Is Your A/R Giving You Any Credit?

From time to time, small businesses need to borrow funds to cover cash shortfalls, manage seasonality, or take advantage of unexpected sales opportunities. Traditional banks tend to limit loan amounts to a percentage of the business’s net worth or a percentage of high-quality assets. For many businesses, accounts receivable is one of their most significant assets -- and helping your lender appreciate the quality of that A/R can help you borrow the maximum amount at optimal rates.

Bank Guidelines for SMB Loans

The maximum loan amount for many lenders is limited by one of two major factors: (1) net worth of the business and (2) asset, or collateral value. The net worth of your business is derived by taking the market value of your assets less the outstanding liabilities. Many banks will lend only 10-20% of your business’s net worth.

But many banks will lend as much as 80% of the value of your major business assets -- and accounts receivable can approach a third to half of all assets for the average small business. Lenders will typically ignore A/R they consider low quality or more than 90 days overdue. You should ask your lender about its specific policies and be ready to defend the quality of your outstanding A/R to get the best possible loan.

Loan Packages Tell Your Story

First of all, most lenders want to make loans. Their compensation, job security, and career prospects are tied to the growth of their loan portfolio. But they still need to make good loans, and what constitutes a good loan is defined by the bank’s credit policy. However, the reality is that very few businesses comply with every factor considered in the bank’s credit policy.

So when traditional banks consider loans for small businesses, they develop a loan package presentation that tells the story of the business, its customers and its ability to perform and repay the loan. This usually includes a current balance sheet, profit and loss statement, and up to three years of full tax returns. If the loan is secured by a business asset like accounts receivable, then other details will be needed, such as an A/R aging schedule.

The purpose of the final loan package presentation is to gain approval from a loan committee or manager. Even when your loan is approved you should also prepare to continually support your story by providing updated statements and reports.

Leveraging Accounts Receivable for a Better Loan

SMBs can often tell a better story and borrow more by leveraging their assets instead of relying only on the business’s net worth. Accounts receivable is often one of the most significant assets a small business has, but it’s also the one lenders need the most help evaluating. The critical things banks want to see include:

  • Customer stability, eg, how long they’ve been buying from you
  • Past purchase amounts, eg, annual sales history, recent sales
  • Collections performance over 12 months or more, ideally with no unresolved issues

This is where an A/R aging schedule falls short. The aging schedule only lists the names and amounts due for customers that currently have outstanding invoices. It does not highlight the number of loyal customers you have or the quality of their payment history.

Better sales analytics and customer reports can help. Tally Street provides summaries of overall sales and collections performance, including KPIs such as repeat sales rates, DSO and ADD. Tally Street also generates customer retention, lifetime value, annual sales, and payment performance for each customer.

Master Customer List sample

These reports help draw a picture of your client base as buying from you regularly, paying you under terms offered consistently, and having a history of an established relationship. If you can show these details, your lender can tell your story, possibly gaining approval of an exception when considering more than just your A/R aging schedule. This information may make the difference in getting the loan approval or not.