Understanding The System When It Comes To Canadian Business Finance
OVERVIEW – Information on business financing loan data points for cash flow success
Business Financing Loan challenges? When business owners and financial managers contemplate additional borrowing for cash flow for their firm they must think in terms of whether the business does, or will, have enough cash flow to make the debt repayments. We can further assure business owners that the bank or lending institution is thinking the same way!
When businesses enter into bank loans or other institutional loans the payments are, 99% of the time fixed and specified. The business owner and financial manager must ensure those payments can be made. If the company has over relied on debt it is viewed as highly leveraged by the lender.
So how can a business owner determine if the company has the cash flow to support the debt? More importantly how does the lender do that calculation?
The calculation that banks and other term lenders focus on is called ‘Times Interest Earned ‘. The business owner (and the banker) can calculate that formula very simply.
The Times Interest formula is calculated as follows:
Net profit before taxes plus interest expense / interest expense
The calculation becomes an absolute number. If the number is in fact ‘1 ‘ that means that the company has in act made enough to pay the exact interest expense for the year. We would point out that this calculation is usually done on an annual basis.
So is ‘1’ the magic number? It’s the minimum, but the answer is no, and the answer should be intuitive to the business owner. That is because a times interest of 1 means there is absolutely no cushion for anything going wrong, and all business owners no about Murphy’s Law!
So if earnings decline or if the company takes on additional debt our ‘ times interest earned ‘ number become unsatisfactory or <1 – that is to say that we have determined there is not sufficient cash flow to service the debt.
We have determined ‘1’ is not a great number then, well what is? The answer, as in many facets of business, is of course ‘that depends ‘. Many industries differ and there is not really any specific number that is viewed as the Holy Grail by lenders. What we have found though is that higher is better. When the number is hovering around 1 both the business owner and the lender, should and will, respectively, have some concern.
We point out also that income, as a key component in our calculation varies between companies in final calculation re tax rate and other accounting adjustments. Some lenders and business owners also add deprecation to the profit because it is not a real cash expense.
There is at least one other respected quick calculation business people can perform to calculate the cash flow number as a per cent age of debt. This calculation is often done by lenders to ensure long term debt is not being misused. If a company has a high percentage of total debt to cash flow it should be a strong indicator to the company owners that growth will be constrained, as all cash is going to debt, not growth. Therefore new equipment, inventory, receivables, etc will suffer in terms of growth.
In summary, business owners, by doing actual current calculations, as well as projections, can easily calculate their ‘times interest earned’ and cash flow as % of debt. This will allow the business to position loan repayments positively with their lenders, at the same time providing them with insights into how the bank or other lender will view payment capability.
Author: Stan Prokop – founder of 7 Park Avenue Financial
Originating business financing for Canadian companies , specializing in working capital, cash flow, asset based financing . In business 10 years – has completed in excess of 90 Million $$ of financing for Canadian corporations . Core competancies include receivables financing, asset based lending, working capital, equipment finance, franchise finance and tax credit financing.
Info re: Canadian business financing & contact details :
7 Park Avenue Financial
South Sheridan Executive Centre
2910 South Sheridan Way
Phone = 905 302 4171
Email = email@example.com
7 Park Avenue Financial
Canadian Business Financing