Commercial Loans to Business

Reference Guide
Omega Performance Corporation provides performance improvement solutions
to financial service organizations worldwide.

Omega Performance helps financial institutions reach new levels of

performance by integrating intensive skill development, comprehensive
learning systems, and a motivational learning environment to create a positive,
lasting behavioral change.

Since 1976, more than two million financial service professionals from over
2,500 global financial institutions have completed Omega Performance
programs in credit and risk management, and sales and sales management.

Omega Performance’s clients include financial service organizations of all

sizes in North America, Europe, Africa, and the Asia/Pacific region.

N O T I C E
This publication is protected by copyright and is licensed to be used by a single
individual only.

It is illegal to reproduce this training system or any part of it in any way, to

share these materials, or to lend or rent them to anyone else.

Copyright © 2018 Omega Performance Corporation. All rights reserved.

www.omega-performance.com
[email protected]

0118
 Table of Contents
Job Aids -------------------------------------------------- 1 The Decision Strategy----------------------------3
Estimating Operating Cycle Financing
Needs ---------------------------------------------5
Preliminary Assessment--------------------------7
Forms of Business Organization---------------9
Identifying Borrowing Cause ----------------- 13
Industry Risk Assessment --------------------- 19
Business Risk Analysis ------------------------- 21
Business Risk Assessment--------------------- 27
Analyzing the Income Statement ------------ 33
Understanding the Balance Sheet ------------ 35
Developing Financial Statement
Expectations----------------------------------- 39
Ratios and Indicators--------------------------- 41
Direct Cash Flow Construction -------------- 43
Cash Flow Summary Tips --------------------- 47
Targeted Cash Flow Analysis ----------------- 49
GAAP Statement of Cash Flows------------- 51
Financial Drivers of Cash Flow -------------- 53
Four Critical Management Areas------------- 57
Making Your Decision------------------------- 59
Credit Facilities---------------------------------- 61
Selecting the Best Facility --------------------- 63
Types of Loan Support ------------------------ 65
Loan Covenants--------------------------------- 67
Worksheets---------------------------------------------71 Borrowing Cause-------------------------------- 73
Risk Assessment -------------------------------- 75
Quick Cash Flow ------------------------------- 77
Cash Flow Summary --------------------------- 79
Financial Drivers-------------------------------- 81
Projection Hypotheses------------------------- 83

© Omega Performance Corporation. All rights reserved. Table of Contents iii

iv Reference Guide RG.SING.0301-2.CLB.doc
 Job Aids

© Omega Performance Corporation. All rights reserved. Job Aids 1

2 Reference Guide © Omega Performance Corporation. All rights reserved.
 The Decision Strategy

Opportunity assessment
Prospecting
Does the prospect match the lending institution’s profiles?
If the prospect is a current customer, can the relationship be expanded?

Identify opportunities
Review the prospect’s strategic objectives and financial structure.
What immediate and long-term needs exist for credit or noncredit services?

Preliminary analysis
Preliminary assessment
What is the specific opportunity? Is the opportunity legal and within your institution’s policy?
Are the terms logically related? Do the risks appear to be acceptable?

Identify borrowing cause

What caused the need to borrow? How long will the borrowed funds be needed?

Repayment source analysis

Industry and business risk analysis

What trends and risks affect all companies in the borrower’s industry?
What risks must the borrower manage successfully in order to repay the loan?

Financial statement analysis

What do the financial statement trends show about the borrower’s management of the business?
What trends will influence the ability to repay?

Cash flow analysis and projections

Will the business have sufficient cash to repay the loan in the proposed manner?
Which risks will have the greatest impact on its ability to repay?

Loan packaging
Summary and recommendation
What are the major strengths and weaknesses of the loan situation? Should a loan be granted?

Loan structuring and negotiation

What are the appropriate facility, pricing, disbursement method, documentation, and covenants?

Loan management

Loan monitoring
Is the borrower performing as expected? What caused variations?
What are the risks to repayment? How can you protect the institution’s position?

© Omega Performance Corporation. All rights reserved. Job Aids 3

4 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Estimating Operating Cycle Financing Needs

Holding period

Inventory
Cost of goods sold x 365 = Inventory days on hand (INVDOH)

Collection period

Net accounts receivable

Net sales x 365 = Accounts receivable days on hand (ARDOH)

Operating cycle

INVDOH + ARDOH = Length of average operating cycle in days

Payment period

Accounts payable
Cost of goods sold x 365 = Accounts payable days on hand (APDOH)

Financing need

INVDOH + ARDOH − APDOH = Days of financing needed

© Omega Performance Corporation. All rights reserved. Job Aids 5

6 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Preliminary Assessment

Step 1: Assess the opportunity

• Identify the potential loan terms:
¾ Amount
¾ Purpose
¾ Repayment source
¾ Term
• Is the potential loan legal?
• Is the potential loan within your institution’s policy?
• Are the purpose, repayment source, and term logically related?

Step 2: Learn about the business

• Determine:
¾ Type of business and product
¾ Legal structure
¾ Age of business
¾ Banking relationship
¾ Market served and competition
¾ Management structure and experience

Step 3: Continue analysis?

YES NO
• Gather three years’ financial • Reject loan opportunity and
statements inform borrower
• Gather other information sources
such as:
¾ Agings
¾ Inventory breakdowns
¾ Projections
¾ Credit ratings

© Omega Performance Corporation. All rights reserved. Job Aids 7

8 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Forms of Business Organization Page 1
Cost and Liability of Continuity of Management Ease of Tax
Ease of Owners the Business Control Raising Implications
Establishment Capital

Sole Proprietorship
Least Unlimited No provision Owner has Borrowing Owner pays
expensive; personal for continuity control over by owner or taxes at
simplest form liability in case of all from individual
to establish death of management owner’s rate on net
proprietor decisions personal income of
assets business

Partnership
General Minimal Unlimited May be Management Borrowing or Each partner
partnership expense; written personal dissolved by by majority bringing in pays taxes
or verbal liability for death or rule; each other on own
agreement filing each partner withdrawal partner may partners or share of net
may be required for any and of general obligate personal income
if doing all partner partnership assets
business under partnership
assumed name debts
Limited Statutory Limited Limited Limited Borrowing or Each partner
partnership requirements partner: partner: partner: not bringing in pays taxes
usually include liability death or allowed to other on own
written limited to withdrawal participate partners or share of net
agreement and investment does not General personal income
statement of General affect partner: assets
limited and partner: General management
general unlimited partner: by majority
partners liability death or rule
withdrawal
of last
remaining
general
partner can
dissolve
partnership
Limited Statutory Extent of May be Management Borrowing or Each partner
liability requirements personal dissolved by by majority; bringing in pays taxes
partnership usually include liability for agreement each partner other on own
written partnership of the may obligate partners or share of net
(LLP) agreement and debts varies partners or the personal income
registration with by state. by death or partnership assets
the State. Many Generally, withdrawal
states restrict partners of a partner
this type of have limited
partnership to personal
professionals liability for
such as lawyers, negligent
accountants, acts or
architects and malpractice
healthcare committed
providers by other
partners

© Omega Performance Corporation. All rights reserved. Job Aids 9

 Job Aid: Forms of Business Organization Page 2
Cost and Liability of Continuity of Management Ease of Raising Tax
Ease of Owners the Business Control Capital Implications
Establishment

Corporation
C corporation Most costly; Limited to Creates Board of Borrowing; Pays taxes at
statutory amount degree of directors other debt corporate
regulations; invested continuity; elected by instruments; rate;
filing fee continues shareholders; sale of stock generally
based on despite centralized higher than
capital death or management individual
structure withdrawal of rate
stockholder

S corporation Fairly easy; Limited to Charter is Board of Must Each

limited corporate revoked by directors primarily use shareholder
number of assets vote or by elected by income from pays taxes on
shareholders; failure to shareholders operations; own share of
filing fee meet stock income at
requirements purchase individual tax
limited by rate
type of
investor and
number;
borrowing

Professional Most costly; Unlimited Creates All Borrowing; Special tax

numerous personal degree of shareholders bringing in rules apply
corporation
fees and filing liability for continuity; must be new
requirements; professional members members of members
professional actions; may be same
licensing of limited required to profession
members also liability for buy shares of
required debts members
who die or
lose license

Nonprofit
Consult your bank’s specialist for detailed information
corporation

10 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Forms of Business Organization Page 3
Cost and Liability of Continuity of Management Ease of Raising Tax
Ease of Owners the Business Control Capital Implications
Establishment

Limited Liability Company (LLC)

Requires Owners, also Creates Most states Borrowing; Generally
filing with known as degree of allow an LLC other debt allowed to
applicable “members,” continuity; to be instruments; elect whether
state have limited may be structured sale of stock to be taxed
authorities liability dissolved however its LLCs may as a
and filing similar to a upon the members generally corporation
fees corporation withdrawal of want it to be offer more or to have
An LLC is not a member, structured than one pass-through
a corporation unless May have class of taxation as in
or remaining board of ownership a partnership
partnership, members directors and interest, and
but combines agree to managers there is
the corporate continue the who may or generally no
advantages business may not be limit to the
of limited members number of
liability with individuals or
the tax entities that
advantages may hold
of a ownership
partnership interest

Business Trust
Easy, fast, Limited to Perpetual Trustees Borrowing; Pays federal
and relatively trust assets continuity or have sale of corporate
inexpensive fixed term, as complete beneficiary taxes; may
except for voted control certificates be exempt
cost of from state
creating trust corporate
taxes

© Omega Performance Corporation. All rights reserved. Job Aids 11

12 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Identifying Borrowing Cause Page 1

Process Likely purpose Method Formula

and term
Short-term Loan will normally Examine monthly sales
sales growth finance temporary data for at least the
accounts receivable last year
and inventory growth Determine whether a
Loan should be short- seasonal trend exists
term with repayment Ensure business is at
following sales decline least marginally
profitable

Increase in Loan will normally Examine year-end Accounts receivable (net)

working finance the increase in balance sheets + Inventory
investment trading assets not Calculate working - Accounts payable
funded by the increase investment for each - Accrued expenses
in spontaneous year = Working investment
financing
Subtract previous year
Loan can be short- from current year to
term if caused by determine amount of
seasonal sales growth, change
or long-term if caused
by long-term sales
growth or permanent
changes in operating
cycle

