Applying for a loan during the COVID-19 outbreak

COVID-19 has had a similar impact on the UK economy as a recession would. No one can reasonably predict how long this impact will be felt; so how can businesses produce projections that lenders can rely on?

To help answer this, Lee Sharman, Sebastian Humberston, Molly Rushworth and Matt Hector combined their knowledge of management accounts, forecasts, corporate finance, lending and investment to put together this short guidance article.

You can also listen to their discussion in our accompanying podcast.

Most lenders will want to see the three items below. This article explains more about points 2 and 3 and then shares a live case study:

  1. The last three years’ finalised accounts – the purpose of this is to show that pre-COVID-19 you had a viable business that could have repaid the proposed borrowing. Therefore, should there not be any material impact on the business in the long term, the business can repay in the future.
  2. Up to date Management Information (MI) – MI bridges the gap between the finalised accounts and projections. MI is important as it will show continued trading up to the point of COVID-19.
  3. Projections & cash-flow forecast – lenders will appreciate that this may be difficult to predict currently, but they will want to see that you have thought about it and documented your expectations. 6 months is the term most lenders are suggesting will be the impact period for businesses.

Management Information (MI)

Demonstrating to a funder that you have a solid grasp of your financial performance is crucial when trying to secure funding. You don’t need to be an accountant, but you do need to be able to show that you get timely, powerful, financial information that helps you make informed decisions. The circumstances that COVID-19 has given rise to only heighten the importance of this. One way management teams will need to demonstrate their understanding is through the provision of quality MI. Below we have highlighted some of the key differentiators that we believe make up ‘quality’ MI.

  • A clear and robust breakdown of performance on an income and cash basis will enable the intended audience to assess the historical and therefore likely future viability of the business. Tracking monthly, and in some cases weekly, changes, in a clear format, can be essential to inform you, and a lender, of your performance. This enables funders to assess the business’ decision-making capabilities and managements’ operating, financing and investing priorities. The reader is not only interested in the overall picture of performance, but that the underlying reasons behind performance trends are the product of strategic decisions and not a fluke. You might be able to use this information to highlight:

– Which customer groups remain strong and which are struggling;
– What activity, if any, is driving revenue growth;
– What gross margin changes have occurred;
– The rationale behind making, or not making, cost reductions;
– Where your cash pinch points are and commenting on what will improve/worsen the situation;
– The impact of government schemes such as the Job Retention Scheme and VAT deferral;
– Demonstrating that you can service debt costs with profits.

  • Your nearly ‘real-time’ balance sheet Stock, debtors, creditors and cash are all key. MI that can quickly tell a story regarding each of these components to short term trading is very powerful. For example, a business that sells products might create MI that shows stock both by monetary value and quantity by SKU and then relate this back to product sales, margins or customer payment speeds in order to demonstrate to a lender how the business can ‘create’ cash. Similarly, MI that highlights the age of creditors and perhaps has comments on the ability to agree delayed payment will help demonstrate a company’s ability to retain cash. Every company in need of further funding will have a different balance sheet story to tell if you do need advice, then please reach out to us.
  • Key Performance Indicators (KPIs) are an important source of narrative reporting as they explain the business’ progress towards its stated goals. They also show the quality of the director’s judgement in really understanding what drives the business. In normal circumstances, KPIs are often a mix of financial, commercial and people-based data. Today, there may be additional ‘short term’ KPIs which are also needed. There may also be industry-specific KPIs that a business would be expected to report against. A bank will want to see that this has been carefully considered, especially if appraising and business in a sector that carries perceived risks in a recession, for example, construction.
  • Link to budgets and projections. Too often, reporting is still perceived as a post-event, reflective exercise and is simply filed away once completed. However, with the increased mainstream use of cloud accounting software, mind-sets are shifting to realise that performance, and reporting is a live event that can be tracked. Therefore, when building projections, the starting point should be working from current performance and not a named point in time where a business can achieve the things it wants to achieve. One simple way to ensure that you can easily link your MI to projections, other than through software packages as mentioned above, is through a well-considered nominal code structure that is sustainable, not only for the day-to-day management of the business but that a set of forecast assumptions can be built from. This ability to show budget vs actual performance is important in demonstrating that the company has, and can, deliver on its plans.
  • Quick and agile reporting processes. The speed at which businesses are able to extract MI, at a standard that can be understood easily, will reflect on the perception of managements’ own grasp of performance. Cloud accounting software provides options to businesses for both reporting and projections. Remember though that reporting (whether utilising software or not) is only as good as the information input. If the right information hasn’t been captured at the point of entry, is incomplete or includes errors, then the reporting and any projections are going to be unreliable and therefore less effective.

Projections

Projections will need to consist of a profit and loss, balance sheet and cash flow forecast. Making sure to keep these in the same format as your year-end accounts and MI, to allow for trend and year-on-year comparisons by the bank.

