Covenant Negotiation Article - Journal of Accountancy August 2010
The August 2010 Journal of Accountancy published an article authored by Ron Box on how to effectively negotiate loan covenants with bankers. The article can be found at:
http://www.journalofaccountancy.com/Issues/2010/Aug/20102671.htm
Sunday, September 12, 2010
Wednesday, November 25, 2009
The AICPA CITP Liaison Program
The Certified Information Technology Professional (CITP) Credential Committee has established a liaison program with participating state societies of certified public accounting. The basic concept of the program is to leverage the strengths of each state society and enhance the position of the CITP credential, which is growing in popularity since the certification was recently re-defined. As more CPAs with qualifying IT experience find more information regarding the enhanced CITP Body of Knowledge and resources available from the AICPA IT Section, the CITP credential should find greater recognition as a premier AICPA certification.The liaison, called a CITP Champion, will work directly with the state society of which they are a member. The CITP Liaison Program’s primary objective is to inform the professional community about the vital role of information technology in the financial management process and the resources available to educate CPAs about information technology. The role of the Champion is to expand communication pathway between AICPA’s CITP Committee and IT Communities at the state level, and lead/ assist on projects important to the CITP program message.
Most state societies are significantly understaffed and unable to take on all of the projects that they would otherwise undertake in order to benefit the membership. In addition, many societies do not have the knowledge or experience to determine what issues are relevant to their CITP members.
So, what would a CITP Champion do? Primarily, he or she would be the main conduit of information and program issues between the CITP Credential Committee and the local society. The Champion would articulate the benefits of being a CITP credential holder by helping the society develop programs, articles, speaking engagements, etc. The Champion would be the local representative of the credential, answering questions and providing insight to the state society membership regarding IT Section and CITP benefits. Current CITP credential holders and anyone considering the certification should be made aware that the new CITP Body of Knowledge has two distinct elements:
To review the complete CITP Body of Knowledge, go to http://infotech.aicpa.org/Memberships/CITP+Body+of+Knowledge.htm
Also, the AICPA IT Section will support the CITP Body of Knowledge by offering new benefits such as webcasts, podcasts, and technical content. In addition, continuing professional education courses will be developed designed to fully support all of the objectives outlined in the body of knowledge. In the near future, a CITP examination will be required for certification and an exam preparation platform will be offered to prepare the candidate for a successful experience.
Why should you consider becoming a CITP Champion? For me, the answer was simple. I strongly believe in the CITP credential, and I think that anyone holding the certification demonstrates a completely unique skill set. The CITP can be a necessary bridge between accounting / finance and technology, each of which have distinct cultures and terminology. More importantly, the CITP can offer unique business insight based on the combined strengths of accounting / finance and technology. From a professional point of view, this is an excellent opportunity to broaden your network while working directly with your state society. Contributing to the state society has been one of the most rewarding experiences of my career, and I believe that most CITPs volunteering for this program will find the same result. If you have any questions regarding the CITP Liaison program, please contact me at rbox@joemoney.com.
Ron Box is a member of the CITP Credential Committee, the CITP Education Task Force, and is a CITP Champion for the Alabama Society of Certified Public Accountants.
Friday, November 20, 2009
Combating Insider Fraud
In these times of great uncertainty, it can appear that threats march toward your business in great numbers. It is easy to believe that the risks facing your business all come from the outside. However, the biggest threat to your business could be inside your business, working a few yards away from your office. That threat could be the very employees that you trust the most. That position of trust, sometimes earned by years of apparently loyal service, can create a great risk. It is difficult for some executives to consider the possibility that fraud, embezzlement, forgery, etc. could be happening today and be perpetrated by the most unlikely of people. Yet, it happens literally every day. This article will discuss simple methods regarding how you can avoid putting your business at risk from insider fraud.
