Banks look carefully at SME companies before they lend money, especially in more challenging funding environments like the present one. The traditional approach for assessing loan applications was based off five primary factors – the “Five Cs”. These are:
The “Five Cs” gave bankers and borrowers a clearly mapped out criteria when considering any lending proposal.
The Irish banking environment has changed considerably since the recession. Greater concentration of banks in recent years means SMEs have less choice. In June 2017 the Central Bank reported a 32% increase in new SME lending but at the same time SME rejection rates have also increased.
Our SME clients consistently tell us that access to investment and working capital is their number one concern. So for an SME looking to raise senior bank debt, ensuring they put forward the best possible application is critical. However, there is a considerable time investment involved and a level of sophistication required when preparing loan applications. With that in mind, our corporate finance team have outlined some of the key components of the “Five Cs” for SMEs to focus on before starting the loan application process.
Trading history: Historical financials should be easily interpreted to provide clarity on the cash generation cycle. Consideration should be given to financial metrics that link audited accounts to operational performance.
Current trading: It is critical to demonstrate that quality management reporting systems are in place that report up-to-date performance to bridge the gap between audit year ends.
Borrower commitments: Provide transparency on terms, conditions and repayment obligations of any existing debt or loan agreements. Pre-existing debt will impact a lender’s view on available cash flows.
Projected performance: Comprehensive financial projections need to reflect any potential risks and demonstrate capacity to cover repayment schedules. Consider introducing sensitivity analysis to cover all eventualities but most importantly bridge the current and future performance with detailed assumptions.
Debt Service Cover (DSC) / Interest Cover (IC): A strong loan application will demonstrate sufficient “headroom” to cover DSC / IC ratios. In simple terms, free cash flow must exceed scheduled loan repayments.