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Using Key Indicators as a Using Key Indicators as a Tool to Communicate with Tool to Communicate with

Your Lender Your Lender

… or, How to Keep Your … or, How to Keep Your Loans in Place in 2007Loans in Place in 2007

Jeff BaldwinJeff Baldwin Emma Shinn Emma Shinn

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Multiple Choice Quiz:Multiple Choice Quiz:

1. When your banker asks you for 1. When your banker asks you for your plan, the best approach in your plan, the best approach in communicating with your banker communicating with your banker is to:is to:a.a.Give them a plan, and make it look Give them a plan, and make it look

really good really good

b.b.Give them a plan that is so confusing Give them a plan that is so confusing they won’t be able to tell how well you they won’t be able to tell how well you are doing are doing

c.c.Don’t give them anything Don’t give them anything

d.d.None of the aboveNone of the above

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Multiple Choice Quiz:Multiple Choice Quiz:

2. When you are about to miss your 2. When you are about to miss your plan, the best approach in plan, the best approach in communicating with your banker communicating with your banker is to:is to:a.a.Act like everything is going to be okay Act like everything is going to be okay

and you will catch up in December and you will catch up in December

b.b.Present so much detail he won’t be able Present so much detail he won’t be able to figure out what is going on to figure out what is going on

c.c.Don’t say anything and hope it will get Don’t say anything and hope it will get better better

d.d.None of the aboveNone of the above

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Communicating with Your Lender

Topics include … Topics include …

1.1. Builder Financing 101 … a few Builder Financing 101 … a few basics about capital basics about capital requirements and sourcesrequirements and sources

2.2. The Lender’s Point of View … The Lender’s Point of View … your capacity to service debt your capacity to service debt

3.3. Key Indicators Used by Lenders … Key Indicators Used by Lenders … how they evaluate your healthhow they evaluate your health

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Builders often need financing for:Builders often need financing for: Work in processWork in process

Spec inventorySpec inventory

Other working capitalOther working capital

Land acquisition and Land acquisition and development development

Other fixed assets, ventures or Other fixed assets, ventures or investments investments

1. Builder Financing 1011. Builder Financing 101

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Capital Requirements and Sources

How will the funds be used?

How much financing is

needed?

What collateral is available?

How quickly is financing needed?

What sources of financing

provide funds for this

purpose?

Who provides financing of this size and

duration?

REMEMBER! Don’t finance

long-term assets with short-term

debt!

What sources of financing do/do not require

collateral?

What sources are most easily approachable?

REMEMBER! Investors take a long time to

decide!

Ask yourself the following questions:

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The answers to these The answers to these questions will help you target questions will help you target the right sources and types of the right sources and types of financing …financing …

And avoid the common mistake And avoid the common mistake of financing a long term need, of financing a long term need, such as land development, with such as land development, with short term borrowingshort term borrowing

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Three Important StepsThree Important Steps

1.1. Know your requirementsKnow your requirements::– Purpose, size, timingPurpose, size, timing

2.2. Determine the appropriate type and Determine the appropriate type and source of financingsource of financing::– Work in process or other working capital loanWork in process or other working capital loan– Construction loansConstruction loans– Land acquisition & development, or other Land acquisition & development, or other

“project” loans“project” loans– Other capital investmentOther capital investment

3.3. Present a business plan which Present a business plan which demonstrates that cash flow will service demonstrates that cash flow will service the debtthe debt

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Demonstrate Your Strategic Thinking Process

Strategic Strategic DecisionsDecisions

Detailed PlanningDetailed Planning

Financial PlanFinancial Plan

Management Management PlanPlan

Production PlanProduction Plan

Analysis Analysis Business PlanBusiness Plan

Market DefinitionMarket Definition

Competitive Competitive AnalysisAnalysis

Market Market SegmentationSegmentation

ProductsProducts

Operating Operating ResultsResults

Financial Financial ConditionCondition

Cash FlowCash Flow

Market TargetingMarket Targeting

Market Market PositioningPositioning

ManagementManagement

Sources of Sources of FundsFunds

Users of FundsUsers of Funds

MarketingMarketingProgramsPrograms

ProductionProduction

Management & Management & StaffingStaffing

Revenue & Revenue & ExpensesExpenses

Market PlanMarket Plan

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Provide financial projections thatProvide financial projections that::

Demonstrate your “strategic” thinkingDemonstrate your “strategic” thinking

Demonstrate sound execution strategiesDemonstrate sound execution strategies

Are consistent with your business planAre consistent with your business plan

Are supported by key assumptionsAre supported by key assumptions

Identify the key revenue and cost drivers Identify the key revenue and cost drivers

… … and include and include the key the key

performance indicatorsperformance indicators

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2. Lender’s Point of View…

In order to obtain the most appropriate financing, the builder needs to understand the concerns of the lender.