The first, most basic, step to take is to adopt a mind set that any of your employees could be engaged in fraud. Human nature sometimes causes us to believe that insider fraud does happen, but that it happens to other businesses. It will not happen “here”. The truth of the matter is that you have to understand that insider fraud can, and will, happen anywhere. In order to take steps to protect your business, you must believe that the threat exists. So, without assigning the threat to a specific employee, accept the possibility that some employees can and will steal from your business.
Next, understand the basics of fraud and why it occurs. Three conditions generally take place to perpetuate fraud (sometimes called the fraud triangle). First, the employee feels some kind of pressure to commit fraud. The pressure could take the form of unpaid medical bills, past due mortgage payments, gambling debts, etc. Whatever the reason, the employee has a financial problem that is difficult to solve through “normal” methods. Second, the employee has the opportunity to commit fraud. This occurs when the controls to prevent theft within your business are ineffective or can be easily overridden. Third, the employee will probably rationalize their acts. An employee could believe that he or she is underpaid (therefore “due” more, so they are not really stealing), that the fraud is a temporary loan to be paid back when times are better, etc. A critical idea in constructing a system to prevent fraud is to understand that even an otherwise honest employee, given enough pressure, can steal from your company. Fraud literature tells us that most employees have a greater tendency to rationalize fraudulent acts as their financial pressure increases.
Of these three elements, notice that two reside with the employee and you have no control over pressure or rationalization. Opportunity, however, is an element that you can control. It is necessary to take several basic steps to create a system of controls that will reduce the opportunity for fraud. Here is a short list of fundamental ideas to consider:
1. Create and maintain an unambiguous culture of ethical behavior.
The “attitude from the top” sets the tone for the organization, and the appearance of tolerating unethical behavior can embolden employees to commit fraud.
2. Create a Policy on Fraudulent Acts with clear and unambiguous penalties.
3. Consider where fraud is most likely to occur in your business.
Ignore personalities and specific employees – focus only on where in your business the risk of fraud is the greatest. If necessary, establish a team to dissect the internal operations in order to list the operational areas with the greatest exposures.
4. Establish Controls to Prevent Fraud. Here are a few basic examples:
1. Segregate duties as much as possible.
Try to construct a situation that would require collusion between employees to perpetrate a fraud.
2. Use approved purchase orders to substantiate expenditures.
3. Limit access to systems.
4. Require documentation on all transactions (authorized, complete, correctly valued, etc.
5. Establish Controls to Detect Fraud. Again, here are a few basic examples:
1. Reconcile bank statements immediately upon receipt.
Look for forged signatures on checks, new vendors, etc.
2. Physically count inventory on a regular basis.
3. Review exception reports.
4. Make all employees aware that surprise inspections can occur at any time.
The establishment of effective prevention and detection controls should be an extensive project, and should be tailored to the risks inherent in your business. These methods collectively constitute your defense against insider opportunity.
Be aware that many commercial checking agreements require notification of any problem with the accounts within 30 days. This is why immediate reconciliation of the bank statements is important. This step also can shorten the time that a fraud can occur by early detection. Also, check your insurance program for “Crime” coverage. Many policies provide coverage in case of employee theft. The coverage is generally inexpensive, and the limits can usually be increased significantly before a fraud occurs. A properly constructed insurance benefit protecting your business from an employee’s criminal acts can be invaluable.
Insider fraud can cause significant damage to your business. Don’t let this happen. Make a real effort to understand the factors that increase the likelihood of fraud and then clear steps to detect and prevent its occurrence. This can be one of the most important steps you can take in protecting your business.
© 2009 Ron Box
The first, most basic, step to take is to adopt a mind set that any of your employees could be engaged in fraud. Human nature sometimes causes us to believe that insider fraud does happen, but that it happens to other businesses. It will not happen “here”. The truth of the matter is that you have to understand that insider fraud can, and will, happen anywhere. In order to take steps to protect your business, you must believe that the threat exists. So, without assigning the threat to a specific employee, accept the possibility that some employees can and will steal from your business.