Long-term Loan will normally Examine recent year-

sales growth finance growth in core end sales figures and X = current year
current assets calculate rate of sales
Y = previous year
Term depends on growth
duration of sales Growth rates over 10%
growth, level of indicate possible (x-y)
y x 100
profitability, and financing needs
availability of outside
capital

© Omega Performance Corporation. All rights reserved. Job Aids 13

 Job Aid: Identifying Borrowing Cause Page 2

Likely purpose
Process Method Formula
and term
Inventory Loan purpose Calculate
slowdown may be to inventory days on Inventory
finance hand and compare Cost of goods sold x 365
temporary to prior years
increases or
structural Examine change
changes in the of inventory
company’s components (raw
business materials, work in Component
process, and Total Inventory x 100
Loan term
finished goods) as
depends on a percentage of
the cause of total inventory
the slowdown
and the Calculate the Current period’s
dollar amount of cost of goods sold
company’s x Previous period’s INVDOH
inventory change 365
ability to that is due to the
generate cash Actual Result of
change in INVDOH − = Change
inventory calculation
Accounts Loan will Determine
receivable finance whether
collection accounts receivable
slowdown receivable collections have
growth resulting slowed
from slowdown Examine recent
Net accounts receivable
Loan term receivables x 365
depends on agings, or Net sales
whether it is a calculate
short-term or accounts
long-term receivable days on
problem hand (collection
period in days)

Calculate the Current period’s Previous

dollar effect of the net sales x period’s
slowdown 365 ARDOH

Discuss with
borrower the
cause of the Actual
slowdown and accounts Result of
− = Change
decide if it is a receivable calculation
short-term or long- (net)
term problem

14 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Identifying Borrowing Cause Page 3
Likely
Process purpose Method Formula
and term
Fixed-asset Loan purpose Obtain
replacement is to purchase information
fixed assets to directly from the
replace borrower
Accumulated depreciation
existing fixed Examine Gross depreciable fixed assets x 100
assets financial
Loan is statements;
normally long- calculate fixed
term; term asset usage
depends on Net depreciable fixed assets
Calculate fixed-
borrower’s Depreciation expense
asset life ratio
ability to
generate cash (If fixed assets
and useful life are substantially
of the asset depreciated, or
if fixed-asset life
is short, fixed-
asset
replacement
needs may
appear in the
near future)

Expansion of Loan purpose Calculate how

fixed assets is to purchase many dollars of
new fixed sales are Sales
assets generated by Net fixed assets
Loan is each dollar of
normally long- fixed assets
term; term
depends on Confirm your
borrower’s findings by
ability to discussing
generate cash them with the
and useful life borrower and
of asset visiting the
production
facilities

© Omega Performance Corporation. All rights reserved. Job Aids 15

 Job Aid: Identifying Borrowing Cause Page 4
Likely
Process purpose Method Formula
and term
Outlays for Loan purpose Check for increase
asset growth and term in asset accounts
depend on not directly linked
which asset to asset conversion
accounts cycle (such as
grew, and why investments,
intangibles,
goodwill)
Perform common- Account balance
size analysis and Total assets x 100
watch for accounts
that change in
proportion to total
assets

Restructuring Loan purpose Stated loan purpose

liabilities may be to may identify this
replace cause
existing debt or Watch for increase Accounts payable
to pay in accounts payable x 365
Cost of goods sold
expenses in relationship to
Loan term sales (accounts
depends on payable days on
the nature of hand)
the liability
being Check for financing
replaced; mismatches by
make sure you comparing growth
have in core and
determined noncurrent assets
the true to growth in long-
borrowing term debt and
cause equity

Unprofitable or Loan purpose Watch for

marginally may be to pay decreases in
profitable expenses, fund percentage of profit
operations increased to sales
assets, or
replace Net profit after taxes
Net sales x 100
equities
Loan term
depends on
duration of low
profitability

16 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Identifying Borrowing Cause Page 5

Process Likely purpose Method Formula

and term
Outlays for Stated purpose Calculate
dividend may be to pay percentage of Cash dividends
NPAT x 100
payments or expenses, fund profits being paid
owners’ draw increased assets, out to owners
or replace or
liabilities
Owners' draw
Term depends on x 100
Net profit
amount and
relationship of
draws to profits; Watch for
the bank might not increasing or
want to lend in this excessive
situation percentages
Be sure to look for
the true borrowing
cause; payment of
dividends may be
a legitimate loan
purpose

One-time or Loan purpose is to Discuss with the

unexpected pay the expense borrower the
expenses Loan term nature of the
depends on the expense and why
amount of the it has occurred
expense and Watch for other
repayment source contributing
borrowing causes

© Omega Performance Corporation. All rights reserved. Job Aids 17

18 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Industry Risk Assessment Page 1

Industry Moderately High

Low Risk Moderate Risk High Risk
Characteristic Risk

Cost structure Low operating Balance of fixed Fixed costs High operating
leverage: and variable costs moderately higher leverage:
• Low fixed costs than variable costs • High fixed costs
• High variable • Low variable costs
costs

Profitability Consistently Consistent but • Profitable during Unprofitable during

profitable through lower than average expansions expansions and
expansions and profitability during • Mildly unprofitable recessions
recessions recessions during recessions

Maturity Mature industry— Maturing industry— Emerging industry— Emerging industry—

sales and profits beyond major still growing rapidly; growing at
still increasing at growth problems weak competitors explosive rate
reasonable rate and shakeout of just beginning to
weak competitors drop out Or declining
industry—sales and
Or highly mature profits decreasing
industry—just on
verge of decline
Technology Technology is Technology change Technology change Technology
stable and has little is gradual and has is gradual and is advancement is
impact on products, some impact on impacting several rapid; products,
production either products, aspects of production
processes, or production products, processes, or
business practices processes, or production business practices
business practices processes, or are changing swiftly
business practices and substantially
Cyclicality Not affected by Sales rise and fall Sales moderately Highly cyclical or
business cycle mildly, reflecting affected by countercyclical
expansion and expansion and
recession recession

Dependence Highly diversified Customers or Customers or Highly dependent

customer or suppliers limited to suppliers limited to on one or two other
supplier base several industries, a few industries: industries or
but none represent some represent customer groups
more than 10% of 20% to 30% of
sales or purchases sales or purchases
Globalization Not affected by Able to source and Global competition Global competition
global competition sell globally but is a factor in is very strong and
relatively industry profitability causing
unaffected by consolidations,
global competition failures, or new
business strategies
in the industry

© Omega Performance Corporation. All rights reserved. Job Aids 19

 Job Aid: Industry Risk Assessment Page 2

Industry Moderately High

Low Risk Moderate Risk High Risk
Characteristic Risk

Vulnerability to No substitutes Few substitutes Variety of Many substitutes

substitutes available or likely available, or high substitutes easily accessible;
switching costs available, or no switching costs
moderate switching
costs

Regulatory Friendly regulatory Unregulated or Regulations have Regulations have

environment environment slightly regulated; noticeable adverse significant chronic
protects or regulatory changes impact on revenues adverse impact on
enhances industry highly unlikely or or costs; industry health;
health; change in predictable predictable and regulations subject
environment highly manageable impact to sudden change
predictable

Operations Business activities Predicting and Predicting and Business activities

are easy to predict controlling controlling are very difficult to
and control and are business activities business activities predict or control
not dangerous to requires normal require special and are dangerous
employees; product routines and care knowledge and skill to employees; even
defects are not by managers and to avoid loss and small product
dangerous to employees; product special employee defects are
customers defects are an precautions to dangerous to
inconvenience avoid danger; customers
rather than a defects are
danger to sometimes
customers dangerous to
customers

20 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Business Risk Analysis Page 1

Type of
Questions to Answer Points to Consider
Analysis
Industry
What are the most important industry risks Cost structure
faced by all firms in this industry? Profitability
Does the company have adequate strategies Maturity of the industry
for dealing with those risks? Technology
Effects of economic cycles
Dependence on other industries
Globalization
Vulnerability to substitute products
Regulatory environment
Operations

Strategy for competitive advantage

How does the company seek to differentiate Cost leadership—being the low cost producer
itself from competitors? Product differentiation—having the best, most
What is its overall strategy for winning unique product
customers? Market focus—having superior knowledge of
the customer

Characteristics and goals

How does the firm compare with other
companies in the industry in terms of market
share, sales, profits, and assets?
Does the firm influence or dominate industry
events?

How mature is the company? Stage in its life cycle (emerging, mature, or
declining)
Likely implications for:
Experience in surviving business cycles
Actions needed to generate sales
Critical success variables and risks to the
lending institution

How diversified is the company’s product line? Dependence on a single product or a small
product line
Dependence on a small or narrow customer
base

How diversified are the company’s markets? Dependence on one economy

Profitability of lines and markets

What are the company’s goals? (How does it Sales growth?

measure its success?) Profit margins?
Are goals consistent with the competitive Significant expense control or spending
strategy? initiatives?
What is the company’s process for strategic Other major, quantified initiatives?
planning and goal setting?

© Omega Performance Corporation. All rights reserved. Job Aids 21

 Job Aid: Business Risk Analysis Page 2

Type of
Questions to Answer Points to Consider
Analysis
Management analysis
Do the senior managers have a reputation for
unquestioned integrity in their business
dealings?
Have the senior managers been with the
company long enough to have experienced
one or more business cycles?

Does the management team have experience General management

and expertise in all major functional areas of Sales management
the business? Financial management
Operations management
To what extent does the management have
the proven ability to execute the company’s
overall competitive strategy successfully (low
cost, product differentiation, market focus)?

To what extent does the company’s success Individuals who make the important
depend on one or more key managers? decisions at the company
Way in which the decisions are made
Adequacy of management depth for the
company to survive the sudden loss of any
one key executive
Whether there is a management succession
plan

Has the management team developed

information and control systems needed to
monitor the critical success variables?
Does management get appropriate assistance
(e.g., accounting, management consulting)
from outside the company when needed?
Does the board of directors serve as an active
and helpful control for management in order to
protect the stockholders’ interests?
Are there any circumstances in the owners’ or
managers’ personal lives that might induce
them to make decisions that would not be in
the company’s or the bank’s best interest?
In an ideal situation, what would the
management of a company like this do to
minimize the risk? How does this company
compare?

