Lending to Business Firms and Pricing

Business Loans
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Key Topics
Types of Business Loans: Short-Term and
Long-Term
Analyzing Business Loan Requests
Collateral and Contingent Liabilities
Sources and Uses of Business Funds
Pricing Business Loans
Customer Profitability Analysis (CPA)

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Short Term Business Loans

Self-Liquidating Inventory Loans
Working Capital Loans
Interim Construction Loans
Security Dealer Financing
Retailer and Equipment Financing
Asset-Based Financing
Syndicated Loans

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Long Term Business Loans

Term Loans
Revolving Credit Lines
Project Loans
Loans to Support Acquisitions of Other
Business Firms
Question: What are the essential
differences between various short- and
long-term business loans?
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Sources of Repayment for Business

Loans
The Borrowers Profits or Cash Flows
Business Assets Pledged as Collateral
Strong Balance Sheet With Ample
Marketable Assets and Net Worth
Guarantees Given By Businesses

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Analyzing Business Loan

Applications
Common Size Ratios of Customer
Over Time
Financial Ratio Analysis of
Customers Financial Statements
Current and Pro Forma Sources and
Uses of Funds Statement

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Financial Ratio Analysis

Control Over Expenses

Operating Efficiency
Marketability of Product or Service
Coverage Ratios: Measuring Adequacy of
Earnings
Liquidity Indicators for Business Customers
Profitability Indicators
The Financial Leverage Factor as a Barometer
of a Business Firms Capital Structure

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Expense Control Measures

Cost of Goods Sold/Net Sales
Selling, Administrative and Other
Expenses/Net Sales
Depreciation Expenses/Net Sales
Interest Expenses on Borrowed Funds
/Net Sales
Taxes/Net Sales

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Operating Efficiency
Annual Costs of Goods Sold/Average
Inventory
Average Receivables Collection
Period
Net Sales/Net Fixed Assets
Net Sales/Total Assets
Net Sales/Accounts Receivables
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Marketability of Product or Service

Gross Profit Margin=(Net SalesCGS)/Net Sales

Net Profit Margin=Net Income After
Taxes/Net Sales

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Coverage Measures
Interest Coverage
Coverage of Interest and Principal
Payments

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Liquidity Measures

Current Assets/Current Liabilities

Acid Test Ratio
Working Capital
Net Liquid Assets

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Profitability Measures

Before Tax Net Income/Total Assets

After Tax Net Income/Total Assets
Before Tax Net Income/Net Worth
After Tax Net Income/Net Worth

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Leverage or Capital Structure

Measures
Leverage Ratio
Total Liabilities/Net Worth
Capitalization Ratio
Debt to Sales Ratio

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Types of Contingent Liabilities

Guarantees or Warrantees Behind
Products
Litigation or Pending Lawsuits
Unfunded Pension Liabilities
Taxes Owed But Unpaid
Limiting Regulations

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Comprehensive Environmental
Response, Compensation and
Liability Act
This Law Makes Current and Past Owners of
Contaminated Property, Current and Past
Owners and Prior Operators of Businesses
Located on Contaminated Property and
Those Who Transport Hazardous
Substances Potentially Liable
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Component of Sources and Uses of

Funds Statement
Cash Flows from Operations
Cash Flows from Investing Activities
Cash Flows from Financing Activities

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Traditional (Direct) Operating Cash

Flows
Net Sales Revenue Cost of Goods Sold
Selling, General and Administrative Taxes
Paid in Cash + Non Cash Expenses

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Indirect Operating Cash Flows

Net Income + Non Cash Expenses + Losses
from the Sale of Assets Gains from the
Sale of Assets Increases in Assets
Associated with Operations + Increases in
Current Liabilities Associated with
Operations Decreases in Current
Liabilities Associated with Operations +
Decreases in Current Assets Associated
with Operations
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Methods Used to Price Business

Loans
Cost-Plus Loan Pricing Method
Price Leadership Model
Below Prime Market Pricing
Customer Profitability Analysis

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Cost-Plus Loan Pricing

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Price Leadership Model

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Prime Rate
Major Banks Established a Base Lending
Fee During the Great Depression. At that
Time It Was the Lowest Interest Rate
Charged Their Most Credit Worthy
Customers for Short-Term Working Capital
Loans

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LIBOR

The London Interbank Offer Rate. The

Rate Offered on Short-Term Eurodollar
Deposits With Maturities Ranging From a
Few Days to a Few Months

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Below-Prime Market Pricing

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Customer Profitability Analysis

(CPA)
Estimate Total Revenues From Loans and
Other Services
Estimate Total Expenses From Providing
Net Loanable Funds
Estimate Net Loanable Funds
Estimate Before Tax Rate of Return By
Dividing Revenues Less Expenses By Net
Loanable Funds

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Quick Quiz
What aspects of a business firms financial
statements do loan officers and credit analysts
examine carefully?
What methods are used to price business loans?
Suppose a bank estimates that the marginal cost
of raising loanable funds to make a $10m loan to
one of its corporate customers is 4%, its nonfunds
operating costs to evaluate and offer this loan are
0.5%, the default-risk premium on the loan is
0.375%, a term-risk premium of 0.625% is to be
added, and the desired profit margin is 0.25%.
What loan rate should be quoted this borrower?
How much interest will this borrower pay in a
year?
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