Next, understand the basics of fraud and why it occurs. Three conditions generally take place to perpetuate fraud (sometimes called the fraud triangle). First, the employee feels some kind of pressure to commit fraud. The pressure could take the form of unpaid medical bills, past due mortgage payments, gambling debts, etc. Whatever the reason, the employee has a financial problem that is difficult to solve through “normal” methods. Second, the employee has the opportunity to commit fraud. This occurs when the controls to prevent theft within your business are ineffective or can be easily overridden. Third, the employee will probably rationalize their acts. An employee could believe that he or she is underpaid (therefore “due” more, so they are not really stealing), that the fraud is a temporary loan to be paid back when times are better, etc. A critical idea in constructing a system to prevent fraud is to understand that even an otherwise honest employee, given enough pressure, can steal from your company. Fraud literature tells us that most employees have a greater tendency to rationalize fraudulent acts as their financial pressure increases.
Of these three elements, notice that two reside with the employee and you have no control over pressure or rationalization. Opportunity, however, is an element that you can control. It is necessary to take several basic steps to create a system of controls that will reduce the opportunity for fraud. Here is a short list of fundamental ideas to consider:
1. Create and maintain an unambiguous culture of ethical behavior.
The “attitude from the top” sets the tone for the organization, and the appearance of tolerating unethical behavior can embolden employees to commit fraud.
2. Create a Policy on Fraudulent Acts with clear and unambiguous penalties.
3. Consider where fraud is most likely to occur in your business.
Ignore personalities and specific employees – focus only on where in your business the risk of fraud is the greatest. If necessary, establish a team to dissect the internal operations in order to list the operational areas with the greatest exposures.
4. Establish Controls to Prevent Fraud. Here are a few basic examples:
1. Segregate duties as much as possible.
Try to construct a situation that would require collusion between employees to perpetrate a fraud.
2. Use approved purchase orders to substantiate expenditures.
3. Limit access to systems.
4. Require documentation on all transactions (authorized, complete, correctly valued, etc.
5. Establish Controls to Detect Fraud. Again, here are a few basic examples:
1. Reconcile bank statements immediately upon receipt.
Look for forged signatures on checks, new vendors, etc.
2. Physically count inventory on a regular basis.
3. Review exception reports.
4. Make all employees aware that surprise inspections can occur at any time.
The establishment of effective prevention and detection controls should be an extensive project, and should be tailored to the risks inherent in your business. These methods collectively constitute your defense against insider opportunity.
Be aware that many commercial checking agreements require notification of any problem with the accounts within 30 days. This is why immediate reconciliation of the bank statements is important. This step also can shorten the time that a fraud can occur by early detection. Also, check your insurance program for “Crime” coverage. Many policies provide coverage in case of employee theft. The coverage is generally inexpensive, and the limits can usually be increased significantly before a fraud occurs. A properly constructed insurance benefit protecting your business from an employee’s criminal acts can be invaluable.
Insider fraud can cause significant damage to your business. Don’t let this happen. Make a real effort to understand the factors that increase the likelihood of fraud and then clear steps to detect and prevent its occurrence. This can be one of the most important steps you can take in protecting your business.
© 2009 Ron Box
Friday, November 13, 2009
Business Intelligence Myth -
Responding to Business Intelligence Myths: BI Is About Technology Software
Have you considered implementing a business intelligence program? What are the critical steps in creating an effective BI system. What are the ultimate results you should expect? This series of articles intends to simplify the process and convince the financial decision makers of the ultimate productive reasoning that a well constructed BI program can produce. Business intelligence can produce a high ROI, and financial executives can approve as well as participate in the BI program with a reliance on the final product adding significant value to the organization.
