Accrued Interest- Interest earned
or incurred, but not yet paid.
Amortization- Pay down
of a mortgage or loan over a fixed period
of time. Also, the diminution of intangible
assets over time.
Assets- Individual or corporate
owned items of economic value.
Balance Sheet- A summary of
the asset, liability and equity accounts of
a business intended to provide an overview
of the financial condition of a business at
a given point in time. The asset side of the
balance sheet always equals the sum of liabilities
Balloon- A provision in a note
or loan requiring a partial or full repayment
of the note or loan at a specified date(s).
Bridge Loan- A short-term loan,
typically 1-60 months in length, usually made
in anticipation of being replaced by intermediate
or long-term financing.
Call- A provision in a loan
or note that gives its holder the right (but
not the obligation) to demand repayment of
the loan or note on or before the expiration
date of the contract.
Cash Flow- The flow of cash
through a business. Typically, cash flows
into a business in the form of revenue and
out of a business in the form of expenses.
Cash also flows into a business through the
acquisition of debt or equity or the sale
of assets and flows out of a business to reduce
liabilities or acquire assets.
Capital- Cash or goods used
to generate income.
Cash Flow Analysis- An analysis
of the cash inflows and outflows of a business.
Cash flow analysis is used by a lender to
evaluate the ability of a business to repay
Collateral- Is generally defined
as an asset used to provide security for a
Commercial Real Estate- Real
estate used in the operation of a business.
Commercial real estate can be leased or owned
and may include a wide variety of property
types, such as office buildings, retail space,
and industrial facilities.
Debt Service Coverage- Provides an
estimate of a business' ability to cover debt
obligations with free cash flow. This ratio
is defined as: Cash Flow Available to Service
Debt/Debt Service. The higher the number,
the greater the business' ability to make
debt payments from cash flow.
Due Diligence Period- Process
period in which details of a potential project
or investment are examined in order to make
a determination to proceed or not to proceed
with the transaction.
EBITDA- Earnings before interest,
tax, depreciation, and amortization.
Equity- The value of a business
to its owner, defined as assets less liabilities.
Also, the value of an asset reduced by the
debt associated with it.
Fixed Rate- An interest rate
option on a loan where the rate paid by the
borrower does not change for a specified period
Floating Rate- An interest rate
option on a loan where the rate paid by the
borrower fluctuates up or down at specified
intervals based on a market-driven rate index.
Hard Money Lenders- Provide
short-term financing, typically secured by
real property, with limited or expedited due
diligence but at increased interest rates,
points, and fees and at a low loan to value.
Index Rate- Published, market-driven
interest rate used by lenders as the basis
for determining interest rate charges.
Interest Rate Cap- Loan feature
which limits the amount the interest rate
can rise on a variable rate loan in any given
adjustment interval and/or over the life of
LIBOR (London Interbank Offered
Rate)- Is the rate of interest at which banks
borrow funds from other banks in the London
interbank market. These rates, which are set
for different borrowing intervals, are commonly
used by other banks and financial institutions
as a basis to establish their interest rate
Loan to Value - Ratio of a loan
amount to the fair market value of the collateral
for the loan. This measure is typically expressed
as a percentage.
Mortgage- Legal document
that pledges title to property as security
for the repayment of a loan.
Origination Fee- A fee charged
by a lender to cover the up-front administrative
costs of processing a loan.
Owner-Occupied Real Estate-
Real Estate which is occupied by its owner.
Permanent Financing- Financing
which is not intended to be replaced in the
immediate or near future.
Personal Guarantee- A guarantee
for repayment of a business' debt made by
an individual, typically an owner or key management
member of a business.
Prepayment Penalty- A fee charged
by a lender for the repayment of a loan prior
to its contractual due date.
Refinance- The process of replacing
a loan with proceeds from another loan.
Return on Equity- Identifies
a business' return in relation to its equity
capital. This measure is usually expressed
as a percent. The ratio is defined as:
Profit before Taxes/Net Worth. The higher
the figure, the higher the productivity generated
by a business' management in relation to the
business' equity capital. However, a high
return on equity may also be representative
of the use of high leverage by a business.
