Important Factors to Be Considered in Business Plan - Essay Example

Bank Lending: Important factors to be considered in Business Plan         Institute                             Business Plan prepared by the entrepreneurs play a role of an Ambassador with reference to Bank, Creditors and other Investors. The banker’s decision to lend loan to a company hinges on the Business Plan drawn by the entrepreneur and submitted along with the application for loan or the plan as laid out in the application itself. The determinant factors involved in the plan or the requirements of the bank in relation to lending are critically analyzed.  In the method adopted, the various factors have been listed out, and its relative merits and demerits are discussed. A good business plan incorporating these factors effectively results in favorable treatment by the bankers and accorded priority status in lending. Other factors related to the process, such as promoters’ background, nature of the business or industry, security offered and credit rating which are not directly connected to the ‘statistics’ of the plan, but have overall impact on the proposal are also highlighted. It can be concluded that the business plan properly developed with attention to details is appreciated by the banks and investors.  This document also acts as a reference guide not only for the banks and investors, but also to the entrepreneurs to compare the actual performance to the ‘standards’ as specified in the business plan.  The achievement of the goal enhances the credibility of the business and the promoters and their trustworthiness.      Business Plan The business plan carefully prepared seeks to give comfort to the lenders with regard to repayment of loan and implied assurance to them that the servicing of the debt could be comfortably undertaken without undue pressure in the operations and schedule of repayment as agreed would be adhered to.   All other factors should be in a position to enhance this comfort level of the banks. Another important aspect the banker would like to look into is the background of the entrepreneur in terms of his qualifications, experience, skill and capability and reputation of the entrepreneurs, status of the earlier projects if any, the honesty and integrity of the entrepreneur, etc.  These factors can also play in favor of the companies in respect of the rates of interest, and the banker could offer a very competitive rate. If the bankers are satisfied on both these counts, then it is only the question of formalities.  However, the other factors assume greater significance in the case of new entrepreneurs.  The new entrepreneurs should be able to sell their concept effectively by concentrating all the aspects of the business plan to improve the confidence level of the bankers.  Because, the other factors put together should compensate the lack of experience and reputation for the bankers to act upon the proposal favorably.  Under the circumstances prevailing in the banking industry world over as of now, the bankers won’t like to take chances, and they would be extremely careful in their judgment and discretion in extending loans.   Repayment of Principal and Interest The banker’s primary concern is repayment of the principal and the interest as per the repayment schedule.  Therefore, more than anything else, he would like to ensure that this aspect is taken care of well in the proposal.  The banker has to rely on the projected cash flow over the period of repayment in this regard.  The gestation period as estimated in the project will be increased by delays in the installation of the plant and machineries or systems, construction and completion of the buildings, arrangements for the supply of power & fuel, etc.  The banks would like to scrutinize source of supply of machineries and equipments, dependability of the suppliers & contractors, and their proven track records of performance in this regard to ensure timely commencement of operations.  Commencement of operations: The banker will also apply his mind to the other factors which have a direct bearing on the commencement of the operations.  He should be thoroughly convinced that the commencement of the operations would be as per the schedule given in the business plan.  The performance on the part of the entrepreneur in respect of repayment of schedule depends upon the commencement of the operations and consequently the cash flow.  Contingency plan: The applicant should give alternative contingent plan, in the event of failure of the plan due to any external factor.  For example, where there are power shortages and the project report is based on 3 shifts per day, installation of generators for electricity should be provided for.  The long term contracts or purchase orders from the buyers or any memorandum of understanding with the buyers, indicating their commitment in off-take, is also very important as the cash flow is directly linked to this aspect of the business.  Types of Loans: There are different types of loans such as Short term loan, Term Loan, Cash Credit and Overdraft.  The same company may enjoy all these or some of the facilities with the bankers, depending upon their business requirements.  When the banker is about to sanction long term loan in respect of the capital assets, he would like to ensure that, for the proper implementation of the project and the commencement of the project on time, the short term capital needs of the business for the purpose of purchase of raw materials, salaries & wages and other overheads has been properly tied up to his satisfaction.  Therefore, cash credits or overdraft facilities for the project should be obtained from the same bank for efficient monitoring of the project. Revision in the schedule of repayment: The delay in the implementation of the project increases the gestation period and cost of funding, and results in revising the schedule of repayment.  The incidence of interest during this period increases the repayment burden considerably.  The banks would be very uncomfortable to face this eventuality, since the government regulations world over, are very strict in respect of non performing assets of the bank.    Projected Cash Flow Statement: The projected cash flow statement is an important piece of document in the proposal, for the bankers to have reassurance about the business plan.  This statement is an estimate and related to future operations of the business.  