First, let us examine why you should consider a business intelligence program at all. In my view, the answer is simple. As a chief financial officer of a regional business, I realized that all of the data that I needed to effectively run the business did reside in various places within the organization. The data, however, was not in a universally accessible location. Some data was in our primary ERP system, some was kept by various employees on Excel spreadsheets for different purposes, and some data resided only in the mind of certain people. I called these various data locations "silos". I realized, in making a business decision, all of the information I needed existed within the company. It was maddening, however, to realize that I could not reach much of the data in a coherent, timely, and well defined manner.
Some decision makers believe that simply purchasing the business intelligence software will automatically create the data solutions needed to more effectively run the business. This step alone will not produce an effective result. As with all software, BI technology is a tool and all tools are subject to the skill of the user. BI technology allows the data to be compiled in one easily accessible location and the software is designed to render the data in the most productive way to the user. The overarching need of the program, however, is to ensure that several steps are effectively carried out so as to ultimately bring enhanced business insight to the user. Before selecting and installing the most appropriate BI software for your organization (a critical step to be sure), you must create procedures that will:
1. Establish at a high level the ultimate objectives required by the BI program.
2. Create an experienced, skilled, and knowledgeable Business Intelligence Team.
3 Ensure that the BI Team has the clear authority to achieve the BI objectives.
4. Determine what data should be available in real time for principle decision makers.
5. Determine where the required data resides within the organization.
6. Ensure the accuracy of the data.
7. Determine how to create a real time, automatic flow of data to the BI system.
8. Input data to the system using the processes to be used for all future data capture.
9. Ensure that the data combines in the most effective means possible.
10. Ensure that the BI program is well maintained, with regular evaluations to improve the process.
The ultimate benefit of an effective and well-implemented business intelligence program can be incredible for a financial executive. Imagine having the necessary data, in real time on your computer, to make critical decisions. The benefits can be decisive in the success or your business (and career). As most financial executives know, the race usually goes to the organization with the best data making the best and quickest decisions. It is my belief that a robust business intelligence program is an indispensable tool in achieving that result.
So, while business intelligence software is clearly an important tool, the program that continuously feeds data to the software is the more critical issue. The rewards of a well planned and well executed business intelligence program can enhance your business and your career. I recommend that the financial executive initiate the steps to create a BI program in your organization. Approve an initial BI project budget to investigate which BI software best suits your needs. Look to the long term and create a trusted project team to evaluate the best software and processes required to achieve your objectives. If you do not, I believe your competitors will.
© 2009 Ron Box
Have you considered implementing a business intelligence program? What are the critical steps in creating an effective BI system. What are the ultimate results you should expect? This series of articles intends to simplify the process and convince the financial decision makers of the ultimate productive reasoning that a well constructed BI program can produce. Business intelligence can produce a high ROI, and financial executives can approve as well as participate in the BI program with a reliance on the final product adding significant value to the organization.
First, let us examine why you should consider a business intelligence program at all. In my view, the answer is simple. As a chief financial officer of a regional business, I realized that all of the data that I needed to effectively run the business did reside in various places within the organization. The data, however, was not in a universally accessible location. Some data was in our primary ERP system, some was kept by various employees on Excel spreadsheets for different purposes, and some data resided only in the mind of certain people. I called these various data locations "silos". I realized, in making a business decision, all of the information I needed existed within the company. It was maddening, however, to realize that I could not reach much of the data in a coherent, timely, and well defined manner.
Some decision makers believe that simply purchasing the business intelligence software will automatically create the data solutions needed to more effectively run the business. This step alone will not produce an effective result. As with all software, BI technology is a tool and all tools are subject to the skill of the user. BI technology allows the data to be compiled in one easily accessible location and the software is designed to render the data in the most productive way to the user. The overarching need of the program, however, is to ensure that several steps are effectively carried out so as to ultimately bring enhanced business insight to the user. Before selecting and installing the most appropriate BI software for your organization (a critical step to be sure), you must create procedures that will:
