Chapter Seventeen

Lending to Business Firms and Pricing Business Loans

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Key Topics
Types of Business Loans: Short-Term and Long-Term Analyzing Business Loan Requests Collateral and Contingent Liabilities Sources and Uses of Business Funds Pricing Business Loans Customer Profitability Analysis (CPA)

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Short Term Business Loans

Self-Liquidating Inventory Loans Working Capital Loans Interim Construction Loans Security Dealer Financing Retailer and Equipment Financing Asset-Based Financing Syndicated Loans

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Long Term Business Loans

Term Loans Revolving Credit Lines Project Loans Loans to Support Acquisitions of Other Business Firms
Question: What are the essential differences between various short- and long-term business loans?
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Sources of Repayment for Business Loans

The Borrowers Profits or Cash Flows Business Assets Pledged as Collateral Strong Balance Sheet With Ample Marketable Assets and Net Worth Guarantees Given By Businesses

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Analyzing Business Loan Applications

Common Size Ratios of Customer Over Time Financial Ratio Analysis of Customers Financial Statements Current and Pro Forma Sources and Uses of Funds Statement

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Financial Ratio Analysis

Control Over Expenses Operating Efficiency Marketability of Product or Service Coverage Ratios: Measuring Adequacy of Earnings Liquidity Indicators for Business Customers Profitability Indicators The Financial Leverage Factor as a Barometer of a Business Firms Capital Structure
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Expense Control Measures

Cost of Goods Sold/Net Sales Selling, Administrative and Other Expenses/Net Sales Depreciation Expenses/Net Sales Interest Expenses on Borrowed Funds /Net Sales Taxes/Net Sales

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Operating Efficiency
Annual Costs of Goods Sold/Average Inventory Average Receivables Collection Period Net Sales/Net Fixed Assets Net Sales/Total Assets Net Sales/Accounts Receivables

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Marketability of Product or Service

Gross Profit Margin=(Net SalesCGS)/Net Sales Net Profit Margin=Net Income After Taxes/Net Sales

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Coverage Measures
Interest Coverage Coverage of Interest and Principal Payments

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Liquidity Measures
Current Assets/Current Liabilities Acid Test Ratio Working Capital Net Liquid Assets

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Profitability Measures
Before Tax Net Income/Total Assets After Tax Net Income/Total Assets Before Tax Net Income/Net Worth After Tax Net Income/Net Worth

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Leverage or Capital Structure Measures

Leverage Ratio Total Liabilities/Net Worth Capitalization Ratio Debt to Sales Ratio

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Types of Contingent Liabilities

Guarantees or Warrantees Behind Products Litigation or Pending Lawsuits Unfunded Pension Liabilities Taxes Owed But Unpaid Limiting Regulations

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Comprehensive Environmental Response, Compensation and Liability Act

This Law Makes Current and Past Owners of Contaminated Property, Current and Past Owners and Prior Operators of Businesses Located on Contaminated Property and Those Who Transport Hazardous Substances Potentially Liable
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Component of Sources and Uses of Funds Statement

Cash Flows from Operations Cash Flows from Investing Activities Cash Flows from Financing Activities

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Traditional (Direct) Operating Cash Flows

Net Sales Revenue Cost of Goods Sold Selling, General and Administrative Taxes Paid in Cash + Non Cash Expenses

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Indirect Operating Cash Flows

Net Income + Non Cash Expenses + Losses from the Sale of Assets Gains from the Sale of Assets Increases in Assets Associated with Operations + Increases in Current Liabilities Associated with Operations Decreases in Current Liabilities Associated with Operations + Decreases in Current Assets Associated with Operations
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Methods Used to Price Business Loans Cost-Plus Loan Pricing Method Price Leadership Model Below Prime Market Pricing Customer Profitability Analysis

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Cost-Plus Loan Pricing

Marginal Cost of Raising Loanable Funds to Lend to Borrower Estimated Nonfund Margin to Bank + + Compensate + Operating Bank for Costs Default Risk

Loan Interest Rate

Bank's Desired Profit Margin

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Price Leadership Model

Default Risk Term Risk Premium Premium for + + for NonLonger Prime Term Credit Borrowers

Loan Interest Rate

Base or Prime Rate

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Prime Rate
Major Banks Established a Base Lending Fee During the Great Depression. At that Time It Was the Lowest Interest Rate Charged Their Most Credit Worthy Customers for Short-Term Working Capital Loans

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LIBOR

The London Interbank Offer Rate. The Rate Offered on Short-Term Eurodollar Deposits With Maturities Ranging From a Few Days to a Few Months

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Below-Prime Market Pricing

Loan Interest Rate

Interest Cost Markup of Borrowing = + for Risk in the Money and Profit Market

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Customer Profitability Analysis (CPA)

Estimate Total Revenues From Loans and Other Services Estimate Total Expenses From Providing Net Loanable Funds Estimate Net Loanable Funds Estimate Before Tax Rate of Return By Dividing Revenues Less Expenses By Net Loanable Funds

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Quick Quiz
What aspects of a business firms financial statements do loan officers and credit analysts examine carefully? What methods are used to price business loans? Suppose a bank estimates that the marginal cost of raising loanable funds to make a $10m loan to one of its corporate customers is 4%, its nonfunds operating costs to evaluate and offer this loan are 0.5%, the default-risk premium on the loan is 0.375%, a term-risk premium of 0.625% is to be added, and the desired profit margin is 0.25%. What loan rate should be quoted this borrower? How much interest will this borrower pay in a year?
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