Want To Buy Office For Your Business? Put Your Books In Order
Are you the sole proprietor of a business and looking to get your next swanky office financed by a bank? The bank will want to study your books of account while considering your property loan application. Unlike an individual approaching a bank for a housing loan, you will have to furnish details of your business and have your financial statements evaluated.
These statements are the record of your business entity's financial health. The bank will evaluate these – balance sheet, income statement, cashflow statement, statement of owner's equity, profit & loss account, and income & expenditure schedule – to make an opinion about your business entity's financial standing over a period of time.
Every document has a story to tell. MakaanIQ tells you top five things that the bank will look for in your financial statements.
- The ratios: The important ratios the bank looks at in your statements are liquidity, activity, leverage and profitability. The assessment of these ratios is done on the basis of the nature of your business. Here's a look at what each of these ratios signifies.
Liquidity ratio helps the bank determine your company's ability to pay off its short-term debt obligations. The common liquidity ratios the bank uses are the current ratio, quick ratio, and Operating cashflow ratio. The bank has a set range for the ratio that it considers safe for going ahead with funding the company. For instance, a current ratio of 2:1 is considered acceptable by most banks. If your company's current ratio is below 1, it may be perceived that you will have problems paying off the obligation. A high ratio is considered safe, but it might also be a signal that your company has problems in collecting its receivables or has a long inventory turnover.
Activity ratio gives an idea of how soon your company can convert its assets into cash. The activity ratios mostly studied are accounts payable turnover ratio, accounts receivable turnover ratio, stock turnover ratio, fixed asset turnover ratio, and sales to working capital ratio. These help estimate the pace at which your company pays its suppliers, collects account receivables from customers, or is able to generate sales from a base of fixed assets.
Leverage ratio is considered a key indicator of your company's debt level. Two most commonly used ones are debt ratio (total debt to total assets) and debt to equity ratio (total debt to total equity). If your company's debt ratio is high, this means it has a lot of debt vis-à-vis its assets – the interest and principal payment may be taking a significant part of its cash flows. High debt to equity ratios indicate your company might not be able to generate enough funds to satisfy debt obligations.
Profitability ratio measures your company's ability to generate earnings with respect to sales, equity and assets. The commonly used profitability ratios are return on sales, return on equity, return on investment, return on capital employed, gross profit margin, and net profit margin.
- Net worth: It is the amount by which your assets exceed your liabilities. In other words, it is the value you are left with if you were to sell off all your assets to repay your liabilities. The bank is aware that every financial move is meant to improve the net worth – increasing assets and reducing liabilities. And, the bank has a milestone fixed for net worth; it might not lend to your company if your net worth is less than, say, Rs 5 lakh.
- Cash/net profit: Cash profit is the value of net cash receipts after deducting all cash expenses, while net profit is the profit left after meeting all operating expenses and other charges like depreciation, taxes and interest. The bank studies the percentage of drop or rise in profits (both cash and net) over a period of time. For example, it might not lend if the fall in your company's profit is higher than 25 per cent year-on-year for consecutive years. It is always advisable that you keep supporting documents handy in case of a higher profit increase in initial years and a dip later.
- Turnover: It is the annual sales volume, net of all discounts and sales taxes. In simple words, it is your company's total revenue or sales. The bank sees if there is a drop in turnover beyond a certain safe rate over a period of time. For example, a turnover drop of more than 25 per cent for three years makes it difficult to go ahead with a loan.
- Leverage: It is the comparison of your company's long-term debt with its equity capital. The greater the leverage, the higher the ratio. Your company might be considered risky if the ratio is high. Leverage works on the principle that no matter how bad the sales, your company must service its debt. High equity provides cushion and is considered financial strength. Banks usually find a leverage ratio of 1.5 or below safe, and a ratio higher than 2 less favourable.