1. Establish at a high level the ultimate objectives required by the BI program.
2. Create an experienced, skilled, and knowledgeable Business Intelligence Team.
3 Ensure that the BI Team has the clear authority to achieve the BI objectives.
4. Determine what data should be available in real time for principle decision makers.
5. Determine where the required data resides within the organization.
6. Ensure the accuracy of the data.
7. Determine how to create a real time, automatic flow of data to the BI system.
8. Input data to the system using the processes to be used for all future data capture.
9. Ensure that the data combines in the most effective means possible.
10. Ensure that the BI program is well maintained, with regular evaluations to improve the process.
The ultimate benefit of an effective and well-implemented business intelligence program can be incredible for a financial executive. Imagine having the necessary data, in real time on your computer, to make critical decisions. The benefits can be decisive in the success or your business (and career). As most financial executives know, the race usually goes to the organization with the best data making the best and quickest decisions. It is my belief that a robust business intelligence program is an indispensable tool in achieving that result.
So, while business intelligence software is clearly an important tool, the program that continuously feeds data to the software is the more critical issue. The rewards of a well planned and well executed business intelligence program can enhance your business and your career. I recommend that the financial executive initiate the steps to create a BI program in your organization. Approve an initial BI project budget to investigate which BI software best suits your needs. Look to the long term and create a trusted project team to evaluate the best software and processes required to achieve your objectives. If you do not, I believe your competitors will.
© 2009 Ron Box
Thursday, October 29, 2009
Business Intelligence as a Mergers & Acquisition Tool
As the global economy begins to recover and banks begin to issue more credit for business deals, the number of mergers and acquisitions (M&A) should increase substantially. In any M&A deal, the due diligence phase requiring vast amounts of data is often the most difficult. Consider the value of financial tools that would provide great insight to the nature and condition of a business serving as the target of a merger or acquisition. Business intelligence tools can provide a tremendous amount of relevant, customized information for the acquiring organization. Broadly defined, business intelligence (BI) is the term given to the process of producing relevant and insightful business data from various, often unrelated, sources. Think about the information needed to make effective business decisions for an organization. Then consider that the data is probably available somewhere, but often residing in systems that cannot talk to one another. This can be a very frustrating realization. Business intelligence, however, can be the framework that will bridge the gap between systems, spreadsheets, and other obstacles to effective information management. This can be especially true in determining if two organizations are as well matched in detail as they appear to be on the surface.
In its most elemental form, business intelligence is simply a method of gathering and validating information from various parts of an organization in order to provide unique business insight. Think of the traditional information available within your company and the limits placed on the data by various systems. Useful information cannot be combined in ways that would be most beneficial because the systems containing the data cannot talk to one another or the information has not been formatted in such a way as to simplify the use of the data. New systems do not talk to legacy systems. Spreadsheets are sometimes developed to bridge these information gaps, but they are generally not automated for real time availability and they frequently contain data that has not been validated. These segments of information that cannot relate to one another are often called “silos”. The object of business intelligence is to provide a framework for cross-siloed data relationships.
Once the relevant data is obtained and validated, it can be used for any number of purposes. Traditionally, this data is used by CEOs, CFOs, controllers, and other business professionals in pre-formatted real time data characterizations (often in simplified presentations called dashboards). Consider the uses available to a trained professional if these information tools are framed in broader terms and nontraditional applications. Any project requiring significant data and due diligence could be a candidate for business intelligence tools.
One clear business need requiring massive amounts of information, due diligence, and insight could be a mergers and acquisition (M&A) project. M&A projects ultimately are performed to determine if companies that superficially appear to be a good match are, in fact, financially compatible. Given the magnitude of effort and funds expended to determine the viability of a merger, and the enormous costs involved such a project, business intelligence can be a small portion of the total budget. Properly formatted data derived from the appropriate application of business intelligence tools could provide critical information indicating the need to proceed, modify, or terminate M&A negotiations. Therefore, the return on investment for a BI project tied to the due diligence phase of an M&A project could be substantial.
