Banks generally lend on the three C’s:
- Capacity (what you can borrow
- Collateral (your security position)
- Character (who you are)
Although this message will focus on your borrowing power, or in bank language, “capacity”, it’s important to remember that if there are any issues with your character, then it doesn’t matter about doing the calculations around your borrowing power.
What impacts Character and how it’s assessed by the Bank?
- ATO arrears
- Excesses on Bank accounts
- Arrears on Bank accounts
- Defaults from providers
- Court actions
- Banks will Google you.
- Some Banks complete Police checks
- What has this person accomplished
- Do they have a trading history
- Are they capable of executing what they want to achieve
- Do they have a history in the industry
- Overall experience
So, Why is Borrowing Power Important?
There are two key fundamental parts of your business that determine Borrowing Power.
- Cashflow Forecast.
- Business Plan. Your Year in Year out or Annualised Cashflow (this is the most important item in Australian Agribusiness Banking, and almost all the Banks are similar in what this is.
What should be in my Business Plan (for Bank purposes)
Put simply, it is where your business is going to be in three to five years’ time, based on an average year. So, if you have a livestock breeding enterprise and you are building up your breeder numbers, you will base your revenue in your business plan on where your numbers will be in three to five years’ time. Similarly, if you are in a cropping enterprise and you are a developing country, then it should reflect the arable area in three to five years.
The same process then applies to expenses (both operating and living expenses). There may be one-off expenses in your business from the last 12 months or even projected for the next twelve months. These one-off expenses should not be included, as the banks wish to see a projection of average expenses and where they’ll be in three to five years’ time.
So, revenue minus operating expenses minus living expenses gives your free cash flow or what is available for servicing debt.
When projecting your revenue and expenses, take a slightly conservative view of where your business will be in three to five years’ time (or based on an average year, rather than a really bad or really good year).
Once your cash flow has been forecasted out, the next step is to allocate your debt repayments. Naturally, banks want to make sure you can service the debt, particularly if interest rates increase. So, using a higher interest rate (usually 2% higher than the current market), banks determine if you’ll still be able to service the loan over 15-20 years.
This is an important point, as banks vary in how they allocate loan servicing. For banks that amortise over a shorter period, you generally need a stronger business plan to meet their criteria (for more information, please contact your Sprout Ag advisor).
To Summarise, your borrowing power is determined by revenue – operating expenses – living expenses – cost of debt (your debt amortised over 15-20 years with a higher rate), and if you have a surplus based on this or in technical terms, after principal and interest sensitised, this may be regarded as a loan that can be serviced. There are some instances where banks look for an interest coverage ratio or some look for a surplus of 1.2 times; this is a good guide to start with.
For a deeper understanding of what banks are looking for and which one will suit your needs, contact your SproutAg advisor for a one-on-one conversation.