comfortable when the cash available is 1.25 times the amount needed to service debt. So, it’s important to have an understanding of the amount of noncash expenses included in your operations, such as depreciation. Understanding any one-time expenses also can help your case with the lender.
Other ways to “wow” your lender include closing your books by the 10th of the following month, preparing weekly cash budgets and maintaining a minimum current ratio (current assets divided by current liabilities) of 1.2. It’s also good to provide a future projection of the financial health of your dealership. This could include sales forecasts, expense forecasts and future cash flow projections. Be conservative with your projections and have a solid game plan for achieving the results.
Strictly adhering to loan covenants — the financial statement benchmarks set forth in your loan agreement — is critical. Dealers who violate loan covenants automatically default on their loans, unless the bank waives its right to call the loan. And, if you violate a loan covenant, auditors won’t sign off on your financial statements until they’ve received the bank’s waiver.
A long-term banking relationship can win you points with your lender. If you’ve stuck by your bank in good times and bad, chances are that they’ll do the same for you, especially if you’ve always made timely payments. But if you’ve switched banks in search of greener pastures in the last few years, you may be out in the cold when you need to take on more debt — or when it’s time to renew your existing loans.
Communication is paramount to building your lender’s trust. Lenders reward borrowers who maintain open, honest lines of communication. Never hide deteriorating financial performance. Experienced lenders have been around the block before and can smell “cooked books.”
With the recession still a fresh memory for lenders, securing a business loan isn’t a slam dunk. But a dealership that makes a strong case for its creditworthiness will likely be able to obtain the financing it needs to reach its goals.