The effect of inputs such as raw materials, salaries & wages, overhead expenses, etc. should be properly forecasted relative to the requirement and cost with reasonable accuracy.  Similarly, the sale value of out put, the finished products should be valued properly in the cash flow projections.  It is a practice to add 2 to 5% as contingencies, in working out the figures, keeping in view the uncertainties involved in estimating the cost.  If this statement has sufficient headroom, by way of allowance towards safety, after incorporating the payments due to bank as per the repayment schedule, the banker is reassured.         Process cycle time and turnover of capital   In any process there is a beginning and an end. If the process cycle time is longer, i.e. beginning to the end of the process, and there are chances for disruption in the process for any reason, the projections in the business plan in respect of this particular period would be upset.  The turnover of capital either decreases or increases depending upon the process cycle time in the business.  Assuming there is a fixed margin of 10% in a transaction, and a retail store sells 100 pieces in 15 days at $ 10 per piece, it makes $ 100 in 15 days or $ 200 per month in sale of the product.  Employing the same capital, if it can sell 100 pieces in 10 days it makes $ 300 per month. Therefore, the bank would be interested to know how efficiently the capital is going to be effectively used.  The banks are in a position to compare the figures given in the business plan with the other customers in the same business to verify the reliability and reasonableness of the figures.  The workings of the cash flow is based on the process cycle time/turnover of capital.  Therefore, utmost care should be exercised in preparation of the statement.  Overheads: Likewise, treatment of fixed and variable overheads is an area where the people make mistakes.  The segregation of various costs into fixed and variable is very important in the projections of the business plan into future. Because, fixed overhead charge per unit of production would come down progressively if the volume of production increases progressively over a period of time in future. The reduction in fixed overhead per unit would translate into profit. Profit Margins  Though the bankers are interested in the repayment of payment of principal and interest due to them, the primary object of lending is to promote industrial and social development in the society.  This is clearly pronounced in the public sector banks in developed countries, popularly known as BRIC countries, viz. Brazil, Russia, China and India, where the clout of public sector banks in the economy is phenomenal.  The viability of the project is dependent upon the profitability of the project.  Gross profit and Net profit margins: Hence, the gross profit margin and net profit margin are the important yardsticks in determining the feasibility of the project.   These are also important measures from the view point of the investors and other creditors other than the bank.  When the net profit after meeting the interest charges as per the projected profit & Loss account is comfortable, it also indicates the margin of safety available to the bank with regard to the repayment as per the schedule.  In other words in the net profit is equal to the principal due for repayment for the period under consideration, the repayment of the capital is assured.   If the net profit remaining after repayment of the principal due for the period under consideration is comfortable, the surplus may be available for distribution to the shareholders/investors, subject to the decision of the board of directors/management after taking into account, the need for building up the reserves to meet the contingencies.   Other financial ratios analysis The banks scrutinize the statement by using a number of financial ratios in addition to Gross profit margin and Net profit margin discussed above.  Return on capital employed (ROCE), Return on total assets, Return on fixed assets, return on working capital, etc. are useful mainly for comparison of the companies within the industries and among the industries with regard to the efficiency in use of capital.  Major deviations from the industry norms are analyzed for causes.  Return on fixed assets for example might indicate the competitiveness of the company in relation to the existing companies who’s written down value of the plant and machinery would be less.   Superior return on working capital might be due to   advanced technology used, efficiency in operations, better stock management and receivables management.  Capital gearing ratio would be useful from the angle of the investors.    It is also useful in analyzing the financial risk arising out of capital structure of the company.   High leverage indicates the burden of debt servicing. Servicing the debt during difficult period would be critical, and the marginal efficiency of the borrowed funds is an important factor to be considered by the investors.  There are other important ratios in connection with the debtors, stock, creditors, liquidity etc. These financial ratios would be good indicators in respect of the existing companies which approach the bank for short term loans, cash credit or overdraft.  Risks in the business In the business environment there are various risks involved, such as trade controls, imposition of taxes and duties, government regulations with regard to labor, pollution control, environment, etc.  However, the entrepreneur while drawing up the business plan takes notice of these issues and properly discounts its effects in the projections.  Generally the entrepreneurs consider the Insurance as an additional burden to the business.  However, the banks insist that the all the assets of the business, other risks in relation to employment, etc. are properly covered under insurance.  The entrepreneur on his part usually bargains with the bank and would like to go far minimum cover to satisfy the needs of the bank or as per the requirements of the bank for sanction of loans.   It is always a good policy to provide for complete insurance in the interest of all the stake holders as well as the promoters.  This enhances the respectability of an entrepreneur as it reflects the attitude and concern of the entrepreneur towards the other stake holders.  