22 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Business Risk Analysis Page 3

Type of
Questions to Answer Points to Consider
Analysis
Product–market match
What products does the company offer?
Are the products final consumables or
intermediate goods?
Who are the company’s customers? Who are
the ultimate consumers of the products? Who
influences their purchasing decisions?
What value or benefits do the company’s
products offer the market? What needs do
they satisfy? What motivates customers to buy
this type of product?

Will there continue to be customers for this Market size (annual industry sales) and
company’s products? growth
Vulnerability to style changes
Risk of technical obsolescence
Vulnerability to substitute products
Importance of the products⎯luxury or
necessity
Dependence on business cycles in other
industries

What are the comparative advantages of this Low prices

company’s products over those offered by Better terms of sales
competitors?
Customer service
High quality
Brand image or unique features and benefits
Availability
Technological leadership

Are the company’s distinct advantages the

ones you would expect, based on its goals and
competitive strategy?
What must the company do to maintain or
increase the comparative advantages of its
product line?
Does management expect to introduce new
products or change existing product
configurations during the expected loan term?
What would be the effects on product–market
match?
In an ideal situation, what would a company
like this one do to minimize the risk of a
product–market mismatch? How does this
company compare?

© Omega Performance Corporation. All rights reserved. Job Aids 23

 Job Aid: Business Risk Analysis Page 4

Type of
Questions to Answer Points to Consider
Analysis
Supply analysis
What are the characteristics of the Raw materials and supplies needed for the
company’s supply lines? production process
Source and method of purchase of raw
materials
Method of transportation
Timing and frequency of purchases

To what extent is the company able to control Critical success variables for maintaining
the price, quality, and availability of the raw adequate supplies of inputs (labor and
materials? materials) at prices that will make the firm
competitive
Steps the company could take to further
assure availability and the spread between
costs of inputs and selling prices

What is the balance of bargaining power

between the company and its suppliers? Is
management taking steps to reduce supplier
bargaining power and to increase its own?
Does the company have an adequate supply
of trained employees?
Does management expect to make any
significant changes in procurement practices
that would affect the cost or availability of
inputs?
In an ideal situation, what would a company
like this one do to minimize the risk of supply
disruption? How does this company
compare?

Production analysis
What is the nature of the company’s Basis on which the company decides to
production process? produce a product:
Confirmed orders
Long-term contracts
Past trends and expected orders
Time and place of production of goods, and
length of production process
Method of controlling inventory investment
Necessary investment in fixed assets
Extent to which the process relies on highly
sophisticated technology or highly sensitive
and delicate machinery
Critical success variables for efficient
production and minimum cost

24 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Business Risk Analysis Page 5
Type of
Questions to Answer Points to Consider
Analysis
Production analysis
Has the company developed any significant Amount of effort management devotes to cost
cost advantages over the competition? reduction, and degree of continuing
investment in more efficient equipment to
reduce production costs

Are there events or conditions that could stop Type of events and whether they have
or constrain production, or substantially occurred before
increase production costs? Amount of advance warning
Amount of damage (actual damages, lost
business, or increased costs) that would result
Likelihood of these events
Steps management can take to reduce the
likelihood of such events or potential damage
if they occur
Does management plan any additions or Relationship to current capacity
reconfigurations of production capacity during Implications for the company’s costs and
the loan term? profitability
Implications for cash flow and ability to service
loans
In an ideal situation, what would a company
like this one do to minimize production risk?
How does this company compare?

Distribution analysis
What is the distribution chain the company’s Steps and parties involved and the effect of
products go through to reach the final the distribution chain on costs
customer? Whether the distribution system provides a
cost advantage over the competition
Extent to which the distribution system
reaches the customers the company has
identified as its primary market

To what extent can the company control or Effect of that degree of control on sales to
promote its products through the distribution customers
chain? Degree of influence the company has over the
ultimate consumers of its products

Is the company’s distribution chain subject to Transportation (strikes, weather, breakdowns)

disruption from outside sources? Breakdown of retail network (such as
bankruptcy of major retail links with
consumers)
In an ideal situation, what would a company
like this one do to minimize distribution risk?
How does this company compare?

© Omega Performance Corporation. All rights reserved. Job Aids 25

 Job Aid: Business Risk Analysis Page 6

Type of
Questions to Answer Points to Consider
Analysis
Sales analysis
How does the sales process work? The company’s customers, and whether there
is any concentration of sales to a few
customers
Major steps in the sales process, and things
that could go wrong
Whether the company has developed
comparative advantages in the sales process
relative to the competition

How does the sales process affect costs? Cost of advertising and other promotional
activities, and cost of the sales force
Extent to which selling costs vary with sales
volume or are relatively fixed

Can the company control its prices to Method of sales (on spec, long-term
maintain its spread? contracts, against confirmed orders) and
potential risks of that type of selling:
Risk of costs rising but prices staying fixed
Risk of prices falling but costs staying fixed
Risk of canceled orders if the current
market price falls below the contract price
Whether the borrower or the borrower’s
customers have the greatest bargaining
power with regard to price
Whether the company is attempting to
increase its own bargaining power or reduce
its customers’ bargaining power

To what extent can the company stimulate

demand for its products? What are the cost
implications?

What management decisions have most Overall market growth

influenced sales performance during the last Product innovation
three to five years? Expansion into new markets
Aggressive selling methods
Extensive advertising
Price competitiveness
Extraordinary circumstances
What are risk implications and success
variables for continued performance?
In an ideal situation, what would a company
like this one do to minimize the risk of
selling? How does this company compare?

26 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Business Risk Assessment Page 1

Business Moderately
Low Risk Moderate Risk High Risk
Characteristics High Risk

Industry
Sales and profits Sales and profits Sales and profits Highly cyclical or
not affected by the mildly affected by moderately affected countercyclical;
business cycle; no expansion and by expansion and many substitutes
substitutes recession; limited recession; a number easily accessible; no
available or likely substitutes of substitutes switching costs
available or high available or
switching costs moderate switching
costs

Strategy for competitive advantage

The firm’s overall The strategy is The firm has no Key competitors
strategy if reasonably clear clear competitive have similar
successfully and affordable and strategy; strategy and are
executed will management is able management is not better able to
favorably set it apart to carry it out, but it focused and may be execute, due to
from key is not proven that spending in areas superior
competitors; the the strategy will not critical to the management
firm has the consistently defeat firm’s success; expertise and
management the competition competitors are financial capacity
expertise and more focused
financial capacity to
carry out the
strategy

General characteristics and goals

Size One of the largest in Average size Small in terms of One of the smallest
terms of sales, sales, assets, profits in terms of sales,
assets, profits, and and market share assets, profits, and
market share market share

Maturity Mature firm— Maturing firm— Emerging firm— Emerging firm—

growing at some shakeout of growing at rapid, not growing at explosive
reasonable rate weaker competition explosive, rate rate
Or declining firm—
sales and assets
declining over a
number of years

Diversification Company sells many Company sells Company has Company sells
products; products several product limited number of single product line
have multiple uses lines; products have products or lines or multiple product
in many different limited flexibility of with limited lines to a single
industries; no use but are sold to flexibility of use; one customer
product line diverse customers; product or product
accounts for 10% or one product or line accounts for
more of company product line more than 30% of
sales or profits accounts for 20- sales or profits
30% of sales or
profits

© Omega Performance Corporation. All rights reserved. Job Aids 27

 Job Aid: Business Risk Assessment Page 2

Business Moderately
Low Risk Moderate Risk High Risk
Characteristics High Risk

General characteristics and goals

Goals The firm has clear Key goals are clear Some key goals are Goals are unclear or
goals that are and consistent with not clear or are inconsistent with
consistent with the the strategy; the inconsistent with the stated strategy
overall strategy; the goal setting and stated strategy; the
goal setting and strategic planning planning and goal
strategic planning process is informal setting process is
process is well and may not not well developed
developed and accommodate and does not
accommodates all important accommodate
important and new information important and new
information information

Management
Experience Extensive industry Has experienced Limited experience in Limited experience in
experience with wide several industry the industry with the industry without
range of conditions cycles minimal exposure to exposure to normal
normal industry industry problems
problems

Breadth Experienced One key functional One key function More than one key
managers in place in manager somewhat without experienced function without
all major functional less experienced manager; other experienced
areas than desirable, but managers covering managers; difficult
learning quickly for other managers to
cover

Depth Unusually high Adequate Insufficient Insufficient

management depth management depth management depth management depth
with succession in all with each critical with some outside with vacancies in key
functional areas function covered by recruiting necessary spots causing serious
provided for at least one qualified to fill vacancies in exposure
internally successor secondary positions

Integrity Established broad Good reputation for Managers known to Managers recently
reputation for integrity in local bank; no reason to acquainted with
unwavering integrity business community question bank; no reason to
in positive as well as management question
adverse integrity, but management
circumstances reputation is not integrity, but
widely known reputation is not
widely known

Advisors and Active board Some outside Outside directors, if Inside board that
board of directors composed of directors of any, are not an does not discharge
nationally recognized moderately important effective control on normal
business leaders stature exercise management responsibilities
serves as a strong average control over
check on management
management

Track record and Long track record of Track record of Inconsistent record of Rarely able to meet
reliability meeting forecasts meeting forecasts meeting forecasts forecasts and goals;
and goals and goals about half and goals some years are
the time better and some are
worse

28 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Business Risk Assessment Page 3

Business Moderately
Low Risk Moderate Risk High Risk
Characteristics High Risk

Product–market match
Importance A staple; always in Deferrable A luxury; thin market An extravagance;
demand; consistent necessity; demand but stable demand market thin and
and predictable cyclical; purchases unstable
demand can be delayed but
not deferred entirely

Product Highly differentiated Some differentiation Nondifferentiable Nondifferentiable

differentiation product; few possible; product with a product with many
comparable comparable number of readily comparable or
substitutes; strong substitutes limited, available better substitutes;
patent protection or perhaps by product substitutes; good no brand loyalty or
consumer loyalty; complexity; some quality reputation mediocre product
excellent reputation brand loyalty and quality
for quality good quality
reputation

Market stability The market is stable Changes in Changes in Changes in

and changes in customer preference customer preference customer
customer occur slowly and are are common and preference occur
preferences occur easy to anticipate companies with rapidly and
very slowly good market randomly and are
research can hard to predict,
identify them in time even by companies
to respond with average or
above average
market insight

