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Chapter Seventeen

Lending to Business Firms and Pricing Business Loans

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Short Term Business Loans• Self-Liquidating Inventory Loans• Working Capital Loans• Interim Construction Loans• Security Dealer Financing• Retailer and Equipment Financing• Asset-Based Financing• Syndicated Loans

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Long Term Business Loans

• Term Loans• Revolving Credit Lines• Project Loans• Loans to Support Acquisitions of

Other Business Firms

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Sources of Repayment for Business Loans

• The Borrower’s Profits or Cash Flows• Business Assets Pledged as Collateral• Strong Balance Sheet With Ample

Marketable Assets and Net Worth• Guarantees Given By Businesses

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Analyzing Business Loan Applications

• Common Size Ratios of Customer Over Time

• Financial Ratio Analysis of Customer’s Financial Statements

• Current and Pro Forma Sources and Uses of Funds Statement

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Financial Ratio Analysis• Control Over Expenses• Operating Efficiency• Marketability of Product or Service• Coverage Ratios: Measuring Adequacy of

Earnings• Liquidity Indicators for Business Customers• Profitability Indicators• The Financial Leverage Factor as a Barometer

of a Business Firm’s Capital Structure

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Expense Control Measures• Cost of Goods Sold/Net Sales• Selling, Administrative and Other

Expenses/Net Sales• Depreciation Expenses/Net Sales• Interest Expenses on Borrowed Funds

/Net Sales• Taxes/Net Sales

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Operating Efficiency• Annual Costs of Goods

Sold/Average Inventory• Average Receivables Collection

Period• Net Sales/Net Fixed Assets• Net Sales/Total Assets• Net Sales/Accounts Receivables

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Marketability of Product or Service

• Gross Profit Margin• Net Profit Margin

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Coverage Measures

• Interest Coverage• Coverage of Interest and Principal

Payments

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Liquidity Measures

• Current Assets/Current Liabilities• Acid Test Ratio• Working Capital• Net Liquid Assets

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Profitability Measures

• Before Tax Net Income/Total Assets• After Tax Net Income/Total Assets• Before Tax Net Income/Net Worth• After Tax Net Income/Net Worth

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Leverage or Capital Structure Measures

• Leverage Ratio• Total Liabilities/Net Worth• Capitalization Ratio • Debt to Sales Ratio

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Types of Contingent Liabilities

• Guarantees or Warrantees Behind Products

• Litigation or Pending Lawsuits• Unfunded Pension Liabilities• Taxes Owed But Unpaid• Limiting Regulations

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Comprehensive Environmental Response,

Compensation and Liability Act

This Law Makes Current and Past Owners of Contaminated Property, Current and Past Owners and Prior Operators of Businesses Located on Contaminated Property and Those Who Transport Hazardous Substances Potentially Liable

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Component of Sources and Uses of Funds Statement

• Cash Flows from Operations• Cash Flows from Investing

Activities• Cash Flows from Financing

Activities

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Traditional (Direct) Operating Cash Flows

Net Sales Revenue – Cost of Goods Sold – Selling, General and Administrative – Taxes Paid in Cash + Non Cash Expenses

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Indirect Operating Cash Flows

Net Income + Non Cash Expenses + Losses from the Sale of Assets – Gains from the Sale of Assets – Increases in Assets Associated with Operations + Increases in Current Liabilities Associated with Operations – Decreases in Current Liabilities Associated with Operations + Decreases in Current Assets Associated with Operations

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Methods Used to Price Business Loans

• Cost-Plus Loan Pricing Method• Price Leadership Model• Below Prime Market Pricing • Customer Profitability Analysis

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Cost-Plus Loan Pricing

Loan Interest

Rate=

Marginal Cost of Raising

Loanable Funds to Lend to

Borrower

+

Nonfund Bank

Operating Costs

+

Estimated Margin to

Compensate Bank for

Default Risk

+

Bank's Desired Profit

Margin

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Price Leadership Model

Loan Interest

Rate=

Base or Prime Rate +

Default Risk

Premium for Non-

Prime Borrowers

+

Term Risk Premium for

Longer Term Credit

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Prime Rate

Major Banks Established a Base Lending Fee During the Great Depression. At that Time It Was the Lowest Interest Rate Charged Their Most Credit Worthy Customers for Short-Term Working Capital Loans

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LIBOR

The London Interbank Offer Rate. The Rate Offered on Short-Term Eurodollar Deposits With Maturities Ranging From a Few Days to a Few Months

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Below-Prime Market Pricing

Loan Interest

Rate=

Interest Cost of Borrowing in the Money

Market

+Markup for Risk

and Profit

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Customer Profitability Analysis (CPA)

• Estimate Total Revenues From Loans and Other Services

• Estimate Total Expenses From Providing Net Loanable Funds

• Estimate Net Loanable Funds• Estimate Before Tax Rate of Return

By Dividing Revenues Less Expenses By Net Loanable Funds