  • We suggest projecting performance for a minimum of 12 months. For a Coronavirus Business Interruption Loan Scheme (CBILS) application, the bank will want to understand expected revenue and the direct costs. In addition, by understanding your non-discretionary fixed cost, minus any Government grants/schemes, they can assess your funding requirement. Most lenders appear to be looking to cover these costs for six months, although they will look beyond this to understand the cash required to get the business back to a cash generative position. At this point, they will then calculate service ability, so projecting over a longer trajectory would be best.
  • Projections are only as strong as the supporting assumptions. The bank will understand that you cannot predict how long the impact of COVID-19 will continue for, but if your assumptions are in-depth and well thought out, it will show that you have considered the variables and have a sound understanding of your business and industry. Our suggestion is that supporting narrative to the numerical assumptions is key, as this both provides vital context and demonstrates the management teams understanding of how to guide the business through these times.
  • Linking projections and MI. The bank will compare your projections to your management information in the first instance to understand what changes there are. Consider if you have made any cost reductions, any large clients that will not survive the pandemic, and the speed at which revenue will pick up as you trade out of the pandemic. If there are differences between your MI and projections make sure these are detailed in the assumptions; show calculations if required.
  • Be realistic. Don’t be tempted to provide a rose-tinted view of reality. The banks will understand that there are ‘ups and downs’ in a business life cycle and will have their eyes open to the fact that there may be a reduction in revenue or an increase in costs over this time. Don’t leave the downs out; the bank would rather know what is coming and the business’ plans to counteract the issue, rather than buy into an unrealistic forecast.
  • Ensure your projections derive from inputs, not outputs. When looking at a borrowing requirement, business owners will often have an idea of the size of the facility required. The tendency is then, to base your projections on this amount. Our advice is to focus on the inputs. This will then drive a true profit figure and therefore, true funding requirement. This can often be far larger than the figure you expect.

The key thing to remember is that, if you had a viable business prior to COVID-19, the banks are there to support.

You can learn more about preparing appropriate financial projections in our Financial Modelling podcasts.

Remember this should be a last resort

Government schemes should be the last lending resort for a bank. What this means is that business owners will be asked to look at all alternative measures to reduce their working capital issue. This will include:

  • Utilising all the Government initiatives available such as grants, rates relief, Tax and VAT deferrals and the employee job retention scheme.
  • Banks will expect business owners to take practical steps such as removing any discretionary costs from the business, reducing directors salaries and dividends and having discussions with creditors (and landlords) regarding owed funds.

In return, the banks will look at quick, short term funding solutions. These may include capital payment holidays on current facilities, increased / new standard overdrafts and, if available, standard bank lending. These options often release cash far quicker than a loan with Government backing, with overdrafts and capital payment holidays often taking effect next day.

We are awaiting updates on the stance underwriters will take, and it is also too early for us to understand the timescales involved between application and drawdown. Some banks state that once a loan offer has been accepted, they expect a 45 day SLA until the Government security is confirmed and drawdown of the loan can take place.

Covenants and financial due diligence have not been noted by the banks. Both these measures are implemented by the lenders at certain debt levels or circumstances. A CBILS loan, for instance, is still a loan and if the banks have standard levels they would introduce measures such as these, we would imagine that they will continue to do so. We will add more information on this as we learn of it.

Live case example

There are still a lot of unknowns surrounding the placing of the government-backed CBILS money. However, we have provided an overview of the current projection process we are going through with an existing client as this may provide some insight into how best to prepare your application.

What can you say with certainty?

  • Revenue – If your business has been forced to close its doors until further notice, then its ability to generate income will be significantly diminished if it hasn’t completely disappeared. In this circumstance revenue, and therefore cash receipts, should be relatively simple to predict at least in the short term. Similarly related direct costs should be predictable with a degree of accuracy, so long as you have a good handle on your fixed vs variable costs.
  • Creditors – In the short term you may be able to agree payment holidays with your existing lenders, landlords and certain trade creditors, however, the extent to which each of these are willing, or able, to support you is more difficult to predict – so have these conversations as early as possible. Projections should reflect the agreements you have been able to agree with certainty, with prudency built-in beyond this temporarily agreed period of relief.
  • Tax liabilities – HMRC are being particularly supportive with companies encountering cash flow difficulties as a consequence of COVID-19, typically agreeing to a minimum of 1-month payment freeze. However, we have heard this freeze is likely to be extended to 3 months where required, with the accumulated liability as at the end of the freeze period being spread across 6 to 12 months.

What is less certain, and what is reasonable to assume?

The speed with which your business may be able to build back up to a ‘business as usual’ level of trading is something which is much more difficult to predict. In the specific case, we refer to above, the directors have prudently assumed a staggered approach over a four-month period to build back up to previously budgeted figures. This staggered period comes after a three month zero-revenue period to June 2020.

Predicting the willingness and ability for suppliers, landlords and lenders to continue forgoing or delaying payments are highly subjective. When building projections and deriving the funding requirement, we suggest adopting prudent approximations of the support you will receive. Erring on the side of caution will hopefully mean that a successful loan application first time round will be sufficient to see you through this period of uncertainty — a far better position to be in than having to submit a second application for additional funds.

 

Key questions to consider and information to prepare before approaching your lender

Each scenario will be different, but here are some questions businesses should be prepared to answer:

  • How much would you like to borrow? How did you get to this figure?
  • How long would you like the loan for? 1-6 years. The term will likely impact the interest rate charged.
  • Provide a detailed breakdown of how the funds will be utilised. Taking care that not too high a percentage is being used for director’s salaries/dividends.
  • What action have you taken to date to reduce costs? Detail any Government / local authority grants or schemes. Include non-discretionary spend that has already been cut and can be cut.
  • What were your fixed monthly costs before the pandemic, and what are they now following any support/action to reduce costs as above?
  • Do you foresee any long term impact on the business? Detail how the business will “trade out” of the situation. Be honest; the bank will want to know the full extent.
  • What is your “Plan B” should the loan not be approved?
  • Have you considered other borrowing options such as overdraft increase/selling assets / using commercial credit cards as an alternative?
  • How much capital has been introduced by the shareholders and/or directors?
  • What is the impact on your supply chain? Have you reviewed their contingency plan?
  • What is your debtor concentration? Taking your top 5 clients, what percentage of your turnover are they? And how have they been impacted by COVID-19?

Price Bailey’s specialists are on hand to support, existing client or not. If you would like any further information or support on anything discussed above, please contact us on the form below.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.

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