Supply
Price Substantial control No control, but Supplies subject to Supplies subject to
(bargaining of price supply supplier competition supplier price supplier price
power) sources ensures fair price influence control

Availability Changes in Changes in Changes in Changes in

availability of availability of availability of availability of
supplies highly supplies reasonably supplies reasonably supplies not
predictable predictable; normal predictable, but predictable with
variations can be large enough to much lead time;
absorbed without cause major impact changes likely to
major impact on profits cause significant
variations in profits

Purchasing Long record of Occasional Periodic instances Frequent oversupply

purchasing supplies instances of of oversupply and or undersupply
in appropriate oversupply or undersupply causing significant
amounts undersupply that causing some variations in profits
were absorbed variations in profits
without major
impact on profits

© Omega Performance Corporation. All rights reserved. Job Aids 29

 Job Aid: Business Risk Assessment Page 4

Business Moderately
Low Risk Moderate Risk High Risk
Characteristics High Risk

Production
Consistency Trouble-free Occasional Fairly frequent Constant unplanned
operations; significant unplanned production
downtime not downtime or disruptions in disruptions; heavy
disrupting production production; impact on costs;
production problems; low to moderate to major cause of cost
schedules or costs moderate impact on significant impact variations
schedules and costs on costs and
deliveries
Vulnerability to An industry leader in Keeps up-to-date Slow to adopt Technology shifts
technology using most current with technology changes; vulnerable rapidly; company
technology; not changes; slow to to shifts in highly vulnerable;
likely to be caught adopt new technology; would major shifts could
off-guard by technologies, but not prove fatal prove fatal quickly
changes in not vulnerable to immediately
technology rapid introduction of
new technology that
would prove harmful
Vulnerability to Not vulnerable or Moderately Catastrophes could Catastrophes would
catastrophes large enough to vulnerable; large have a major impact prove fatal
absorb all imaginable enough to absorb but would not be
events consequences fatal
without major impact
on profits
Labor relations Long history of Occasional strikes or Occasional strikes of History of
harmonious labor work stoppages of significant duration; acrimonious labor
relations brief duration; good some unplanned or relations; strikes tend
working relationship unexpected work to be long and bitter
between union and stoppages
management

Distribution
Reach Reaches all qualified Reaches most Reaches some Severly limited; not
and desirable qualified and qualified and reaching desirable
customers desirable customers desirable customers customers

Control Controls distribution Controls significant Sells to wholesalers Sells to wholesalers

down to consumer; portion of distribution or distributors who or distributors who
has complete control chain; some carry limited number carry many substitute
over product opportunities to of substitute products; no control
promotion promote products in products; minimal over promotion or
chain or to influence control over distribution
purchasing decisions promotion or
distribution
Flexibility Can respond quickly Changes in Distribution changes Change in
and economically to distribution occur occur rapidly; distribution patterns
changes in frequently but can be management can could prove fatal to
distribution anticipated; changes anticipate changes the company;
requirements; have small to most of the time; changes occur
changes can be moderate impact on errors costly but not quickly; virtually
anticipated and profits fatal impossible to
planned years in anticipate and
advance respond

30 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Business Risk Assessment Page 5

Business Moderately
Low Risk Moderate Risk High Risk
Characteristics High Risk

Sales
Competition Faces no direct Faces some Faces moderate Faces heavy direct
competition in its competition in its competition from competition from
primary markets primary markets; stronger, larger stronger, larger
generally does better companies companies
than its primary
competitors
Bargaining power Substantial control Significant influence Minimal influence Customers have
over sales price of its over prices over prices significant control
primary products over price of
company products
Demand Substantial influence Limited control over No control over Customers have
of or control over demand demand significant control
product demand over demand

Concentration Highly diversified Diversified customer Moderately Undiversified

customer base; no base; one customer diversified customer customer base; sells
single customer or or industry group base; significant to one or two
industry group accounts for more dependence on a few customers who
accounts for 10% of than 10% of sales; customers account for 100% of
sales loss of such accounts sales; loss of
would have accounts would prove
temporary adverse fatal
impact

© Omega Performance Corporation. All rights reserved. Job Aids 31

32 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Analyzing the Income Statement Page 1
Examination of income statement for accounting risk
Determine whether revenue is • How and when is revenue recognized?
overstated • How does that revenue−recognition method affect sales and
accounts receivable?
• Are sales final?
• Are receivables real and collectible?
• Has a change in accounting methods affected the reported
revenues?
Determine whether expenses • How and when are expenses recognized?
are understated • How do those expense−recognition methods affect reported
profits and related balance sheet accounts?
¾ What method is used to account for cost of goods sold
and inventory?
¾ Are there inventory profits or holding gains?
¾ If the company uses LIFO, has there been a LIFO
liquidation?
¾ What methods are used to amortize the costs of long-
lived assets?
• Are all expenses necessary to produce the revenues
recorded?
• Are there capitalized expenses?
• Can the borrower explain each expense account and provide
breakdowns when needed?
• Has a change in accounting methods affected reported
expenses?
Common-size analysis
Display data to facilitate • Organize the income statement in a consistent hierarchy of
comparisons accounts
• Calculate each significant category of expense as a percent
of net sales
• Calculate gross profit margin, operating profit margin, pre-tax
profit margin, and net profit margin
Analyze trends in the • Present the most significant findings
borrower’s performance • Explore the reasons for the most important and largest
changes
• Explore the reasons for the instability of things that might
have changed
• Consider how the borrower’s actual performance compares
to your expectations about the borrower’s production risk,
value added, and length of asset conversion cycle
Compare the borrower’s • Determine SIC and/or NAICS code
performance with an industry • Obtain appropriate industry data for current period and prior
standard years
• Make sure industry ratios and borrower’s ratios are
comparable
• Present the most significant findings
• Explore the reasons for the most important and largest
differences

© Omega Performance Corporation. All rights reserved. Job Aids 33

 Job Aid: Analyzing the Income Statement Page 2
Revenue and expense analysis
Account Questions or Issues to Consider

Identify the components of • What are the trends in unit volume and unit price?
revenue • Does the business engage in two or more distinct lines of
business?
¾ By product?
¾ By customer segment?
¾ By geographic market?
¾ By production location?

Assess management’s • Can the business generate a growing level of sales?

performance in sales and • How does sales growth compare with the rest of the
expense control industry?
• How well has management been able to control costs?
• How well has management been able to maintain healthy
profit margins?
• How does the profitability compare with the industry’s?
• How is the borrower’s competitive strategy affecting sales,
expenses, and profits?

Evaluate operating leverage • Which of the company’s expenses tend to be fixed and which
tend to be variable?
• What is the company’s approximate contribution margin?
• What is the opportunity for increased profitability if sales
rise?
• What is the risk of losses or decreased profitability if sales
decline?
• What is the approximate sales level at which the company
breaks even?

34 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Understanding the Balance Sheet Page 1
Current assets
Account Questions or Issues to Consider
Cash • Where is it deposited?
• Is any of it restricted (pledged to another lender or available
only for specific purposes such as liquidation of deferred
liabilities or purchase of fixed assets)?
• Is any of the cash in foreign currencies and therefore subject
to fluctuations in value relative to the dollar?
Marketable securities • What types of securities⎯U.S. government securities,
commercial paper, municipal bonds⎯are included in this
category?
• Do they really represent a temporary and short-term
investment of surplus cash? Or are they long-term
investments that should be regarded as noncurrent assets?
• Are they truly marketable (convertible to cash at short
notice)? Are any of them restricted or pledged to another
lender?
• What is the value of these securities? (They may be carried
at cost, but market value should be determined if a thorough
analysis of this account is required.)
Accounts receivable • What is the breakdown of receivables according to age?
• What portion of the receivables is considered uncollectible?
• Are they highly concentrated among a limited number of
borrowers or in a small geographical area?
• What is the company’s experience with bad debt losses and
recoveries?
• Is the reserve for estimated doubtful accounts adequate to
absorb bad debt losses?
• Are any receivables pledged to creditors other than your
bank?
Inventory • What method does the company use in valuing its inventory?
• What is the breakdown of inventory into its components (raw
materials, work in progress, and finished goods)?
• What is the general character of the inventory? Is it subject
to fashion or technological obsolescence? It is perishable?
Does it have specialized or general uses?
• Is it insured against fire and other hazards?
• Is it readily marketable without too much loss in value in the
case of liquidations?
• Is it pledged to other creditors?
• If taken as collateral, can a security interest be perfected?

© Omega Performance Corporation. All rights reserved. Job Aids 35

 Job Aid: Understanding the Balance Sheet Page 2
Current assets (continued)
Account Questions or Issues to Consider
Receivables from affiliated • Do these receivables really qualify as current (subject to
companies regular liquidation in the short run)?
• Are they restricted to trade transactions, or are they related
to advances made for longer-term purposes (such as loans
for working capital)?
• Are they collectible in case of liquidation?
• Unless the answers to these questions are satisfactory,
receivables from affiliated companies should be reclassified
as noncurrent assets.
Receivables from company • What circumstances created these receivables?
officers, directors, • When will they be paid?
stockholders, or employees • Do they make up a significant proportion of current assets?
• In general, a conservative banker will view this category of
receivables as noncurrent, even when listed by the borrower
under current assets. These receivables are usually difficult
to collect. And, in the case of receivables from a stockholder,
creditor and debtor are one and the same.
Prepaid expenses • Prepaid expenses represent disbursements already made,
though their benefits will be enjoyed sometime in the future.
By their nature, prepaid expenses will not convert into cash
in the course of operations or during liquidation. For this
reason, this account is often reclassified from current to
noncurrent.
Noncurrent assets
Account Questions or Issues to Consider
Fixed assets • What are the values of the different components of fixed
assets?
• If market valuations are provided, who did the assessments,
and how reliable are they?
• Is a portion of the company’s fixed assets already pledged as
collateral?
• What would the value of fixed assets be in case of
liquidation?
• In case of liquidations, who would be first (and second) in
line for the proceeds?
• Is any portion of fixed assets⎯outside real estate, for
example⎯not being used in the ordinary operation of the
business?
Long-term investments • What circumstances gave rise to these investments?
• How liquid are they?
• Would they have any realizable value in case of liquidation?

