Community Banking Advisor: Measure your borrowers’ performance

Are your business loan customers using the professional tools available to keep an eagle’s eye on their company’s performance? If you think your hands are tied when it comes to affecting your borrowers’ financial professionalism, think again. Consider the following hypothetical case.

Igniting change

When Ann Blank switched banks to consolidate her company’s debt and lower its interest rates, she received an unexpected bonus — financial insight — from an unexpected source: her new banker.

As part of its standard due diligence protocol, the banker benchmarks each borrower’s financial statements against Risk Management Association industry norms. Benchmarking, a powerful analytical tool, compares a company’s performance against industry norms and best practices. If a borrower fails to measure up, the owner receives a friendly follow-up call.

When the banker phoned Ann, he pointed out that her company’s days-in-receivables was 15 days longer than the industry average and its days-in-inventory was nearly double the norm.

Ann was defensive: “You ‘suits’ need to spend some time in the real world! Our collections have been around 65 days since the ’80s. Customers won’t pay faster. Small businesses can’t afford to push customers — or we’ll lose them!”

Netting results

Having heard every excuse in the book, the banker pointed out that his portfolio included other borrowers in the same industry, of roughly the same size, that matched the benchmarks. Although Ann’s performance didn’t violate any loan covenants, he recommended she consult a CPA to get her company’s asset management back on track.

Thanks to the banker’s insight, Ann’s average collection period is down to 52 days. She’s also being trained on inventory management software to assess safety stock (a level of extra stock maintained to mitigate risk of stockouts) and reorder points. And she’s freed up cash to spend on new equipment and pay shareholders an unexpected dividend.

Making peer comparisons

Changes in a borrower’s performance over time tell only part of the story. Just because a company has survived for 25 years with a 65 days-in-receivable ratio doesn’t necessarily mean it’s healthy. A collection period of 65 days is unacceptable if competitors collect in 50 days.

Owners and lenders need to gauge how others in the industry fare in terms of asset management, growth, profitability and debt coverage. Major expenses worthy of comparison include rent and management compensation, especially if paid to related parties.

No universal benchmarks apply to all types of businesses. So it’s important to seek data sorted by industry, size and geographic location, if possible. Encourage borrowers to share the data they receive from trade journals, conventions or local roundtable meetings.

Absent industry-specific data, there are several benchmarking resources you might want to look into, such as MicroBilt’s Integra Financial Benchmarking Data, Dun and Bradstreet’s Industry Norms and Key Business Ratios, ValuSource’s IRS Corporate Ratios, and Risk Management Association’s Annual Statement Studies.

Benchmarking data has its limits, and comparisons may be imperfect. But it usually provides some insight, no matter how small a niche a borrower’s operations may be.

Faring well over time

Ratios also change over time. For example, if more competitors enter the marketplace, collections might slow and margins narrow. That’s because the more suppliers there are in an industry, the less control those suppliers have over their customers.

Other factors that affect ratios include regulations, technology and economic conditions. Use current benchmarking data to avoid setting unreasonable goals. Also recognize that benchmarking is a continuous process, not a one-time event.

Advancing professional tools

Most borrowers will benefit from professional tools such as benchmarking. Lenders are in a position to suggest ways business customers can improve their performance and, thus, enhance their chances of timely loan repayment and continued success.