Traditional Cash Flow- Traditional
cash flow is used by a lender to evaluate
debt repayment ability and is intended to
approximate free cash flow available to be
used for debt repayment. It is typically calculated
from a business' profit and loss statement
and is generally calculated as the sum of
Earnings before Taxes, plus Interest Expense,
plus Depreciation/Amortization Expense, plus
other non-cash expense items, plus non-recurring
CASH FLOW ANALYSIS
Cash Flow Analysis is used by a lender
to evaluate the ability of a business to repay
debt with a comfortable margin. There are
two primary types of cash flow a lender may
analyze in order to determine this figure,
and a lender may use either or both types
to perform its analysis.
The first type is traditional cash flow. Traditional
cash flow is calculated from the annual profit
and loss statement using the following formula:
Earnings before taxes
+ Interest expense
+ Depreciation expense
+ Amortization expense
+ Other non-cash expense items
+ Any non-recurring expenses = Traditional
An example of a non-recurring expense would
be rent if the business were moving from a
leased space to an owner occupied space. The
resulting traditional cash flow figure is
also commonly referred to as earnings before
interest, taxes, depreciation and amortization
(or EBITDA) plus other non-cash expense items
and any non-recurring expenses.
The other type of cash flow analyzed by lenders
is actual cash flow. Actual cash flow is determined
through utilizing a business' Statement of
Cash Flows and the line item known as "Cash
Flow from Operating Activities." However,
in a large number of instances a Statement
of Cash Flows is not prepared by a small business'
controller or CPA. Therefore, many lenders
utilize the balance sheet and profit and loss
statements of a business to build a Statement
of Cash Flows and calculate "Cash Flow from
Operating Activities." Besides normal profit
and loss items that affect cash flow, balance
sheet items may affect this calculation. This
can include items such as changes in inventory
levels, accounts receivables, accounts payables,
etc. As with traditional cash flow, certain
adjustments are also made to "Cash Flow from
Operating Activities" including adding back:
· Interest expense
· Non-recurring expenses
In some cases, a lender may also subtract
provisions for additional items from traditional
and actual cash flow figures. These may include
items such as owner/outside party management
fees; capital expenditure reserves; and furniture,
fixtures and equipment replacement reserves.
The amount and type of additional provisions
subtracted from cash flow are typically a
function of the type of business being financed.
CREDIT / FINANCIAL ANALYSIS
Lenders utilize Credit/Financial Analysis
in conjunction with cash flow analysis to
determine a business' financial history and
overall financial strength.
Typically, a lender will obtain a business
credit report, such as a Dun and Bradstreet
Business Information Report, for an overview
of a business' credit history. A report such
as this will typically provide a classification
of the business which is determined by its
size and its payment history with trade creditors.
The report may also reflect any outstanding
liens and judgments or pending lawsuits which
may adversely impact the current or future
prospects of the business and will provide
a brief history and description of the business.
Aside from an obvious reflection of weak financial
performance, a poor repayment history on business
debt may also be representative of lack of
management ability and/or character.
A lender will also obtain a personal credit
report to see how much personal debt the primary
owner of the business is carrying and his/her
payment history on personal debt obligations.
In doing so, a determination can be made as
to whether or not the business' owner is taking
an adequate salary to cover his/her personal
debt obligations. If the owner is not taking
an adequate salary, then cash flow of the
business may be reduced accordingly. On the
other hand, if the owner is taking a more
than adequate salary, then a positive adjustment
may be made to cash flow. Poor payment history
on personal debt obligations may also be representative
of poor management ability or character.
Lenders perform financial analysis on a business
in an effort to assess and identify financial
strengths and potential or existing financial
weaknesses not necessarily reflected by a
business' repayment ability or credit history.
A lender will usually perform financial analysis
on three full years of financial statements
and if applicable, a current year interim
financial statement dated within sixty to
ninety days. Projected financial statements
may also be included in financial analysis.
Financial analysis involves calculating financial
ratios from items on a business' balance sheets
and profit and loss statements. Current performance
can be determined for a variety of financial
measures and improving or worsening trends
can be revealed. Some financial ratios can
also be compared to industry standards for
the business obtained through publications
such as The Risk Management Organization or
RMA (formerly known as Robert Morris Associates)
Annual Statement Studies. This allows the
lender to compare a business' performance
to its industry.