Business intelligence applications are especially well suited to any projects that require large amounts of information. In many organizations, business intelligence is considered an IT Department function because of the technology required to reach and format data. However, this view restricts the ultimate objective of business intelligence, which is the effective use of information. Finance can be, and in many cases should be, the driving force behind the use of business intelligence tools. In most cases, like the M&A scenario presented here, the CFO will work closely with the CEO and other primary executives to determine if the merger should go forward, and on what terms. Consequently, BI should be considered a major finance tool with a definable return on investment.
Think of the “bad” mergers that have been well documented in the news and the enormous amount of resources wasted in these deals. Could a more effective due diligence process providing more insightful information have caused many of these deals to have been called off? Most would agree that better insights in to the target business would provide a much better framework for effective decision-making. Well designed business intelligence applications can be the means to a happy and profitable merger.
In its most elemental form, business intelligence is simply a method of gathering and validating information from various parts of an organization in order to provide unique business insight. Think of the traditional information available within your company and the limits placed on the data by various systems. Useful information cannot be combined in ways that would be most beneficial because the systems containing the data cannot talk to one another or the information has not been formatted in such a way as to simplify the use of the data. New systems do not talk to legacy systems. Spreadsheets are sometimes developed to bridge these information gaps, but they are generally not automated for real time availability and they frequently contain data that has not been validated. These segments of information that cannot relate to one another are often called “silos”. The object of business intelligence is to provide a framework for cross-siloed data relationships.
Once the relevant data is obtained and validated, it can be used for any number of purposes. Traditionally, this data is used by CEOs, CFOs, controllers, and other business professionals in pre-formatted real time data characterizations (often in simplified presentations called dashboards). Consider the uses available to a trained professional if these information tools are framed in broader terms and nontraditional applications. Any project requiring significant data and due diligence could be a candidate for business intelligence tools.
One clear business need requiring massive amounts of information, due diligence, and insight could be a mergers and acquisition (M&A) project. M&A projects ultimately are performed to determine if companies that superficially appear to be a good match are, in fact, financially compatible. Given the magnitude of effort and funds expended to determine the viability of a merger, and the enormous costs involved such a project, business intelligence can be a small portion of the total budget. Properly formatted data derived from the appropriate application of business intelligence tools could provide critical information indicating the need to proceed, modify, or terminate M&A negotiations. Therefore, the return on investment for a BI project tied to the due diligence phase of an M&A project could be substantial.
Business intelligence applications are especially well suited to any projects that require large amounts of information. In many organizations, business intelligence is considered an IT Department function because of the technology required to reach and format data. However, this view restricts the ultimate objective of business intelligence, which is the effective use of information. Finance can be, and in many cases should be, the driving force behind the use of business intelligence tools. In most cases, like the M&A scenario presented here, the CFO will work closely with the CEO and other primary executives to determine if the merger should go forward, and on what terms. Consequently, BI should be considered a major finance tool with a definable return on investment.
Think of the “bad” mergers that have been well documented in the news and the enormous amount of resources wasted in these deals. Could a more effective due diligence process providing more insightful information have caused many of these deals to have been called off? Most would agree that better insights in to the target business would provide a much better framework for effective decision-making. Well designed business intelligence applications can be the means to a happy and profitable merger.
Saturday, October 24, 2009
How Do You Make Yourself Important to Your Banker?
Most bankers do not take the time to stay current on accounting issues like XBRL and IFRS. Adoption of both XBRL and IFRS will have major implications on financial statement reporting, and bankers have to understand the changes.
XBRL (eXtensible Business Reporting Language) requires a standard format for all financial statements, so tags are used to map individual general ledger accounts to the pre-determined format.
IFRS (International Financial Reporting Standard) accounting rules represent a generally uniform global approach to capitalization, revenue, and expense recognition. The Securities and Exchange Commission recently reaffirmed its commitment to a convergence of US GAAP to IFRS [1].
