Community Banking Advisor: Business plans can provide vital information on your borrowers

February 12, 2015

How do you know where your business customers — or potential business customers — are headed? How do you know that the strategies and actions they’ve planned will allow them to meet their financial goals?

Business plans provide investors and lenders with an assessment of a business’s current operations, as well as its game plan for the future. They can help you gauge if your borrowers’ business goals are doable.

Defining business plans

Complete plans traditionally include these six components: 1) executive summary, 2) business description, 3) industry and marketing analysis, 4) management team description, 5) implementation plan and 6) financials.

Small and midsize businesses might balk at compiling a comprehensive business plan, but it’s imperative when a company is teetering on the edge of bankruptcy or needs financing for a major capital expenditure. The best plans are quite simple, however. Executive summaries can be as short as a paragraph. Long-winded plans tend to bury management’s message. For small businesses, executive summaries shouldn’t exceed one page, and the maximum overall length should be less than 40 pages.

Weighing in on executive summaries

Executive summaries are often the first place lenders look, but they’re the last page management should write. Business planning starts with a long-term vision: Where is the company now and where does it want to be in three, five or ten years? In other words, wise business owners start with historic financial results and then identify key benchmarks that management wants to achieve. These assumptions will drive the financials.

Sizing up financials

The second place lenders look when reviewing a business plan is the financials section. Management’s goals are fleshed out in its budgets and financial projections.

For example, suppose a company with $12 million in sales in 2014 expects to double that figure over a three-year period. How will the borrower get from Point A ($12 million in 2014) to Point B ($24 million in 2017)? Many roads lead to the desired destination.

Let’s say the management team decides to double sales by hiring four new salespeople and acquiring the assets of a bankrupt competitor. These assumptions will drive the projected income statement, balance sheet and cash flow statement.

When projecting the income statement, management makes assumptions about variable and fixed costs. Direct materials are generally considered variable. Salaries and rent are generally fixed. But many fixed costs can be variable over the long term. Consider rent: Once a lease expires, management can relocate to a different facility to accommodate changes in size.

Balance sheet items — receivables, inventory, payables and so on — are generally expected to grow in tandem with revenues. Management makes assumptions about its minimum cash balance, and then debt increases or decreases to keep the balance sheet balanced. In other words, your bank will be expected to fund any cash shortfalls that take place as the company grows.

The financials outline how much financing the borrower will need, how it plans to use those funds and when the borrower expects to repay its loans. As the lender, it’s your job to assess whether a borrower’s plan appears realistic.

Know your borrower

The rest of the business plan describes your borrower’s internal and external environment. These sections demonstrate that management has done its market research and risk analysis — and truly understands the marketplace. It can be informative reading material, even if you think you know an existing borrower.