by Merlin Hernandez 


       The fundamental difference in requirements for start ups and established businesses is that since start ups do not have a track record of financial statements that can be analyzed for operational efficiency and business acumen, there is a strong reliance on personal finances, and the level of personal financial investment. Starts up loans are usually difficult to obtain because they are often undercollateralized. Lending agencies would require a personal background statement and resume, and a personal financial statement with at least two years personal tax returns. The examination of personal finances can be rigorous and detailed – a credit score of 600+, no late bill or mortgage payments for at least 12 months, and no history of bankruptcy or foreclosure in the past 2-3 years. A co-signer to the loan may also be necessary and may be subject to similar scrutiny. This needs to be backed by a solid business plan. Start up funding may also require a business that is somewhat operational for at least six months with evidence of a steady cash flow.

Established businesses would need to provide two or three financial statements – income statement, balance sheet, cash flow statement – to prove the viability of the business and its potential to re-pay the loan. Projected revenues and expenditures that bear a close relationship to existing statements are needed as well. This type of loan may also require a co-signer based on collateral needs. Banks and lending institutions are often more open to lines of credit for existing businesses which is a flexible proposition with several advantages – it provides an available cushion for unexpected expenses, can be used for any purpose at any time, affords reduced loan payments which are only made on money actually used, supports strong relationship banking as bank becomes more familiar with your financing needs, and reduced debt liability offers better debt to equity ratios for a healthier financial picture.

Financial Ratios are important as no financial statement or even group of statements can fully measure the nuances of operational efficiencies. These ratios are the tools to analyze and interpret the data presented and answer critical questions about a company’s financial strengths and weaknesses. Issues of profitability, liquidity, and solvency can be addressed by an examination of the relationships among items contained in the financial statements or between statements. Industry financial benchmarking may be a part of the comparative/competitive analysis of opportunity and the readiness of the business to exploit it.

Benchmarking is a process of systematic diagnostic valuation for identifying and implementing best practices and may involve a comparison of performance levels among organizations to determine the methodologies that produce exemplary results. Financial benchmarks are industry norms or standards that relate to the costs associated with business activities. The cost of manufacturing a product will depend on the cost of each manufacturing element – materials, labor, overheads etc., and comparisons across businesses can present standards of efficiency and best practices to arrive at optimum costs for profitable operations. Financial and operating ratios like the Receivables Turnover Ratio or the Times Interest Earned Ratio, when compared with the industry in which a business operates, aid in understanding if the business is performing above or below industry averages. Industry benchmarks may be obtained from the North American Industry Classification System (NAICS) Code developed by the Office of Management and Budget (OMB) to allow for a high level of comparison of business statistics.

The SWOT analysis is of great value in outlining to a lender the internal strengths of a new business venture and how you propose to deal with potential weaknesses. It also demonstrates that the business derives from a coherent external opportunity and how threats to success can be mitigated. The SWOT is a useful way to define how a business might map its success as well as a valuable baseline developmental tool for strategic planning. Its inclusion in the business plan assures the lender of capable management and well crafted planning. The business plan, however, must demonstrate capabilities that are much broader in scope as it brings great insight into the critical issues that will affect the new business and tells the lender that that there are plans and structures in place to deal with them. 

Many small businesses prefer to use the cash accounting method once they are not required by law to use accrual accounting. But with a strong reliance on credit card usage and significant sales increases closer to the end of a monthly accounting period, monthly accounts may not reflect a true picture. This is especially important if a company is operating with a line of credit and may need to provide monthly financial statements. Accrual accounting can provide a better picture of the company’s financial position through the accrual of unrecorded expenses/revenues, and recognition of unearned revenues to present a more lucid liquidity picture on the balance sheet.

As small businesses go lean, they may no longer hold inventory, and the accrual system would not be mandated by the IRS. But accrual accounting still offers the better alternative as it also allows greater tax flexibility where the company can project sales and credit needs to show increased revenues or decreased liability if necessary. By having customers place orders in advance in a low income year or the company advance-ordering supplies and being invoiced in a high income year can help to reduce the tax burden. Some expenses can also be paid off in a high income year to increase deductible expenses.

Benchmarking is more easily facilitated by accrual accounting which is really the more realistic tool to represent what’s happening in the business and making comparisons with prior periods and industry standards. Accrual accounting might be a little harder to read for people with limited accounting skills because of the increased number of transactions needed to record the same financial event. But it gives a much more accurate representation of the financial position of the business and more effectively positions a small business for future growth.

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