Using Key Indicators as a
Tool to Communicate with
Your Lender
… or, How to Keep Your
Loans in Place in 2007
Jeff Baldwin
Emma Shinn
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Multiple Choice Quiz:
1. When your banker asks you for
your plan, the best approach in
communicating with your banker
is to:
a.Give them a plan, and make it look
really good
b.Give them a plan that is so confusing
they won’t be able to tell how well you
are doing
c.Don’t give them anything
d.None of the above
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Multiple Choice Quiz:
2. When you are about to miss your
plan, the best approach in
communicating with your banker
is to:
a.Act like everything is going to be okay
and you will catch up in December
b.Present so much detail he won’t be able
to figure out what is going on
c.Don’t say anything and hope it will get
better
d.None of the above
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Communicating with Your Lender
Topics include …
1. Builder Financing 101 … a few
basics about capital requirements
and sources
2. The Lender’s Point of View …
your capacity to service debt
3. Key Indicators Used by Lenders
… how they evaluate your health
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1.1.Builder
BuilderFinancing
Financing101
101
Builders often need financing for:
Work in process
Spec inventory
Other working capital
Land acquisition and
development
Other fixed assets, ventures or
investments
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Capital Requirements and Sources
Ask yourself the following questions:
How will the
funds be used?
What sources
of financing
provide funds
for this
purpose?
How much
financing is
needed?
Who provides
financing of
this size and
duration?
REMEMBER!
Don’t finance
long-term
assets with
short-term
debt!
What collateral
is available?
What sources
of financing
do/do not
require
collateral?
How quickly is
financing
needed?
What sources
are most easily
approachable?
REMEMBER!
Investors take
a long time to
decide!
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The answers to these
questions will help you target
the right sources and types of
financing …
And avoid the common mistake
of financing a long term need,
such as land development, with
short term borrowing
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Three Important Steps
1. Know your requirements:
– Purpose, size, timing
2. Determine the appropriate type and
source of financing:
– Work in process or other working capital loan
– Construction loans
– Land acquisition & development, or other
“project” loans
– Other capital investment
3. Present a business plan which
demonstrates that cash flow will service
the debt
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Demonstrate Your Strategic Thinking Process
Analysis
Strategic
Decisions
Detailed Planning
Business Plan
Market Definition
Competitive
Analysis
Market Targeting
Market
Segmentation
Market
Positioning
Financial Plan
Marketing
Programs
Production
Products
Operating
Results
Financial
Condition
Management
Sources of
Funds
Users of Funds
Management
Plan
Production Plan
Market Plan
Management &
Staffing
Revenue &
Expenses
Cash Flow
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Provide financial projections that:
Demonstrate your “strategic” thinking
Demonstrate sound execution strategies
Are consistent with your business plan
 Are supported by key assumptions
 Identify the key revenue and cost drivers
and include the key
performance indicators
…
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2. Lender’s Point of View…
In order to obtain the most
appropriate financing, the builder
needs to understand the concerns
of the lender.
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Capacity to Service Debt
Banks usually consider the big picture …
Sources: Government publications
•Domestic and foreign influences and bank policy
ECONOMIC PERSPECTIVE:
•Regulation and policy
•Technological change
•Market / customer expectations
INDUSTRY PERSPECTIVE:
Sources: Internet,
databases, regional news
services and industry
specific publications
•Industry life cycle
•Industry benchmarks
•Competitive pressures
•Capacity (supply and demand)
OPERATIONAL PERSPECTIVE:
Sources: Business plan,
•Management
site visit and meetings,
•Processes and controls
industry expertise
•Production efficiencies
•SWOT analysis
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Currently, there are Red Flags at all levels …
ECONOMIC PERSPECTIVE:
•Federal deficit
•Interest rates
•Market expectations
INDUSTRY PERSPECTIVE:
•Mortgage defaults
•Sales decline
•Inventory levels
OPERATIONAL PERSPECTIVE:
•Management experience
•Cycle times
•Inventory levels: land & WIP
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When you ask lenders about the
current environment:
“… what do you look at for home
builder loans that is different from
the past?”
Many respond with two words:
Staying Power
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How do lenders evaluate “Staying
Power”?
Debt to equity
Liquidity, i.e., current ratio and working
capital
Components of working capital, i.e.,
inventory, specs, etc.
Note that all of these are balance sheet
indicators – which many builders ignore
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One thing has not changed …
The single most important factor in the
bank’s decision to lend, is the
company’s …
Capacity to service debt
Lender’s often evaluate this by looking
at several key indicators.
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3. Key Indicators Used by Lenders
Key indicators are criteria that help to evaluate
the financial condition, or health, of a company.
These criteria include both financial ratios and
other signs that point to the health - or
sickness - of a company.
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Key Financial Indicators
Lenders
examine key
indicators
related to
these areas:
 Liquidity and financial
stability
 Balance sheet and capital
structure
 Turnover of assets
 Cash Flow
 Operating performance
– Return on assets
– Return on equity
– Benchmark to industry
standards
 Sales trends
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Key Financial Indicators
Definitions of the most common financial ratios:
Ratio
Current Ratio
Definition
Current Assets / Current Liabilities
Asset Turnover
Sales / Total Assets
Debt to Equity
Total Liabilities / Net Worth
Net Profit Margin
Net Profit / Sales
Return on Assets
Net Profit / Total Assets
Return on Equity
Net Profit / Total Equity
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Key Financial Indicators
The primary financial ratios used :
Ratio
Best
Okay
Red Flag
Debt to Equity
< 2.5
~ 4.0
> 7.0
Current Ratio
> 1.5
~ 1.2
< 1.0
Net Profit to Sales
> 10%
~ 4%
<0
Gross Profit to
Sales
> 25%
~ 20%
< 15%
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Key Financial Indicators
The secondary financial ratios used:
Ratio
Best
Okay
Red Flag
Return on Assets
> 25%
~ 10%
< 5%
Asset Turnover
>3
~2
<1
Inventory
Turnover
>2
~2
<2
Specs to Total
Inventory
< 10%
~ 25%
> 50%
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Key Financial Indicators
Other financial ratios sometimes used:
Ratio
Best
Okay
Red Flag
Operating
Expenses to Sales
> 12%
~ 16%
> 20%
Revenues to
Working Capital
> 10
12-14
> 17
Months of Interest
Carried
> 24
18
> 18
Profit on Equity
> 50%
25-40%
< 15%
Percentage of
Profit Distributed
> 50%
~ 50%
> 70%
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When bankers are concerned about the
accuracy and reliability of financial
statements provided by a company, they
often consider other indicators:
• Track record of meeting sales and delivery
commitments
• Cash balances
• Credit history and terms that suppliers are
offering
• Supporting evidence that tax payments and
payroll obligations are current
• Sales prices and trends
• Sales pace and trends
• Reputation among competitors, creditors, and
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within industry
Footnote:
Your lender is likely to have their
own criteria – talk to them to find
out what they are looking for.
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Remember . . .
Your lender is your most important
“Strategic Alliance” …
Get them in the loop, and keep
them there.
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