Improve Your Financial Position:Know how your bank works out how ‘risky’ you are and what to do when things get tough, financially.
Finance is key to business survival. But how much do you know about how banks view your business?
Knowing what underpins your financial position requires you to understand how banks operate and what bankers think. In other words, you need to know how banks view your risk and how you should behave if things get a little tough financially.
Your risk rating (also known as risk grade) is absolutely vital with everything you do with your bank or financial institution. Once a risk grade is calculated, it determines whether the bank will lend you money in the first place and it will also determine the interest rate, fees charged and the length of time that the bank will lend you the money. It will also determine how the bank deals with you should things take a turn for the worse.
In this article we’ll talk about risk ratings and what you can do to improve your position with your bank by understanding how they view you – if you’re trying to grow your business – and we’ll also discuss some tactics you could undertake with your bank when things get a bit tough – financially.
If you’ve ever found it difficult to get a loan or negotiate more favourable terms with your bank, including a lower interest rate or fees, your risk grade might be behind it.
A risk rating is what banks use to assess your ability to meet your financial commitments. All banks have a specific set of metrics (also known as risk grade models) they use to rate their customers.
In Australia, franchisors borrowing $1 million or more are risk rated, by their financial institution, annually on receipt of the financial statements. It is useful to know that banks also use risk grades for businesses with borrowing under $1 million as the starting point for negotiations, however, it’s not a mandatory annual process. In all cases, regardless of the size of business or level of debt, banks don’t usually communicate the results of a risk assessment.
Because it can be difficult to get visibility on your risk rating, successful franchisors make a point of understanding how banks view their risk and use this knowledge to help improve the quality of existing banking relationships. It can also help identify and leverage untapped growth opportunities.
How do banks use risk rating?
Banks use your risk rating to inform the outcome of all their interactions with you. Your risk rating will determine:
• if banks will lend for new purchases or business acquisitions;
• the maximum amount of borrowing;
• your interest rates and fees;
• the terms of your facility, including security and loan repayments;
• your reporting requirements;
• the outcome of any restructures of current arrangements; and
• the outcome of disputes or settlement negotiations.
What do banks measure?
All banks have a specific set of metrics they use to rate their customers based on financial results, debt levels and business behaviours. Typically, banks will consider a combination of:
• Your past track record of financial performance;
• Quality of management information including budgets and forecasts;
• Current level of equity;
• Current industry dynamics and future trends;
• Debtor and creditor management;
• Management experience;
• Bank history and behaviours; and
• Your current ATO position and previous compliance history.
Ultimately the two major factors are how well you can service your debt and the amount of equity available in your franchise business. This is all great when things are going well but what happens when things get tough, financially? How do you manage your relationship with your bank to achieve the most positive outcome?
Banks in general these days have quite a different approach when it comes to dealing with business customers experiencing financial challenges. In the ‘old days’ it was not uncommon for a bank’s relationship manager to have an account decline over time and eventually see the client end up in the bank’s asset management area where receivers were quite often appointed. Things have changed.
Working with your bank
These days, the banks are reticent to appoint receivers unless there is a compelling reason to do so. All banks are keen to work with a client to assist in addressing the reasons for the financial hardship. Also, the bank’s relationship managers are taking more responsibility in identifying risks and the deterioration in client’s accounts much earlier. It is more than likely that if a small business is experiencing difficulties, and is up-front about it, the bank will be supportive and will work with you to turn things around and repatriate the businesses.
Now it is hand-on-heart time. If you think your business might be approaching tough times, there are some important things you can do right now to steer your business onto a positive path with your bank.
• Put your hand up early. Don’t be fearful of what your bank might do. It takes courage to be transparent with your bank but the benefits of being open and honest about your situation will position you well with the bank’s decision makers. You might be relieved to hear that generally there is an onus on the bank to provide assistance if it’s notified of financial distress.
• Make full disclosure to your bank – don’t hold anything back. This means telling them about anything that might affect your financial situation, including outstanding issues with the ATO or other creditors.
• Be accessible and responsive to your bank. Many people start avoiding calls from the bank when things get tough; this is a bad strategy. Take the call – you might be surprised how helpful the bank can be.
Remember ‘a stitch in time saves nine’, sort out problems immediately – it may save extra work later. To give you and your business the best chance it is imperative you have:
• Accurate and timely management information;
• Historical financial data that goes back at least two years;
• Three-way (balance sheet, cash flow and profit and loss) forecasts for the next one -two years;
• Systems that help you identify problems early;
• Advice from an external source, like an accountant or business restructuring professional; and
• A good plan as to how you are going to resolve the current issues for you and the bank.
Your behaviour, not just the financials, can affect your risk rating and how the bank manages your account.
By having insight into how banks assess you and your business, you can modify your behaviours and you can ensure that you do things in a timely manner to improve how your bank views your ‘riskiness’.
Keeping these points in mind will put you in good stead with your bank if and when your franchise business is looking to grow – or if it is facing tough times.
Peter Winterflood is a debt advisory partner in BDO Australia’s business restructuring division. Joining as Partner in 2016, Peter’s extensive banking experience uniquely positions him to deliver a full range of financial solutions and he has a proven ability to bridge the communication gap that often emerges between clients and their bankers.
As part of the global accounting and professional services firm, BDO’s debt advisory team in Australia joins the hands of businesses and their bankers, translating the messages businesses receive from their bankers and working with them to improve their risk scores with their bank.
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