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ECONOMIC PERSPECTIVE:•Domestic and foreign influences •Regulation and policy•Technological change •Market / customer expectations

INDUSTRY PERSPECTIVE:•Industry life cycle•Industry benchmarks•Competitive pressures•Capacity (supply and demand)

OPERATIONAL PERSPECTIVE:•Management•Processes and controls•Production efficiencies•SWOT analysis

Sources: Government publications and bank policy

Sources: Internet, databases, regional news services and industry specific publications

Sources: Business plan, site visit and meetings, industry expertise

Banks usually consider the big picture …Capacity to Service Debt

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ECONOMIC PERSPECTIVE:•Federal deficit •Interest rates•Market expectations

INDUSTRY PERSPECTIVE:•Mortgage defaults•Sales decline•Inventory levels

OPERATIONAL PERSPECTIVE:•Management experience•Cycle times•Inventory levels: land & WIP

Currently, there are Red Flags at all levels …

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When you ask lenders about theWhen you ask lenders about thecurrent environment: current environment:

“… “… what do you look at for home what do you look at for home builder loans that is different from builder loans that is different from the pastthe past?” ?”

Many respond with two words:Many respond with two words:

Staying PowerStaying Power

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How do lenders evaluate “Staying How do lenders evaluate “Staying Power”?Power”?

Debt to equityDebt to equityLiquidity, i.e., current ratio and working Liquidity, i.e., current ratio and working capital capitalComponents of working capital, i.e., Components of working capital, i.e., inventory, specs, etc. inventory, specs, etc.

Note that all of these are balance sheet Note that all of these are balance sheet indicators – which many builders ignoreindicators – which many builders ignore

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One thing has not changed …

The single most important factor in the bank’s decision to lend, is the company’s …

Capacity to service debt

Lender’s often evaluate this by looking at several key indicators.

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Key indicators are criteria that help to evaluate the financial condition, or health, of a company.

These criteria include both financial ratios and other signs that point to the health - or sickness - of a company.

3. Key Indicators Used by Lenders

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Key Financial Indicators

Lenders examine key indicators related to these areas:

Liquidity and financial stability

Balance sheet and capital structure

Turnover of assets Cash Flow Operating performance

– Return on assets– Return on equity– Benchmark to industry

standards Sales trends

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Key Financial Indicators

Definitions of the most common financial ratios:

DefinitionRatioCurrent Ratio

Asset Turnover

Debt to Equity

Net Profit Margin

Return on Assets

Return on Equity

Current Assets / Current Liabilities

Sales / Total Assets

Total Liabilities / Net Worth

Net Profit / Sales

Net Profit / Total Assets

Net Profit / Total Equity

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Key Financial Indicators

The primary financial ratios used :

RatioRatio BestBest OkayOkay Red FlagRed Flag

Debt to EquityDebt to Equity < 2.5< 2.5 ~ 4.0~ 4.0 > 7.0> 7.0

Current RatioCurrent Ratio > 1.5> 1.5 ~ 1.2~ 1.2 < 1.0< 1.0

Net Profit to SalesNet Profit to Sales > 10%> 10% ~ 4%~ 4% < 0< 0

Gross Profit to Gross Profit to SalesSales

> 25%> 25% ~ 20%~ 20% < 15%< 15%

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Key Financial Indicators

The secondary financial ratios used:

RatioRatio BestBest OkayOkay Red FlagRed Flag

Return on Assets Return on Assets > 25%> 25% ~ 10%~ 10% < 5%< 5%

Asset TurnoverAsset Turnover > 3> 3 ~ 2~ 2 < 1< 1

Inventory TurnoverInventory Turnover > 2> 2 ~ 2~ 2 < 2< 2

Specs to Total Specs to Total InventoryInventory

< 10%< 10% ~ 25%~ 25% > 50%> 50%

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Key Financial IndicatorsOther financial ratios sometimes used:

RatioRatio BestBest OkayOkay Red FlagRed Flag

Operating Operating Expenses to SalesExpenses to Sales > 12%> 12% ~ 16%~ 16% > 20%> 20%

Revenues to Revenues to Working CapitalWorking Capital > 10> 10 12-1412-14 > 17> 17

Months of Interest Months of Interest CarriedCarried > 24> 24 1818 > 18> 18

Profit on EquityProfit on Equity > 50%> 50% 25-40%25-40% < 15%< 15%

Percentage of Percentage of Profit DistributedProfit Distributed > 50%> 50% ~ 50%~ 50% > 70%> 70%

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When bankers are concerned about the When bankers are concerned about the accuracy and reliability of financial accuracy and reliability of financial statements provided by a company, they statements provided by a company, they often consider other indicators:often consider other indicators:

• Track record of meeting sales and delivery Track record of meeting sales and delivery commitments commitments

• Cash balancesCash balances• Credit history and terms that suppliers are Credit history and terms that suppliers are

offeringoffering• Supporting evidence that tax payments and Supporting evidence that tax payments and

payroll obligations are currentpayroll obligations are current• Sales prices and trends Sales prices and trends • Sales pace and trendsSales pace and trends• Reputation among competitors, creditors, and Reputation among competitors, creditors, and

within industrywithin industry

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Footnote: Footnote:

Your lender is likely to have their Your lender is likely to have their own criteria – talk to them to find own criteria – talk to them to find out what they are looking for.out what they are looking for.

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Remember . . .Remember . . .

Your lender is your most important Your lender is your most important “Strategic Alliance” …“Strategic Alliance” …

Get them in the loop, and keep Get them in the loop, and keep them there.them there.