Business finance, read from the credit side

Most finance guides are written from the lender's side of the desk: here are the products, here are the rates, here is who lends what. That is useful once you know what you are asking for. It is not much help when the real question is whether your business will be approved at all, and if not, why not.

This guide is written from the other side. It sets out what a commercial credit team does with your file once it arrives: which earnings it adopts, what rate it tests them at, what it takes as security, and what it will hold you to afterwards. Every one of those is knowable before you apply, and most declines happen because nobody checked.

The four tests

Strip away the product names and a commercial credit assessment comes down to four questions, asked in this order. A file that answers all four in the lender's own language is easy to approve. A file that leaves them to be assembled is where good businesses get declined.

Notice that price is not on that list. The rate is decided after the answer, not instead of it, and negotiating hard on a rate before the first three questions are settled is effort spent in the wrong place.

The earnings picture

No credit team adopts the profit figure at the bottom of your accounts. It rebuilds it, because reported profit is shaped by decisions that will not carry forward to a lender's view of the business: what the owner chose to pay themselves, what the business bought through the company that a new owner would not, what sits in one year that belongs across five.

What gets added back

An add-back is a cost in the accounts that a lender accepts is not a real cost of running the business. Interest, tax, depreciation and amortisation come out first, which is what EBITDA means. After that the adjustments get specific, and each one needs a document behind it.

• One-off costs that will not recur: a legal dispute, a relocation, a failed project. The evidence is an invoice and an explanation, not an assertion.
• Personal expenses run through the business, where they are identifiable and defensible.
• Related-party costs at other than market rates: rent paid to a family trust, a vehicle on the business that is not used in it.
• Owner remuneration, which is the largest adjustment in most small business files and the one most often got wrong.

The owner's salary is not an add-back

This is the single most consequential difference between the way earnings are commonly presented and the way they are adopted. You will see earnings quoted before the owner's remuneration, sometimes written EBITDAO. That figure adds back what the owner actually paid themselves and stops there.

A credit team does not stop there. It puts the cost of the role back in at what it would cost to hire. Whoever owns the business next still has to get that work done, either by doing it or by paying somebody, and earnings that assume the work is free are earnings nobody can collect.

Where an owner has been underpaying themselves, this adjustment reduces earnings sharply and it is the most common reason a deal that looked comfortable does not service. Where an owner has been taking more than the role is worth, the adjustment runs the other way and works in your favour.

Capacity, and the rate you were not quoted

Once the earnings are settled, they are divided by what you have to pay. That is the cover ratio, and there are two of them.

Debt service cover compares cash earnings to everything owed to lenders in a year, principal and interest, across every facility. Interest cover compares earnings to the interest alone. Cover of 1.0x means you earn exactly what you owe, with nothing spare, and no credit team lends at 1.0x.

The assessment rate is the whole game

The number that decides most files is not the rate on the offer. Lenders test serviceability at an assessment rate above the rate they are charging, because a facility written today has to survive rates that have not happened yet. The gap between the two is where comfortable deals turn marginal.

This is why a calculator built on the advertised rate is worse than useless: it tells you the answer to a question nobody is asking. It is also why the first thing worth doing, before you approach anyone, is running your own numbers at a rate well above the one you expect.

Security, and the number it is measured against

Security is what a lender holds if the business stops paying. It does not make a bad deal good, and no credit team lends on security alone, but it decides how much of the price is funded and on what terms.

Advance rates differ enormously by asset

The same borrower with the same financials will be funded to very different proportions depending on what is being bought. That is not inconsistency. It is one question applied consistently: if this has to be sold, how deep is the market and how long will it take?

Which value, though

The percentage is only half the calculation and often the less important half. What matters as much is the figure it applies to, and an asset has more than one. Market value assumes a willing seller and a reasonable marketing period. Orderly liquidation assumes you have to sell but have a couple of months. Forced sale assumes it goes now, to whoever is in the room.

The gap between the top and the bottom of that ladder on a single machine is routinely a factor of two. If a valuation is quoted to you without saying which basis it was prepared on, the number is close to meaningless.

What else sits behind the facility

• A general security agreement over the business's assets, registered on the Personal Property Securities Register.
• A mortgage over property, where property is in the picture.
• Personal guarantees from the directors, which are close to standard on small business lending regardless of the asset.
• Sometimes cross-collateralisation, where one asset supports more than one facility. It is worth understanding before you agree to it, because it restricts what you can do with that asset later.

Covenants, and the part nobody reads

Serviceability decides whether you get the money. Covenants decide whether you keep it. They are the tests in your facility agreement that run every quarter for the life of the facility, and most owners never read them until one is breached.

A breach rarely means the lender calls in the facility. More often it converts an ordinary year into a negotiation you did not plan for, with waivers, repricing and reporting conditions attached. Knowing where your headroom sits before the quarter closes is what keeps that conversation on your terms.

Structure, and the cost of deferring

Two facilities at the same rate can cost very different amounts, because the rate prices the money and says nothing about when you hand it over.

Term and amortisation are not the same thing

The term is how long the facility runs. The amortisation period is the schedule the repayment is calculated on. They are often the same and sometimes deliberately are not, and where they differ there is a balance owing at the end that has to be repaid, refinanced or rolled.

Balloons, deposits and the timing of money

A balloon lowers the monthly payment because you are not repaying all of the debt. The part you are not repaying is still there at the end, and it has been earning interest for the financier the whole time. That can be exactly the right trade if the asset holds its value or if cash now is worth more to you than cash later. It is a trade, though, and only one side of it appears on the quote.

The same logic runs the other way on a deposit. Money paid today is the most expensive money in the deal, because it is the earliest. Two offers that look a percentage point apart can rank differently once the deposit, the fees and the balloon are all placed on the dates they actually fall.

What the file needs

The information request is not a formality, and it is not the same for everyone. What gets asked scales with how long the business has traded and how much you want.

• Two to three years of financial statements, and tax returns for the business and often the directors.
• Management accounts, if more than six months have passed since the last full financials. This is the document least likely to already exist, and the one that most often holds a file up.
• Six to twelve months of bank statements, for every trading account.
• Twelve months of BAS lodgements.
• An aged debtors and creditors listing, which tells a credit team more about a young business than a profit figure does.
• Details of every existing facility, because the new debt is tested on top of what you already carry.

Bank statements and BAS lodgements are not duplicates of the financials. They are the independent check. Revenue that reconciles across your accounts, your bank and your lodgements is close to bankable fact; revenue that appears in only one of the three gets discounted.

The acronyms, in one place

What we can and cannot tell you

A guide written by a broker usually ends with a basis of recommendations: which lender, which product, why. We cannot write that section, and it is worth being plain about why rather than quietly leaving it out.

Andorra Advisory Group does not arrange credit and is not a credit representative. We build the analysis and the documents. Where a client wants the finance arranged as well, that is a referral to The Lending Lab Pty Ltd, a separate broking business, and the relationship is disclosed in writing at engagement. Our fee is fixed and payable regardless of whether finance is approved or what the analysis concludes.

So this guide names no lender and quotes no lender's policy. Every threshold in it is a level commonly seen across the market, and every lender sets its own. We also give no taxation advice, no legal advice and no financial product advice: tax positions belong with a registered tax agent, legal positions with your solicitor.

What is left is the part that actually decides the outcome, and it is the part you can do something about before anyone sees your file: the earnings that will be adopted, the rate they will be tested at, the security that will be taken, and the covenants you will live inside afterwards.

General information only. Not credit advice, not a credit assessment, and not an offer of finance. Lending decisions rest with the lender and depend on your circumstances and their criteria.