Commit yourself to learning the accounting issues that your banker needs to know. Offer to provide the information to your banker as a professional courtesy. I can tell you from experience, the benefits can be well worth the effort.
For a more in-depth discussion of how to be more important to your banker, see the following profile from Cfo.Com:
http://www.cfo.com/article.cfm/13131183/1/c_13131494?f=home_todayinfinance
Footnote:
[1] http://blog.ifrs.com/2009/09/sec-breaks-silence-on-ifrs.html
Most bankers do not take the time to stay current on accounting issues like XBRL and IFRS. Adoption of both XBRL and IFRS will have major implications on financial statement reporting, and bankers have to understand the changes.
XBRL (eXtensible Business Reporting Language) requires a standard format for all financial statements, so tags are used to map individual general ledger accounts to the pre-determined format.
IFRS (International Financial Reporting Standard) accounting rules represent a generally uniform global approach to capitalization, revenue, and expense recognition. The Securities and Exchange Commission recently reaffirmed its commitment to a convergence of US GAAP to IFRS [1].
Commit yourself to learning the accounting issues that your banker needs to know. Offer to provide the information to your banker as a professional courtesy. I can tell you from experience, the benefits can be well worth the effort.
For a more in-depth discussion of how to be more important to your banker, see the following profile from Cfo.Com:
http://www.cfo.com/article.cfm/13131183/1/c_13131494?f=home_todayinfinance
Footnote:
[1] http://blog.ifrs.com/2009/09/sec-breaks-silence-on-ifrs.html
Commercial Banking –What is Going On?
Access to credit can mean the difference between life and death for many businesses. The financial crisis has caused a great deal of change in the banking industry and, unfortunately, this can mean trouble for many businesses. Ask yourself a few questions. Does it appear that your bank is being very cautious about credit commitments? How does your bank decide credit issues? Do you know the risk rating assigned to your company by your banks regulators? What can you do in these uncertain times to improve your chances of getting the credit your business needs? The answers to these questions can dictate the survival of your company.
Commercial banking has changed a great deal in the past couple of years. Financial institutions now see capital preservation as a primary factor in doing business. Many banks use some form of profitability model to determine whether or not a customer adds to or subtracts from existing capital. One common method is called the Risk Adjusted Return on Capital (or RAROC – pronounced “ray-rock”). Essentially, the bank will assess how much a customer brings to the table with interest revenue, fees, and deposits. These are capital additions attributable to the customer. Financial institution regulators require a bank to set aside more capital as a reserve when the risk of loan default increases. As the customer’s profitability and cash flow becomes impaired and more capital must be reserved, the bank is forced to reduce its available capital. The loan loss reserves coupled with any specific costs associated with the relationship are capital reductions. The bank knows how much capital is required to run the business, so this type of profitability model allows the bank to calculate the relative contribution or cost a customer creates. Knowing how the bank calculates the value of your relationship can be very important.
When a line of credit is renewed, it often will pass through a credit committee of some type within the bank. Depending on the amount of the credit, the review may be limited to several credit specialists or it may go to a formal committee with numerous bank officers and in-depth debate of a customer’s financial position. The key to successfully navigating this process lies in preparation. Your banker will put together a package providing information to the credit committee on relevant factors supporting renewal of the credit line. The more he or she knows to support a positive decision, the better your chances. Prepare a written business plan using realistic assumptions and trends. Accurately project your capital needs and cash flow. This meeting is one of the most important that your business will be involved in each year, so make sure that the bank has the best information that you can provide.
