The most important of the five C’s of Credit is Capacity. It is the one C that an SBA guaranty does not negate. If an applicant cannot show that they can repay the loan from the debt service of the business there is no loan. In reviewing historical financials of a business I look for two things Trends and Anomalies. It is more difficult now due to COVID for these to stand out, but they are still an important factor.
Let’s start with Trends - Trends are especially important now as we want to know how well a business recovered between 2020 and 2021. It is important to look at trends both in revenues and in margins. Remember that profit repays your loan, not revenues. Increasing revenue trends are great, but at what cost. We are in inflationary times, so increased revenues may not result in increased profitability. Conversely, declining revenue trends do not always spell disaster. Many businesses needed to reinvent themselves due to COVID and found ways to derive more profitable by reducing product lines or consolidating locations. In your analysis recognize these trends and ask your applicants about them to provide a more thorough understanding of the condition of the business you’re financing.
Come back next week to learn about Anomalies!