36 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Understanding the Balance Sheet Page 3
Noncurrent assets (continued)
Account Questions or Issues to Consider
Intangible assets • The value of intangible assets is subtracted from total assets
and net worth in order to arrive at tangible equity position.
This provides a more conservative basis to judge the value of
a borrower’s assets.
Deferred charges • This account has the same characteristics as prepaid
expenses and intangibles. In the interest of conservatism,
the value of deferred charges could be deducted from total
assets and net worth.

Liabilities
Account Questions or Issues to Consider
Notes payable • How many are there and to whom are they payable?
• Is a more detailed breakdown available?
¾ Secured versus unsecured
¾ Notes payable to your bank versus notes payable to
other banks
¾ Notes payable to stockholders and other insiders
• Under what circumstances and conditions were these
obligations incurred?
• What are their terms, rates, and maturities?
• Does the borrower intend to review any of these notes?
• Are any assets pledged as collateral?
• Are proceeds of the loan you are now processing intended to
pay off any of these notes?
Current portion of long-term • Does this account accurately include all such obligations?
debt (Occasionally, you may run across a balance sheet that
neglects to segregate the current portion of long-term debt.
This practice will have the effect of understating current
liabilities.)
Accounts payable • Do these payables accurately represent trade liabilities?
(Any other payables should be shown separately if these
involve significant amounts.)
• Is the customer staying current?
• Will any of the proceeds of the loan you are now processing
be used to pay off trade creditors?
Accrued expenses • Can a breakdown be obtained to identify the most significant
items in accrued expenses?
Deferred credits and • What is the specific nature of these obligations?
unearned revenues • Will failure to comply with these obligations result in fines or
refunds to customers?

© Omega Performance Corporation. All rights reserved. Job Aids 37

 Job Aid: Understanding the Balance Sheet Page 4
Liabilities (continued)
Account Questions or Issues to Consider
Long-term notes • The questions listed under notes payable also apply to long-
term notes. In addition, you should determine whether the
maturity of any of these long-term obligations can be
accelerated. If so, conservative practice would be to regard
such obligations as current.
Subordinated obligations • Does the subordination agreement really provide the bank
with solid protection? (Legal help may be required to answer
this question.) Can the bank obtain possession of the
subordinated note?
Contingent liabilities • How much is likely to be payable? To whom?
• Under what conditions will the contingent obligation become
an actual liability?
• Is the liability secured? By what assets?

38 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Developing Financial Statement Expectations

Focus Expectation
Profitability analysis
Value added • The greater the value added, the greater the expected profit
Asset conversion cycle length • The longer the cycle, the greater the expected profit
Risk • The greater the risk, the greater the expected profit
Level of profit (profit as percent • In general:
of sales) Manufacturer’s profit > Retailer’s profit > Wholesaler’s profit
Asset structure and turnover analysis
TYPICAL RANGES
Product Businesses Service Businesses
Manufac- Whole- Capital- People-
Retailers
turers salers Intensive Intensive
Cash 5-8% 5-8% 5-8% 5-8% 5-20%
Accounts receivable 20-25 25-35 0-10 0-20 20-60
Inventory 25-35 35-50 50-60 0-10 0-10
Fixed assets 30-40 10-20 10-20 50-70 10-30
Other 5-10 5-10 5-10 5-10 5-10
Total assets 100% 100% 100% 100% 100%

Sales to Assets 2-5 4-6 1-3 1-2 7-10

Inventory DOH 60-100 60-100 100-200 NA NA
Receivable DOH 40-60 30-50 0-20 0-35 20-35
Capital structure analysis
Stability of financing • Volatile asset base⎯need short-term, flexible financing (current
liabilities)
• Stable asset base⎯need long-term financing

TYPICAL RANGES
Product Businesses Service Businesses
Manufac- Whole- Capital- People-
Retailers
turers salers Intensive Intensive
Current liabilities 30-40% 50-65% 50-60% 20-30% 40-50%
Long-term debt 15-25 15-20 10-20 20-30 0-10
Owner’s equity 35-50 30-40 25-35 35-50 35-50
Total liabilities and equity 100% 100% 100% 100% 100%

Proportion of equity in capital • The higher the business risk, the higher the optimal proportion of
structure equity

© Omega Performance Corporation. All rights reserved. Job Aids 39

40 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Ratios and Indicators Page 1

Calculation Definition

Profitability
Gross margin Gross profit Represents the spread between the cost
X 100 of producing the goods and the sales
Net sales
prices.
Operating profit Represents the percentage of profits
margin Operating profit retained from each sales dollar after
Net sales X 100 deducting cost of goods sold plus
operating expenses (SG&A).
Pre-tax profit Pre-tax profit Measures the business’s profitability
margin X 100 without potential distortions caused by
Net sales
changes in tax rates or strategies.
Net profit margin Net profit Measures the business’s ability to
Net sales X 100 generate profit from each sales dollar.

Contribution Variable costs The amount of each dollar of sales that is

margin 1 − Sales available to pay fixed costs.

Breakeven sales Represents the level of sales at which a

point Fixed costs business makes no profit before tax but
incurs no loss. Estimates the level to
Contribution margin
which sales could fall before the
borrower would break even.
Liquidity
Current ratio Current assets Indicates current asset dollars available
Current liabilities to pay current obligations.
Quick ratio Cash + Marketable securities + Net Measures the ability to pay current
accounts receivables liabilities without reliance on inventory.
Current liabilities
Working capital Measures the excess of current assets
Current assets − Current liabilities over current liabilities as a dollar amount.

Leverage
Debt to total Total liabilities Indicates the degree to which assets are
assets Total assets funded by external creditors.
Debt to net worth Total liabilities Measures how many dollars of outside
financing there are for each dollar of
Net worth
owners’ equity.
Debt to tangible Total liabilities A more accurate measure of leverage
net worth that eliminates intangibles from assets
Tangible net worth
and net worth.
Adjusted debt to Moves any subordinated debt from the
Adjusted debt
adjusted tangible numerator (liabilities) to the denominator
Adjusted tangible net worth (net worth).
net worth

© Omega Performance Corporation. All rights reserved. Job Aids 41

 Job Aid: Ratios and Indicators Page 2

Calculation Definition

Leverage (continued)

Indicates whether the cash produced by

EBITDA the business is sufficient to support both
EBITDA to senior
debt Interest on senior debt + Current the principal and interest payments due
portion of senior long-term debt on debt that is not subordinated.

Indicates whether the cash produced by

EBITDA
EBITDA to total the business is sufficient to support the
debt Interest on total debt + Current key obligations (principal and interest) of
portion of all long-term debt
interest-bearing debt.

Efficiency

Net sales Indicates the dollar amount of sales

Sales to assets generated by each dollar invested in
Total assets
assets.

Inventory days on Inventory The average number of days in the

hand
Cost of goods sold X 365
holding period.
(INVDOH)

Accounts
receivable days Net accounts receivable The average number of days in the
Net sales X 365
on hand collection period.
(ARDOH)

Sales to net fixed Net sales The dollar amount of sales generated for
assets Net fixed assets each dollar invested in fixed assets.

Return on assets Net profit before taxes Measures the return on investment
Total assets X 100
(ROA) represented by the business’s assets.

Return on equity Net profit before taxes Measures the rate of return on owners’
Tangible net worth X 100
(ROE) equity.

42 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Direct Cash Flow Construction Page 1

Target 1: Cash collected from sales

Line : 1 Record net sales (total revenues less returns and allowances).
2 Record the change in net accounts receivable.
3 Combine lines 1 and 2. This is cash collected from sales.
Target 2: Cash from trading activities
Line: 4 Record cash cost of goods sold (cash COGS), calculated as follows:
COGS from accrual income statement
Less: Noncash expenses in COGS, such as depreciation
Equals: Cash COGS
5 Record the change in inventory.
6 Record the change in accounts payable.
7 Combine lines 4, 5, and 6. This is cash paid for production.
8 Combine lines 3 and 7. This is cash from trading activities
Target 3: Cash after operations
Line: 9 Record cash SG&A expense, calculated as follows:
SG&A from accrual income statement
Less: Interest expense, if reported in SG&A
Less: Depreciation and amortization
Equals: Cash SG&A expense
Do not subtract from SG&A the provision for losses on receivables, if any, because net
accounts receivable is used to calculate line 2, Δ Accounts receivable.
10 Record the change in current prepaid expenses.
11 Record the change in accrued expenses.
12 Combine lines 9, 10, and 11. The result is cash paid for operating costs.
13 Combine lines 8 and 12. The result is cash after operations.
Target 4: Net cash after operations
Line: 14 Record the sum of other income and expense from the accrual income statement. Do not
include interest expense.
15 Record the change in other current and noncurrent assets and liabilities. "Other" means all
miscellaneous balance sheet accounts not accounted for elsewhere in the cash flow summary.
Do not include the following accounts: interest, dividends, or income taxes payable; interest-
bearing debts; fixed assets, investments, or intangibles; or any equity accounts.
Calculate the change in current and noncurrent accounts as follows:
Beginning other current assets
Less: Ending other current assets
Plus: Beginning other noncurrent assets
Less: Ending other noncurrent assets
Less: Beginning other current liabilities
Plus: Ending other current liabilities
Less: Beginning other long-term liabilities
Plus: Ending other long-term liabilities
Equals: Change in other current and noncurrent accounts
A positive result is a source of cash.
A negative result is a use of cash. Record in ( ).
16 Record total income tax expense from accrual income statement.
17 Record the change in deferred income taxes, including current portions, if any.
18 Record the change in income taxes payable.
19 Combine lines 14, 15, 16, 17, and 18. The result is taxes paid and other income (expense).
20 Combine lines 13 and 19. The result is net cash after operations.

