Solvency key for self-employed borrowers

ANZ business training manager Christine Greer said that businesses fail for all sorts of reasons, one of the main ones being a matrimonial breakdown.

But, more often than not, business failure comes down to cash flow.

Speaking at the National Advisers Conference 2016 in Auckland yesterday, Greer said that 82% of business failures are due to poor cash flow - yet 69% of businesses are profitable when they fail. 

Profitability meant a business is able to pay its bills on time and could display a healthy bank balance, she said.

“But there are reasons, like the time between a sale or service and getting the money for it, why a bank balance differs from a net profit.

“Profit is not cash flow. A balance sheet is a photo in time, while a profit & loss statement is what has happened over a year – the money that has gone in and out.”

Essentially, a business’s cash flow comes down to the efficiency of its cash conversion cycle. If the cycle is not efficient, the business in question will go out of business.

Greer said, to this end, businesses must be solvent and, when approaching banks, self-employed business owners must be able to demonstrate their solvency.

“To check the solvency of a business, ideally there should be a 2:1 ratio of assets to liabilities, so the business should have $2 for every $1 owed.

“If the ratio is less than 1:1 that means the business is insolvent, trading insolvent - and you don’t want that.”

It is not possible to accurately assess a balance sheet and a profit and loss statement without ratios, she said.

“You need to ascertain a trend of some type in the balance sheet too. You want to see growth. So, for example, you might look at the see sales growth ratio and compare it to the industry average to get an accurate gauge.”

Industry benchmarks are a great way of establishing how a business is doing as they show whether a business is performing or not as compared to industry norms, Greer added.

“But there are also several things that banks cross out when looking at balance sheets. One is ‘good will’, which is not real until the business owner sells and cashes up.

“Likewise, depreciation is not real. It is on the books, sure. But, unless the business owner has saved the money, it gets added back into the books.”

Greer’s presentation was a spotlight on lending to self-employed borrowers, but part of the session focussed on understanding business financials.

The rest of the session focussed on ANZ’s income verification criteria and what information should be included in a good loan application.