Since banks’ profitability is partly determined on how well they analyze corporate loan applications, the review process is quite relevant to risk management. To help the bank determine company viability and capacity to repay a loan, many financial, operational, market and economic factors are weighed into the loan application and company analysis.
This article will discuss these factors. The section on bank policy and loan criteria will discuss the relevance of bank policy and loan criteria. “Company performance factors” goes into greater detail about the specific items banks look at in analyzing and assessing corporate viability. Lastly, analytical tools used by banks in evaluating company performance and qualification are also of relevance to businesses considering bank financing options.
Bank policy and loan criteria
Bank policy is the framework within which loan applications are considered. The first step in a company loan application is compliance with the bank’s policy. Otherwise banks could immediately disqualify a company from qualifying for a loan and bypass the company analysis altogether. An example of bank policy in regard to company loan applications are the type of companies and company loans the bank provide. Moreover, some banks specialize in specific types of business loans only, making loan applications outside this criteria invalid. Moreover, the bank policy may also outline different analytical criteria dependent on the types of loan.
The bank officials’ skill and carrying out of bank policy is also important in the loan application process. Loan officers often follow pre-determined criteria for approving loans and understanding these criteria is helpful if not essential in understanding how banks analyze company loan applications. Thus, the loan criteria are the broad requirements that a loan application must comply with to be considered further. The steps of loan analysis can vary but generally follow specific instructions and criterion. According to the “The five Cs of lending” banks look at the following factors before approving loan:
- Capacity: Financial resources available to repay a loan
- Character: Professional ability, history and credibility
- Collateral: Assets that can be used to secure loans
- Capital: Personal and other funds already invested in the business
- Conditions: Business revenue, income and commercial potential
Company performance factors
Financial strength from revenue, cash-flow and project management, streamlined operations, competitive positioning, financial ratios and corporate valuation are just a few of the items a bank may look at when considering a company loan. Other factors include the size of the loan, existing debt, credit history, loan use, business plan, application quality and applicant presentation. These are a lot of things for a busy business manager to consider in order to obtain bank financing, but it is in a nutshell, how banks manage their loan risk. Examples of a few of the specific qualifiers a bank may measure are below:
- Company ability to provide all required documentation
- Debt level below a percentage of total average annual income
- Debt level below a percentage of company asset value
- Potential and probability of loan to facilitate profitability
- Credibility with vendors, lenders and credit agencies
- Banking history and assets held within the bank
- Proven company compliance with government tax code
- Compliance with loan terms and agreements
The bank itself is yet another factor in how a company is analyzed for loans. This is so as different banks may have varying loan requirements, expectations, risk structure, bank policy, financial environment, economic forecasts, liquidity etc. These underlying factors are likely to influence how a bank analyzes a loan application in the sense that it predisposes the bank to either be stricter or more lenient on some aspects of loan applications.
Analytical tools used by banks
Without analytical tools a bank official would have little means by which to determine if a company’s loan application meets company performance factors as required by bank policy. Several analytical methods and tools are listed below. These tools are used by banks and taught to bank officials so they are better able to accurately determine the viability of a company in its ability to repay a bank loan.
- Ratio analysis
- Cash-Flow analysis
- Operational risk assessment
- Bookkeeping evaluation
- Breakeven analysis
- Forecast and probability measurement
- Multivariate analysis
Each of the above analytical tools is designed to measure different aspects of a business’ performance. Since no one metric is able to provide a complete picture of a company’s valuation, ability to repay, credibility, profitability etc. multiple analytical tools must be used.
Definitions of each of these analytical metrics can be found by performing a keyword search for each term. For example, to learn more about the different types of ratios used in banking analysis of company loans, the keyword ratio analysis can be typed into a search engine search bar. Additionally, reviewing the U.S. Small Business Administration’s “Borrowing money for your business” page and calling a bank’s loan department and asking if they can provide information on loan assessment criteria can help a company better prepare for and meet the loan application criteria.
About the author: A.W. Berry is the Managing Editor of Moneycation and has published articles at numerous business websites specializing in financial information. He has an M.B.A. in finance from the Bloch School of Business at the University of Missouri.