What does this mean to the finance executive in business and industry? It can explain why some banks, particularly the larger ones, are focused like seldom before on interest rates, fees, deposits, etc. It can also explain why that drop in cash flow or recent loss on the financial statements from last year is apparently now a much bigger concern than had been anticipated. Many bankers believe that the best way to mitigate problems caused by any downturn in your business is to communicate openly and frequently. Make sure you monitor every covenant required by your loan agreements. If you believe that a covenant breach is likely to occur, be sure to discuss this with your banker as early as possible. Bankers hate surprises. If brought to the banks attention early enough, it is possible that a covenant waiver can be granted by the bank. Although a waiver fee may be assessed or the interest rate may be adjusted, these options are preferable to a loan violation leading to default.
Your best interest will be served by knowing as much as is possible about the banking business. Understanding the bank’s regulatory environment and how banking decisions are made will allow you to put yourself in the banker’s shoes. You know your business better than anyone does. You can improve your chances of getting the credit you need if you can anticipate what the bank will need for good credit decisions. Working collaboratively with your banker to get the most from your relationship is usually the best way to ensure positive results.
Access to credit can mean the difference between life and death for many businesses. The financial crisis has caused a great deal of change in the banking industry and, unfortunately, this can mean trouble for many businesses. Ask yourself a few questions. Does it appear that your bank is being very cautious about credit commitments? How does your bank decide credit issues? Do you know the risk rating assigned to your company by your banks regulators? What can you do in these uncertain times to improve your chances of getting the credit your business needs? The answers to these questions can dictate the survival of your company.
Commercial banking has changed a great deal in the past couple of years. Financial institutions now see capital preservation as a primary factor in doing business. Many banks use some form of profitability model to determine whether or not a customer adds to or subtracts from existing capital. One common method is called the Risk Adjusted Return on Capital (or RAROC – pronounced “ray-rock”). Essentially, the bank will assess how much a customer brings to the table with interest revenue, fees, and deposits. These are capital additions attributable to the customer. Financial institution regulators require a bank to set aside more capital as a reserve when the risk of loan default increases. As the customer’s profitability and cash flow becomes impaired and more capital must be reserved, the bank is forced to reduce its available capital. The loan loss reserves coupled with any specific costs associated with the relationship are capital reductions. The bank knows how much capital is required to run the business, so this type of profitability model allows the bank to calculate the relative contribution or cost a customer creates. Knowing how the bank calculates the value of your relationship can be very important.
When a line of credit is renewed, it often will pass through a credit committee of some type within the bank. Depending on the amount of the credit, the review may be limited to several credit specialists or it may go to a formal committee with numerous bank officers and in-depth debate of a customer’s financial position. The key to successfully navigating this process lies in preparation. Your banker will put together a package providing information to the credit committee on relevant factors supporting renewal of the credit line. The more he or she knows to support a positive decision, the better your chances. Prepare a written business plan using realistic assumptions and trends. Accurately project your capital needs and cash flow. This meeting is one of the most important that your business will be involved in each year, so make sure that the bank has the best information that you can provide.
What does this mean to the finance executive in business and industry? It can explain why some banks, particularly the larger ones, are focused like seldom before on interest rates, fees, deposits, etc. It can also explain why that drop in cash flow or recent loss on the financial statements from last year is apparently now a much bigger concern than had been anticipated. Many bankers believe that the best way to mitigate problems caused by any downturn in your business is to communicate openly and frequently. Make sure you monitor every covenant required by your loan agreements. If you believe that a covenant breach is likely to occur, be sure to discuss this with your banker as early as possible. Bankers hate surprises. If brought to the banks attention early enough, it is possible that a covenant waiver can be granted by the bank. Although a waiver fee may be assessed or the interest rate may be adjusted, these options are preferable to a loan violation leading to default.
Your best interest will be served by knowing as much as is possible about the banking business. Understanding the bank’s regulatory environment and how banking decisions are made will allow you to put yourself in the banker’s shoes. You know your business better than anyone does. You can improve your chances of getting the credit you need if you can anticipate what the bank will need for good credit decisions. Working collaboratively with your banker to get the most from your relationship is usually the best way to ensure positive results.
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