When assessing the short- and long-term viability of commercial borrowers, lenders have many tools at their disposal, including business plans. A business plan provides essential information on how management expects the company to grow — and what strategies it expects to use to achieve its goals. Here are some important questions to consider when examining your borrowers’ business plans.
Does the business plan cover all the bases?
Comprehensive business plans traditionally are composed of these six sections:
- Executive summary,
- Business description,
- Industry and marketing analysis,
- Management team description,
- Implementation plan, and
A small or midsize business might balk at compiling a comprehensive business plan. But it’s an essential part of the loan application process for start-ups and when a company is teetering on the edge of bankruptcy or needs financing for a major capital expenditure.
The best plans can be quite simple. In fact, long-winded plans tend to bury management’s message. For a small business, the executive summary shouldn’t exceed one page, and the maximum number of pages should generally be fewer than 40.
What is the company’s vision?
Business planning starts with a long-term vision: Where’s the company now and where does it want to be in three, five or 10 years?
Executive summaries are often the first place lenders look, but they’re the last page management should write. In other words, wise business owners start with historic financial results and then identify key benchmarks that management wants to achieve. These assumptions will drive the financials.
What about the financials?
The second place lenders look when reviewing a business plan is the financials section. Management’s goals are fleshed out in its budgets and financial projections.
For example, suppose a company with $10 million in sales in 2017 expects to double that figure over a three-year period. How will the borrower get from Point A ($10 million in 2017) to Point B ($20 million in 2020)? Many roads may lead to the desired destination.
Let’s say the management team decides to double sales by hiring four new salespeople and acquiring the assets of a bankrupt competitor. These assumptions will drive the projected income statement, balance sheet and cash flow statement.
When projecting the income statement, management makes assumptions about variable and fixed costs. Direct materials are generally considered variable. Salaries and rent are generally fixed. But many fixed costs can be variable over the long term. Consider rent: Once a lease expires, management can relocate to a different facility to accommodate changes in size.
Balance sheet items — receivables, inventory, payables and so on — are generally expected to grow in tandem with revenues. Management makes assumptions about its minimum cash balance, and then debt increases or decreases to keep the balance sheet balanced. In other words, your bank will be expected to fund any cash shortfalls that take place as the company grows, so cash flow projections are among the most significant for lending purposes.
The financials outline how much financing the borrower will need, how it plans to use those funds and when the borrower expects to repay its loans.
Win or lose?
To better understand your borrower’s game plan, take a closer look at the company’s industry and marketing analysis, management team description and implementation plan sections. If these sections also contain reasonable and well-founded data and analyses, chances are your borrower — and you — will have a winning game.