© Omega Performance Corporation. All rights reserved. Job Aids 43

 Job Aid: Direct Cash Flow Construction Page 2

Target 5: Cash after financing costs

Line: 21 Record interest expense from accrual income statement. Do not net interest income.
22 Record the change in interest payable.
23 Record, in ( ), dividends declared, owners' withdrawal of equity, or other equity distributions
from the statement reconciling changes in stockholders' equity or surplus.
Beginning retained earnings
Plus: Net profit after taxes
Less: Ending retained earnings
Equals: Dividends declared or owners' withdrawals
24 Record the change in dividends payable.
25 Combine lines 21, 22, 23, and 24. The result is cash paid for dividends and interest (financing
costs).
26 Combine lines 20 and 25. The result is cash after financing costs, also called net cash income.
Target 6: Cash after debt amortization
Line: 27 Record, in ( ), the current portion of long-term debt from the prior year (the balance sheet for
the beginning of the period).
Assume the amount that was due to be paid during the period of the cash flow summary was,
in fact, paid. Prepayments or payments not made will be accounted for on line 35.
If the cash flow summary is for a period of less than 12 months, record on line 27 the portion
of beginning current maturities of long-term debt that were scheduled to be paid during the
period. If unknown, prorate and be aware that you might overstate or understate the financing
surplus (requirement) on line 33 and the change in long-term debt on line 35.
28 Combine lines 26 and 27. The result is cash after debt amortization, often called CADA.
Target 7: Financing surplus (requirement)
Line: 29 Record the change in fixed assets after adjusting for depreciation, as follows:
Beginning net fixed assets
Less: Depreciation expense (from COGS, SG&A, or both)
Equals: Expected ending net fixed assets
Ending net fixed assets
Less: Expected ending net fixed assets
Equals: Change in net fixed assets
Do not adjust for disposals of fixed assets if you included the gain or loss on sale of fixed
assets when calculating line 14, other income and expense.
If you did not include the gain or loss on sale of fixed assets when calculating line 14, adjust
beginning fixed assets by adding the gain or subtracting the loss before performing the
calculation shown above.
30 Record the change in investments after adjusting for amortization, as follows:
Beginning investments
Less: Amortization expense (if any)
Equals: Expected ending investments
Ending investments
Less: Expected ending investments
Equals: Change in investments
31 Record the change in intangibles after adjusting for amortization, as follows:
Beginning intangibles
Less: Amortization expense (if any)
Equals: Expected ending intangibles
Ending intangibles
Less: Expected ending intangibles
Equals: Change in intangibles
32 Combine lines 29, 30, and 31.
33 Combine lines 28 and 32. The result is financing surplus (requirement).

44 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Direct Cash Flow Construction Page 3

Target 8: Financing surplus (requirement) + Total external financing

Line: 34 Record the change in short-term debt.
35 Record the change in long-term debt, calculated as follows:
Ending long-term debt
Plus: Ending CPLTD
Less: Beginning long-term debt (long-term portion only)
Equals: Change in long-term debt
Note: The CPLTD for the beginning period was already accounted for on line 27.
36 Record the change in preferred stock.
37 Record the change in common stock.
Note: Calculate only changes to equity accounts other than retained earnings. The change in
retained earnings is automatically accounted for in the cash flow construction.
38 Combine lines 34, 35, 36, and 37. The result is total external financing.
39 Combine lines 33 and 38. The result is the calculated change in cash.
Proof: To prove the accuracy of your calculations
Line: 40 Record the actual change in cash between the beginning and ending balance sheets. Your
calculations are accurate if the amounts on lines 39 and 40 are the same.
Note: Accuracy in a manual cash flow is secondary to identification of key variables influencing
cash flow and analysis of the “Why?” behind the numbers.

© Omega Performance Corporation. All rights reserved. Job Aids 45

46 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Cash Flow Summary Tips

Getting started
Be sure to use the income statement and balance sheets (beginning and ending) for the same
period of time.
• If statements are company-prepared, be sure the balance sheet balances and the income
statement has been totaled properly.
• Begin with line 1 of the cash flow summary and work down to line 2, then line 3, and so on,
analyzing as you go.
• Place a check mark (√) on the balance sheet and income statement next to each account as
you use it on the cash flow summary. Circle any noncash items that you have deducted from
COGS or SG&A.
Recording income statement information
Lines of the cash flow summary in boldface type call for information from the income statement.
• Record revenues, sources of cash flow, as positive numbers.
• Record expenses, uses of cash flow, as negative numbers, in parentheses ( ).
Recording balance sheet information
• Lines of the cash flow summary that include the Δ symbol (change in) call for information
calculated from the balance sheets for the beginning and end of the period of the cash flow.
• Calculate changes in balance sheet accounts using the following formula:
Ending balance
Less: Beginning balance
Equals: Change in (Δ) the account
• Classify changes as sources or uses of cash according to the following rules and table:
- Record an increase in an asset or a decrease in a liability in ( ) as a use of cash.
- Record a decrease in an asset or an increase in a liability as a source of cash.
+ –
A (U) S
L/E S (U)

• Line 27 calls for the CPLTD from the beginning balance sheet (or a prorated amount if the
cash flow is for an interim period).
Troubleshooting
If lines 39 and 40 are unequal, be sure you have:
• Accounted for (placed a check [√] beside) all income statement and balance sheet accounts.
• Transferred figures properly from the income statement to the cash flow summary, and
enclosed all expense items in ( ).
• Calculated the amount of each source or use correctly, and enclosed each use in ( ).
• Used the net, not gross, amounts to calculate the change in such accounts as accounts
receivable and long-term assets.
• Checked your addition and subtraction for each target.
• Checked your calculation of the change in other accounts (line 15) by following these steps:
- For each category of other accounts (current and noncurrent assets and liabilities),
calculate the change and classify each result as a source or a use of cash.
- Combine the sources and uses. For example, an increase in other current assets is a use
of cash; a decrease in other noncurrent liabilities is also a use of cash.

© Omega Performance Corporation. All rights reserved. Job Aids 47

48 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Targeted Cash Flow Analysis

• How has cash collected from sales been affected by:

¾ Change in average daily sales?
1 Cash Collected from Sales ¾ Change in accounts receivable DOH?
(line 3) • What industry and business conditions and management action or
inaction influenced those changes?
• What are the implications for future cash flow?

• How has cash from trading activities been affected by:

¾ Change in average daily cash COGS?
¾ Change in inventory DOH?
2 Cash from Trading Activities ¾ Change in accounts payable DOH?
(line 8) • What industry and business conditions and management action or
inaction influenced those changes?
• What are the implications for future cash flow?

• How has cash after operations been affected by:

¾ Change in required working investment?
3 Cash after Operations ¾ Change in cash expenses for SG&A?
(line 13) • What industry and business conditions and management action or
inaction influenced the change in cash SG&A expenses?
• What are the implications for future cash flow?

• Has the company been able to meet all the cash requirements of its
4 Net Cash after Operations operating cycle and pay income taxes with internally generated cash?
(line 20) • If so (line 20 positive), how?
• If not (line 20 negative), why not?

• Has the company been able to pay interest expense with internally
generated cash?
5 Cash after Financing Costs • If yes (line 26 positive), is the cash after financing costs sufficient to pay
(line 26) existing and proposed principal debt service?
• If no (line 26 negative), will loan proceeds be used to pay interest?

• Has the company been able to meet both interest and principal debt
service with internally generated cash?
6 Cash after Debt Amortization • If yes (line 28 positive), is all debt fully amortized, and is CADA sufficient
(line 28) to make needed capital investments?
• If no (line 28 negative), how can debts be restructured or reduced?

• If negative, what is the company's total need for external cash?

7 Financing Surplus • If positive, were long-term investments sufficient to maintain capacity and
(Requirement) (line 33) capability, and what cash flow is available to make further reductions in
short- or long-term debt or to reduce equity?

8 Financing Surplus • How has the company financed its need for external cash?
(Requirement) + Total External
• Is the structure of new financing appropriate?
Financing (line 39)

© Omega Performance Corporation. All rights reserved. Job Aids 49

50 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: GAAP Statement of Cash Flows Page 1
Features
• Categorizes activities as operating, investing, or financing
• Reconciles cash flow to the actual change in cash and equivalents
• Operating activities may be direct or indirect:
¾ Direct: Begins with sales, subtracts noncash revenue items, adjusts for changes in certain balance
sheet accounts, especially current assets and current liabilities
¾ Indirect: Begins with net income, adds noncash expenses, adjusts for changes in certain balance
sheet accounts, especially current assets and current liabilities
• If indirect, includes cash payments of interest, income taxes, and leases in memo items

Financing need or repayment capacity

Is cash flow sufficient without additional debt or equity or reducing cash?
• Net cash provided by (used in) operating activities
• Plus: Net cash provided by (used in) investing activities
• Equals: (Financing need) or debt reduction capacity

Layers Two and Three analyses

OPERATING Related cash flow summary targets: 1, 2, 3, and 4
ACTIVITIES Critical management areas: Sales, operating cycle, expenses

• Is net cash provided by operating activities positive and greater than CPLTD?
• If yes, the company is more likely to pay CPLTD without additional borrowing, unless
fixed-asset expenditures exceed depreciation expense or dividends are significant.
• If no, the company cannot pay CPLTD without additional borrowing, new equity, or
sale of assets. Which components had a material effect on cash flow?
• If net profit:
¾ Can management maintain or improve the trend?
¾ How has management controlled expenses and profit margins?
¾ Was other income (expense) material, and is it repeatable?
• If change in accounts receivable or inventory:
¾ Was change due to change in average daily sales or cash COGS?
¾ Was change due to change in ARDOH or inventory DOH?
• If change in accounts payable:
¾ Was change due to change in average daily cash COGS, driven by sales?
¾ Was change due to change in APDOH?
• What industry conditions, business strategies, or management decisions influenced
the changes in sales, turnover, or profitability?
• Are significant changes repeatable?
• What are the implications for future cash flow from operating activities

© Omega Performance Corporation. All rights reserved. Job Aids 51

 Job Aid: GAAP Statement of Cash Flows Page 2

Layers Two and Three analyses

INVESTING
Related cash flow summary targets: Within target 7, lines 29-32
ACTIVITIES
Critical management areas: Capital investment cycle

How does net cash provided by (used in) investing activities compare to net profit plus
depreciation?
• If net cash used in investing activities is less than net profit plus depreciation, the
company has less need to borrow.
• If net cash used in investing activities is more than net profit plus depreciation, the
company has more need to borrow.
If net cash from investing activities is positive, are sales declining, or is the company
deferring important expenditures?

FINANCING
Related cash flow summary targets: Within target 5, lines 23, 24; all of target 6; and
ACTIVITIES
within target 8, lines 34-38
Critical management areas: Cumulative effects of all

• How did the company apply cash provided by operating and investing activities?
• How did the company raise cash externally to supply cash used in operating and
investing activities?
• Is the long- or short-term structure of liabilities appropriate to the borrowing causes?
• What are the implications for future cash flow, including interest expense, required
principal payments, and dividends?

