Lowering Your Cost of Capital
Source Capital & Consulting has seen a vast array of companies. Each one is its own unique business that has unique characteristics. Some are in strong financial condition and some are not as fortunate. When it comes to interest rates funders want compensated for the perceived risk they are taking, i.e. Risk = Return
Becoming bank financeable is extremely important for your business. Where historically most loans were made by banks, in today’s financial markets there are multiple sources of funders and banks are only one. Banks still offer the lowest cost of capital. Other sources of financing can start as low as bank pricing but then go up from there to where the proposed “approved loan” could have substantially negative results on the business. It is important to remember that in competitive markets, with all other factors being equal, the business with the lowest cost of capital will thrive and other companies will struggle.
How does your business get the lowest interest rates? Here are some items to consider.
Personal credit score: Most banks require the personal guaranty of the owner. The bank then will put weight in the owners personal credit score. Not only do banks have a low FICO score cut off for declines, the results of how high or low your credit score is can affect whether or not your company will get the lowest interest rate available.
Know your DSCR and how it can help you: Debt Service Coverage Ratio is a ratio that determines how many times your EBTDA covers your annual debt service. Again, banks have a bottom ratio score that can be used to decline a credit, but there is a propensity for funders to offer lower rates to companies that have strong (1.3 times and higher) DSCR’s.
Manage and monitor your accounts receivable. Your account receivable aging summary gives a banker a look at multiple risk factors. How much payment failure risk is the company exposed to and is this risk concentrated in a few accounts? How does management react to slow paying accounts? How often are your accounts receivable turning per year? Are there non collectable items in the accounts receivable that are creating a false asset?
Manage and monitor your accounts payable. How are you paying others? Are you falling behind in keeping your vendors and supplier paid? This is a major consideration for a funder who assumes he will be treated the same way.
Keep and monitor up-to-date financial records. This comes down to what we consider the most critical factor for a lender. Is the information we are receiving accurate enough to make a decision from? Can management demonstrate an understanding of the financial statements? If not, it demonstrates that you are not paying attention to them. The more doubt the higher the interest rate. If the answer is “we cannot get a handle on the company’s stability based upon the condition of the financial statements”, the credit will be declined.
The timing of the request for credit. Finance when sales and profits are strong, not when they are showing significant decline. Nothing makes funders happier than year over year growth in both sales and net profits. A company that can predict growth and profitability (an annual budget) will receive a much better interest rate than those who can’t.
This is by no means a complete list of considerations and each one is a part of an overall funder’s decision on interest rate. They are however items that should be considered when as you manage your company and anticipate a need for outside capital in the future.