TERMS GLOSSARY


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 and equity.

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 obligations.

Collateral- Is generally defined as an asset used to provide security for a lender's loan.

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 of time.

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 the loan.

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 charges.

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 expenses.

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 Cash Flow

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.