It also indicates the confidence level of the banker since the entrepreneur in taking complete charge of the project with positive attitude in identifying and eliminating the risks involved in the business. Security offered At the end of the day, the banker has to protect his interest and insists on security which is free from all encumbrances.  However, it should be remembered, the security commands only secondary importance in sanctioning of loans by the banks.  In the event of failure of the business, the bank would like to fall back on the security offered by the promoters.  A good security compensates some inevitable drawbacks in the business plan such as excess competition in the business, long gestation period, lack of experience in the case of a new entrepreneurs, longer process cycle time, etc.  The reason behind the concept is, competition should not be factor in denying loan, long gestation period or longer cycle time might be inherent in a business in particular industry and the applications of the young and new entrepreneurs should not be turned down, citing the reason  inexperience because, they deserve support in the interest of development of the economy.  In all such reasonable cases, the banks are usually satisfied with the security, provided the project is considered viable based on the other criterion.   Credit Rating  The business and the industrial establishments are nowadays approaching the credit rating agencies, for rating of their establishments or with reference to issue of shares or debentures, and the rating is assigned based on a number of factors.   ‘These factors include: industry characteristics, regulations, competitive position of the issuer, operational efficiency, management quality, commitment to new projects and other associate companies, and funding policies of the issuer. A detailed analysis of past financial statements is made to assess performance under "real world" business dynamics. Estimates of future earnings over the next 3-5 years under various sensitivity scenarios are drawn up and evaluated against the claims and obligations that require servicing. Primarily, it is the relative comfort on the level and quality of the issuers cash flows to service obligations that determines its rating. (Icra Ltd. 2009) The credit rating enhances the credibility to a greater extent considering the expertise of the credit rating agencies in the field. As they are specialized in this field and taking various factors as referred above, while assigning the ratings, it is considered to be superior compared to the bank’s assessment. Therefore, the banks have also come to depend upon these ratings by way of additional safety factor and recommend the companies to go for credit ratings. Documentation  It is in the interest of the business or industrial establishments who seek bank finance to ensure that the documentation in this respect is exhaustive. The details with reference to the nature of the products, demand and supply conditions of the products in the country, scope for exports, substitution values of the products, technological advances in the field, profile of the customers, cost structure, competition involved, imported products available in the category, quality issues, government regulations with regard to manufacturing and distribution, segmentation in the usage of the products in respect of sales and marketing should be given in the business plan. Likewise, details regarding availability of the raw materials, supply of raw materials and the other ingredients, constraints in sourcing of the raw materials, processes involved in manufacturing, etc. in respect of production should be furnished in detail. Details with regard to the manufacturing facilities, regional offices or branch offices, arrangements made for distribution of the products or services, etc. should be included. The literature forming part of the business plan, with regard to the above could be attached with the main document, separately as an annexure. This procedure is recommended to avoid delays that may arise on account of clarifications required from the banks at the time of processing of the application for loan at various levels. Also, this procedure would enhance the level of transparency at all levels. Government Policy The acceptance of a business plan perfect with reference to the scope, presentation and the contents may also be delayed due to various factors. Subjectivity, bias and discretion of the sanctioning authorities also play an important role. The nature of the industry and the priorities of the banks in lending to such industries, the guidelines of the Central Bank of the country in this regard and the regulatory frame work in the country are some of the factors which should also be taken into account. An article recently published in the Financial times in this regard could be highlighted in this connection which stated, ‘The chancellor told the Treasury select committee the “credit adjudicator”, proposed in the Budget to give small businesses a right of appeal against their bank, would need a statutory right to force lenders to co-operate. “It’s got to be legislated for, because of the power to get access to bank information,” Mr. Darling said.’ (Eaglesham, J. March, 30 2010) Proper licenses secured in this regard, no objection certificate, if any, obtained from the government authorities, details of permits, if any, applied for, registration with the industry association, compliance certificates or approval of plans by the town planning authorities, pollution control board, etc. wherever necessary may be included in the business plant, to avoid delays in processing of the application.   References:   Citibank (2009), Policy Framework for Micro and Small Enterprises, Retrieved from http://www.online.citibank.co.in/portal/newgen/cards/MSME-policy-Ver1.pdf    National Institute of open schooling, Loans and Advances, Business studies, Retrieved from http://www.nos.org/srsec319/319-35.pdf   ICRA Ltd. (2009), New Capital Adequacy Framework under Basel II Guidelines, Retrieved from http://www.icra.in/files/pdf/bank/basel2ratings.pdf Bytestart.co.uk (2008), Why a good credit rating is essential for small companies, Retrieved from http://www.bytestart.co.uk/content/finance/funding/business-credit-score.shtml  Economy Watch,  Small Business Bank Loan, Retrieved from http://www.economywatch.com/loans/business/small-business-bank-loan.html  Eaglesham, J. ( 2010, March 30)Darling to act on bank loans to business, Financial Times, Retrieved from http://www.ft.com/cms/s/0/a994570c-3c23-11df-b40c-00144feabdc0.html Read More