52 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Financial Drivers of Cash Flow Page 1
Change in sales
STEP CALCULATION ANALYTICAL INSIGHTS
A. Measure sales and cash Current period’s sales • The total cash impact of sales
COGS growth (or decline) Less: Prior period’s sales and cash COGS growth (or
1. Calculate the % Divided by: Prior period’s sales decline) is cash flow absorbed
increase or decrease (used) in or released (provided)
Equals: % change (up or down)
in sales from one from the operating cycle as a
in sales
period to the next result of the change in sales
and cash cost of goods sold.
2. Calculate the % Current period’s cash COGS
increase or decrease in • It includes the amounts by
Less: Prior period’s cash COGS which A/R and inventory would
cash COGS from one Divided by: Prior period’s cash
period to the next have increased (a cash use) or
COGS decreased (a cash source), and
Equals: % change (up or down) the amount by which accounts
in cash COGS payable would have increased
(a cash source) or decreased (a
B. Measure the impact on: Beginning accounts receivable cash use) due only to the
1. Accounts receivable Times: % change in sales change in sales and cash COGS.
Equals: Change in A/R due to • If A/R, inventory, or A/P
change in sales changed by more or less than
this amount, the remainder of
2. Inventory Beginning inventory the change (and the cash flow)
Times: % change in cash COGS can be due only to a change in
Equals: Change in inventory turnover.
due to change in cash COGS

3. Accounts payable Beginning accounts payable

Times: % change in cash COGS
Equals: Change in A/P due to
change in cash COGS

C. Measure the combined Change in A/R due to change

impact of sales and cash in sales
COGS growth (or decline) Plus: Change in inventory due
on working investment to change in cash COGS
Plus: Change in A/P due to
change in cash COGS
Equals: Total impact of sales
and cash COGS growth (or
decline)
Increases in accounts
receivable or inventory are
uses of cash.
An increase in accounts
payable is a source of cash.

© Omega Performance Corporation. All rights reserved. Job Aids 53

 Job Aid: Financial Drivers of Cash Flow Page 2
Changes in turnover
STEP CALCULATION ANALYTICAL INSIGHTS
A. Measure turnovers and
change in days
1. Change in ARDOH Beginning A/R Ending A/R
Divided by: Sales first Divided by: Sales second
(prior) year year
Times: 365 Times: 365
Equals: Beginning ARDOH Equals: Ending ARDOH
Ending ARDOH
Less: Beginning ARDOH
Equals: Change in ARDOH
2. Change in INVDOH Beginning inventory Ending inventory
Divided by: Cash COGS Divided by: Cash COGS
(prior) year (second) year
Times: 365 Times: 365
Equals: Beginning INVDOH Equals: Ending INVDOH
Ending INVDOH
Less: Beginning INVDOH
Equals: Change in INVDOH
3. Change in APDOH Beginning A/P Ending A/P
Divided by: Cash COGS Divided by: Cash COGS
(prior) year (second) year
Times: 365 Times: 365
Equals: Beginning APDOH Equals: Ending APDOH
Ending APDOH
Less: Beginning APDOH
Equals: Change in APDOH
B. Measure the cash • One day of sales is the
impact of one day amount of cash required for
1. Calculate the Annual sales each day in the collection
amount of one day Divided by: 365 period.
of sales Equals: Average daily sales • One day of cash COGS is
2. Calculate the the amount of cash
Annual cash COGS
amount of one day required for each day in the
Divided by: 365 holding period.
of cash COGS Equals: Average daily cash COGS • One day of cash COGS is
C. Measure the cash the amount of cash
impact of the changes provided by each day in the
in turnover payment period.
1. ARDOH Change in ARDOH
Times: Average daily sales
Equals: Cash impact of change in ARDOH
2. INVDOH Change in INVDOH
Times: Average daily cash COGS
Equals: Cash impact of change in INVDOH
3. APDOH Change in APDOH • Cash flow impact of
Times: Average daily cash COGS borrower’s management of
Equals: Cash impact of change in APDOH turnovers is independent of
the cash flow impact a
Measure total cash Cash impact of change in ARDOH change in sales has on the
impact of changes in Plus: Cash impact of change in INVDOH same accounts: accounts
turnover Plus: Cash impact of change in APDOH receivable, inventory, and
Equals: Total cash impact of changes in turnover accounts payable.

54 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Financial Drivers of Cash Flow Page 3
Change in margins
STEP CALCULATION ANALYTICAL INSIGHTS
A. Measure the change
in margins
1. Calculate the Δ Cash COGS for first (prior) period Reduce cash COGS as % of
cash COGS as a Divided by: Sales for the same (first) period sales → Improve gross
% of sales Equals: Cash COGS as % of sales, first period profit margin → Increase
Cash COGS for second period cash flow
Divided by: Sales for the same (second) period Reduce cash SG&A as % of
sales → Improve operating
Equals: Cash COGS as % of sales, second period
profit margin → Increase
Cash COGS as % of sales, second period cash flow
Less: Cash COGS as % of sales, first period
Equals: Δ cash COGS as % of sales
2. Calculate the Δ Cash SG&A for first (prior) period
cash SG&A as a Divided by: Sales for the same (first) period
% of sales Equals: Cash SG&A as % of sales, first period
Cash SG&A for second period
Divided by: Sales for the same (second) period
Equals: Cash SG&A as % of sales, second period
Cash SG&A as % of sales, second period
Less: Cash SG&A as % of sales, first period
Equals: Δ cash SG&A as % of sales
B. Measure the $ cash
impacts
1. Calculate $ cash Δ cash COGS as a % of sales • This cash flow is
impact of Δ cash Times: Sales for the second period independent of any
COGS as % of change in total dollars
Equals: $ impact of Δ cash COGS as a % of sales of expense that are the
sales
result of a change in
2. Calculate $ cash Δ cash SG&A as a % of sales the amount of sales.
impact of Δ cash Times: Sales for the second period • This isolation of the
SG&A as % of
Equals: $ impact of Δ cash SG&A as a % of sales cash impact of the
sales change in margins
3. Calculate $ impact of Δ cash COGS as a % of sales allows the lender to
combined impact focus on the
Plus: $ impact of Δ cash SG&A as a % of sales
of Δ cash COGS importance of expense
Equals: Combined impact of Δ cash COGS as % of management to the
as a % of sales
sales and cash SG&A as a % of sales borrower’s cash flow.
and changes in
cash SG&A as a
% of sales

© Omega Performance Corporation. All rights reserved. Job Aids 55

 Job Aid: Financial Drivers of Cash Flow Page 4
Investment in long-term assets
STEP CALCULATION ANALYTICAL INSIGHTS
A. Measure the amount spent Beginning net long-term
to acquire long-term assets assets
Less: Depreciation and
amortization expense for the
period
Equals: Expected ending net
long-term assets
Actual Ending net long-term
assets
Less: Expected ending net
long-term assets
Equals: Amount spent to
acquire long-term assets
B. Calculate indicators of the When the amount spent is
reason for spending greater than the depreciation
and amortization expense:
1. Compare the amount Amount spent to acquire long-
term assets • Internally generated cash
spent to the annual
flow is less likely to be
depreciation and Less: Depreciation and
sufficient to meet other
amortization expense amortization expense for the
cash needs
same period
• Company is more likely to
Equals: Difference between
need to borrow
amount spent and
depreciation and amortization When the ratio is increasing,
expense the company may:
• Be using its long-term
2. Calculate the ratio of Sales assets more efficiently, or
sales to net long-term Divided by: Ending net long- • Soon need to use cash
assets term assets flow to expand productive
Equals: Ratio of sales to net capacity, or
long-term assets • Both
The greater the accumulated
Accumulated depreciation and depreciation and amortization
3. Calculate the % of
amortization as % of gross book value of
original costs that have
long-term assets, the more
been expensed Divided by: Gross long-term likely:
assets
• Assets may show signs of
Equals: % of original costs that aging
have been expensed
• Expenses for maintenance
and repair may increase
• Borrower may suffer from
obsolescence and other
inefficiencies
• Cash flow may be required
to replace existing
productive capacity

56 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Four Critical Management Areas
Sales
• How have economic and industry conditions, trends, or events influenced the level of
or change in sales?
• What has the company's management done or not done to influence sales, and how
effective has that action been?
• How has a change in sales affected profitability, asset structure, and leverage?
• What are the implications for the future?

Operating cycle
• How have economic and industry conditions or events influenced the level of accounts
receivable and inventory?
• How have economic and industry conditions influenced the level of spontaneous
financing from accounts payable and accruals?
• What has the company's management done or not done to influence the level of
needed working investment, and how effective has that action been?
• How has management financed working investment, and does the financing seem
appropriate?
• How has a change in needed working investment affected the company’s profitability
and leverage?
• What are the implications for the future?

Expenses
• How have economic and industry conditions and events influenced production, SG&A,
interest, and income tax expenses?
• What has the company’s management done or not done to influence and control
expenses, and how successful have those actions been?
• How has a change in expenses affected the company’s asset turnover and leverage?
• What are the implications for the future?

Capital investment cycle

• How have economic and industry conditions affected the need for plant, equipment,
and other long-term assets?
• How well has the company’s management planned and directed investments for
adequate capacity and capability?
• How has management financed the capital investments, and does the financing seem
appropriate?
• How have capital investments affected profitability and leverage?
• What are the implications for the future?

© Omega Performance Corporation. All rights reserved. Job Aids 57

58 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Making Your Decision

Are the major risks you have identified critical to successful

performance and loan repayment?
Is management responding effectively to the risks?
How quickly could conditions change, requiring a new response?
Consolidate the analysis
What could be the impact of changes and risks on the company’s ability
to repay?
Can you set up an early warning system to help you spot changes that
might adversely affect repayment?

Proceed to
NO loan Do you have enough confidence in management’s ability and the
structuring? company’s situation to justify investing time in structuring a loan?

YES What terms and conditions are needed to protect the institution and
Develop loan structure satisfy the customer?
proposal Facility—timing of disbursements and repayments
Conditions–restrictions or requirements placed on borrower
Support—assets pledged to the institution (secondary repayment
source)
Negotiate with customer
Pricing—fees, rate
What documentation will be needed to summarize the agreement and
protect all parties?

