Profits, sound pretty simple doesn’t it? You sell, you take off your costs, take off your overheads, feed the family, and what’s left is profit.
Maybe, but it is important to understand what profitability is in the eyes of a banker.
So what is different and what does a banker look at when profit is analysed to show whether a loan is affordable.
The Five Key Factors
- Are profits increasing with sales?
- What is the quality of the profits? Are they the direct result of sales or is there an extraordinary element in them?
- Are profits being retained in the business?
- If a loss has been made, has the cause been identified and remedial action taken?
- Are there any changed in the return earned on capital employed?
We can go into some depth on what this all means, however in the simplest form it looks something like this –
- If sales have increased, have profits. Are sales a result of price reductions, therefore the margin made has reduced
- Has there been a one off event, maybe one large not to be repeated sale. Have costs been reduced, maybe a bulk purchase which will not happen again. Remember that a banker is looking at future profits, what has happened is only an indication of what will happen, so profit quality is key
- We all like to take our profits, after all it is what you work for, but some need to be retained, it shows faith and trust in your business. If you want someone to put their money in, then put your’s in also
- Losses are not always a bad thing, they happen. Don’t hide them, understand them and show you understand them. If anything over analyse losses, obsess about them and show the banker you are on top of it. Never let the banker be the one to ask you about a loss, get in there first
- What has happened to your investment. Has the return on your investment changed, you may have equipment, staff, premises etc, all of which may be giving a return, so if it has changed then why? The same practice as number 4 is relevant. We would suggest asking your accountant this question before your accounts are finalised
Profits = Tax, Doesn’t it?
We often see accounts where the profit has been reduced to avoid paying tax, perfectly genuine and legally. But, remember that if you are borrowing money then profits will be what proves affordability, so don’t cancel them all out for the sake of a little tax.
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See our other blog posts –
Why Profits Are Good, But Cash Really Matters /2013/01/14/cash-cash-cash
Six People Who Can Change Your Business /2013/01/13/the-6-people-i-met-who-changed-my-business
How Your Bank Sees Profitability, Not How You Do /2013/01/13/profitability-and-what-is-it-in-the-eyes-of-a-banker