The Alaska Contractor - Spring 2011 - Keep Trees

FINANCIAL SERVICES & CONTRACTORS
Contractor fi nancing from a
banker’s perspective
Obtaining optimal fi nancing during diffi cult or uncertain
times rests on the quality and accuracy of current
fi nancial statements.
Contractors, more than other industries in general, are
fi nding the going rough as a result of the great recession and
credit crunch of the past few years.
Contractors are sensitive to business cycles, experience
wider revenue swings and deal with high levels of competition.
These factors make contractor fi nancing more challenging for
banks and therefore it becomes imperative for contractors to
clearly demonstrate their creditworthiness.
How do banks determine your creditworthiness?
Bankers lend to contractors who clearly communicate and
demonstrate their ability to repay their loans.
The fi nancial statements most critical in the determination
of creditworthiness are: balance sheet, income statement,
accounts receivable and inventory aging, job status reports
and cash fl ow projections
Are the fi nancial statements prepared in-house or by a CPA?
Are the statements of compiled, reviewed or audited quality?
Third-party confi rmation provides more assurance to bankers.
Primarily a banker must determine if cash fl ow generated
from the operations of the business will be suffi cient to repay
the loan and still meet all other existing and proposed obligations
for that business.
Bankers need to see contracts and cash fl ow projections.
Much of the contractor’s working capital is tied up in construction-in-progress
inventory. Progress billings acceptable to the
project owners are the contractor’s source of cash for labor,
materials, taxes, debt service and other associated costs. A
banker will need monthly and quarterly cash fl ow projections
over the life of these contracts.
In addition to the cash fl ow banks review both collateral
and personal guarantees from the owners. Repossessing equipment
often puts a contractor out of business while collecting
on billings for work-in-progress is sometimes futile. The work
is usually not fi nished so it becomes diffi cult to collect.
If a contract is bonded and not completed by the contractor
the bonding company normally takes fi rst position over the
bank’s rights. Many contractor loans are viewed as unsecured
even with collateral. Personal guarantees and fi nancial capacity
are what banks look for.
Banks consider both fi nancial and non-fi nancial factors
but the following four fi nancial factors are: primary profi tability,
solvency, liquidity and fi nancial leverage.
Many jobs or contracts carry high costs up front and the
BI L L CESSNUN
Vice President,
Northrim Bank
profi ts are realized later on. A contractor must demonstrate the
ability to fi nish jobs profi tably.
Does the company have the cash and working capital on
hand to cover a few months of payroll and other payables?
Will the contractor be able to meet both short- and longterm
obligations to debt and equity holders? The more positive
tangible net worth there is, the better the solvency picture will be.
Is there enough cash fl ow to cover principal and interest, capital
expenditures, rent and lease payments, and other equity draws?
If contractors are highly leveraged with debt there can be a
problem. Debt to worth ratios paint a picture, however the terms
of debt are important. If debt to worth is 4:1 and the majority of
debt is longer term then banks are somewhat assured there is
not a large short-term debt due.
Additionally, banks will consider many non-fi nancial factors:
• Is the contractor a general or subcontractor? Generals
are one step closer to the contract owner, or the source of
payment.
• What is management’s experience? How capable
is management? Is there excessive turnover in
management?
• Is the owner involved? Close supervision by vested
owners positively impacts time and on-budget success.
• What are the billing practices? Bankers will be wary of
front end loaded billings.
• Who are the customers involved? Some public jobs have
lower margins but are larger contracts.
• How seasonal and cyclical is the contractor’s business?
• How capital intensive is the business?
• What is the condition of the equipment?
• What are the OSHA and workmen’s compensation records?
This impacts insurance premiums.
What is the competitive landscape?
In the end a banker will weigh the strengths and weaknesses
of both fi nancial and non-fi nancial factors. High-quality leadership
for the contractor’s business will be the most critical component,
yet the fi nancial picture must make sense and provide
cushion for the “unknown” or possible future negatives.
Expect banks to require loan covenants to include ongoing
fi nancial reporting, minimum fi nancial ratios like current ratio,
debt to worth ratio, and a minimum tangible net worth. Each
contractor is unique so these loan covenants will vary.
Building a strong relationship with your bank is an outcome
of clear communication and full exchange of information. The
better the information the better the decisions made.
44 The Alaska conTrAcTor Spring 2011