Does the loan

NO meet the needs Does it meet the customer’s needs?
of the lending Does it protect your institution?
institution and Is this loan acceptable to your institution’s management?
customer?

YES

Complete the loan:

Reject Documentation
loan Final negotiation
with customer

© Omega Performance Corporation. All rights reserved. Job Aids 59

60 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Credit Facilities

Borrowing Disburse-
Credit Facility Amount Maturity Examples
Frequency ment

Short-term needs
Short-term loan One-time or Face value of One-time for the Specific, pre-set • Single
occasional note full amount maturity date of payment
one year or less loan
• 90-day note
• Demand
note
• Bridge loan
Uncommitted Seasonal or Various amounts Restricted to Payment is due • Unadvised or
line of credit periodic up to the line one draw or may on demand guidance line
limit permit
borrowing, • Foreign
repayment, and exchange lines
re-borrowing are often
uncommitted
Committed line Seasonal or Various amounts Permits Outstanding • Advised or
of credit periodic up to the line borrowing, amounts due on confirmed line
limit; some sub- repayment, and maturity date,
• Accounts
limits may apply re-borrowing usually 364
receivable or
days; may or
inventory line
may not require
annual cleanup

Long-term needs
Revolving credit Seasonal or Various amounts Permits Outstanding • Accounts
periodic up to the line borrowing, amounts due on receivable or
limit; some sub- repayment, and maturity date, inventory
limits may apply re-borrowing more than one financing with
year from borrowing
effective date base formula
• Reducing
revolver
• Revolver
converting to
term loan
Term loan One-time or Face value of One-time for the Specific maturity • Amortizing
occasional note or full amount or with set term loan
increasing in periodically, as repayment
• Mortgage loan
increments up needed during schedule, longer
to the face value agreed draw- than one year • Bridge or
of the note or down bullet loan
commitment • Standby term
loan

© Omega Performance Corporation. All rights reserved. Job Aids 61

62 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Selecting the Best Facility

Purpose?
Borrowing cause?
Repayment source?

Short-term need Long-term need

Purpose: Short-term benefit Purpose: Long-term benefit
Borrowing cause: Temporary Borrowing cause: Long-term sales
timing difference growth, purchase long-term assets or
Repayment source: Cash other investments, replace equity
flow from conversion of Repayment source: Cash flow from
assets, Type B cash flow operations, Type A cash flow

Borrowing Disbursement
frequency? period?
Fluctuation of
need?

One-time or Periodic or
occasional seasonal Long disbursement One-time or short
period disbursement period
Fluctuation of need Constant need

Credit
quality Cash
flow sufficient to
amortize loan?
Benefit of term loan
Satisfactory, Strong, justifies cost?
but less than stable No
strong and growing

Yes

Uncommitted Committed Revolving

Short-term Term Loan
Line of Line of Credit
Loan
Credit Credit

© Omega Performance Corporation. All rights reserved. Job Aids 63

64 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Types of Loan Support

When to Other
Type of Support Definition Value
Take/Use Characteristics

Collateral An asset in which • Provides lender • Primary Take most liquid,

the lender institution with control over a repayment source, marketable, highest
takes a security repayment source whenever possible quality assets
interest (entitles it to available
• Less than
cash derived from
excellent credit
the sale of the
risk
asset)
• New borrowers

Guaranty Agreement of a third • Provides lender • Partnerships Follow law (Equal

party to repay loan if with an alternative (general partners) Credit Opportunity
borrower defaults repayment source Act)
• Closely held
• Psychological corporations
reminder of (officers, principal
personal stockholders)
responsibility • Subsidiary
• Removes limited corporation
liability of (parent company)
corporation’s • New business
owners (owner, SBA)

Subordination Another creditor • “Safeguards” • Leveraged May have total or

takes a secondary repayment source companies partial subordination
position to the loan of all principal and
• Gives lender • Substantial notes
interest payments
seniority in payable to officers
liquidation or owners shown
on the statements

Support is not a substitute for creditworthiness.

Taking support does not ensure repayment.

© Omega Performance Corporation. All rights reserved. Job Aids 65

66 Reference Guide © Omega Performance Corporation. All rights reserved.
 Job Aid: Loan Covenants Page 1

Preserve Maintain Maintain Maintain Ensure

Control Full
Asset Cash Net Mgmt. Continued
Affirmative Covenants Quality Flow
Growth Disclosure
Quality Existence
Worth

Casualty insurance:
A casualty insurance policy on all borrower assets
protects the bank against damage or destruction. X X X X
Bank should be named as the beneficiary (loss
payee) on the policy, in an amount at least equal to
the loan balance.

Life insurance:
Owners, as well as key mangers and employees of
the borrower, can be covered by life insurance.
Depending on the situation, you may take an X X X X
assignment of the policy or be named as loss payee.
The amount of the insurance should be at least
equal to the bank’s exposure under the loan terms.

Liens:
The company agrees to comply with all applicable
laws and pay all obligations that, if unpaid, might X X
result in a lien (another claim on the borrower’s
assets resulting from nonperformance or
nonpayment).

Financial statements:
The borrower agrees to submit financial statements
to the bank within a certain period following the end
of a financial reporting period (month, quarter, year). X
You should state whether statements must be
audited and describe the scope and level of detail to
be covered in the statements.

Accounting procedures:
The borrower agrees to maintain substantially the
same procedures as it uses at the time the decision X
to lend is made, If changes are required, you should
require advance notification in writing explaining the
change and the reasons for the change.

Inspection:
The borrower agrees to permit persons designated X X X
by the bank to inspect the financial records and
assets.

Contingent liabilities:
The borrower agrees to tell the bank about any
litigation (actual or likely) or changes in existing X X X X X
conditions that might affect the business
significantly.

Fixed assets:
The borrower agrees to maintain the plant in good X X X
repair.

© Omega Performance Corporation. All rights reserved. Job Aids 67

 Job Aid: Loan Covenants Page 2

Preserve Maintain Maintain Maintain Ensure

Control Full
Asset Cash Net Mgmt. Continued
Affirmative Covenants (continued) Quality Flow
Growth Disclosure
Quality Existence
Worth

Financial ratios:
The company agrees to maintain certain minimum
or maximum levels for various ratios. These are
triggers; if the borrower fails to comply, company
performance is outside the expected range.
Frequently used ratios are:
Current ratio—minimum X
Quick ratio—minimum X X
Sales/assets—minimum X X
Profits/assets—minimum X X
Return on equity or profits/tangible net worth—
minimum X
Debt/cash flow—maximum X X
Debt/equity—maximum X X
ARDOH—maximum X X
INVDOH—maximum X X
APDOH—maximum X X
Times interest earned—minimum X X
Fixed charge coverage—minimum X X
Working capital:
The borrower agrees to maintain a minimum dollar X X X
amount of working capital during the course of the
loan based on the projections of future performance.

Net worth:
The borrower agrees to maintain a certain minimum
level of net worth. This amount may increase for X X X X
each year of the loan to correspond to the projected
net worth levels.

Negative Covenants

Additional loans:
Places an upper limit on additional borrowing in
terms of a dollar amount or a ratio. Limit should X X X
permit normal operations and other expected and
acceptable needs.

Sale of assets:
Limits the borrower’s ability to sell assets to a
maximum dollar amount. (The exception to this is X X X X
assets sold in the normal course of the company’s
business—inventory, for example.)

68 Reference Guide © Omega Performance Corporation. All rights reserved.

 Job Aid: Loan Covenants Page 3

Preserve Maintain Maintain Maintain Ensure

Control Full
Asset Cash Net Mgmt. Continued
Negative Covenants (continued) Growth Disclosure
Quality Existence
Quality Flow Worth

Capital expenditures:
Places a limit on expenditures for expansion of fixed
assets to some amount in excess of annual X X
depreciation expense. You can either use a dollar
figure or limit asset growth to a certain percentage
increase each year

Lease payments:
Puts an upper limit on monthly or annual lease X X
payments.

Investments:
Prohibits the company from making short-term X X
investments in anything other than U.S. government
obligations.

Loans:
Prohibits or severely limits loans to parties other X X
than officers of the company and subsidiaries.

Change of business:
Prohibits the borrower from engaging in any X X X X
business other than that in which it is operating at
the time of the loan.

Mergers or sales:
Prohibits the borrower from merging with or
acquiring another company or entity. May also X X X X X
prohibit the borrower from being acquired by
another company.

Change in management:
Prohibits any change in management or ownership
that would significantly change the business
philosophy of the company or the mix and extent of X X X X X X X
management skills, particularly if the company
depends heavily on one or more key managers for
its success.

Dividends:
Limits payment of dividends to some percentage of
net income earned after the date of the loan X X
agreement. The percentage should be based on net
income less all debt principal and interest payments
to be made in the next year.

Officers’ salaries:
In small companies, limits salaries or other forms of
compensation paid to officers of the company to X X
prohibit the officers from milking the company with
excessive compensation.

© Omega Performance Corporation. All rights reserved. Job Aids 69

70 Reference Guide © Omega Performance Corporation. All rights reserved.
 Worksheets

© Omega Performance Corporation. All rights reserved. Job Aids 71

72 Reference Guide © Omega Performance Corporation. All rights reserved.
 Borrowing Cause Worksheet
Company Name:
Possible Borrowing Cause and Formula Year 1: Year 2: Year 3:

1. Long-term sales growth

[(Year 2 – Year 1) ÷ Year 1] x 100 % %

2. Short-term sales growth

Month in which most sales occur

3. Changes in working investment

Accounts receivable (net)
+ Inventory + + +
– Accounts payable – – –
– Accrued expenses – – –
= Working investment = = =

Change in working investment from previous year $ $ $

4. Inventory slowdown: Inventory DOH

(Inventory ÷ Cost of goods sold) x 365

5. Accounts receivable slowdown: Accounts receivable DOH

(Net accounts receivable ÷ Net sales) x 365

6. Fixed-asset replacement
(Accumulated depreciation ÷
Gross depreciable fixed assets) x 100 % % %

Net depreciable fixed assets ÷ Depreciation expense

7. Expansion of fixed assets

Net sales ÷ Net fixed assets

8.Outlays for other asset growth (look at such items as

investments, other assets, and any large or growing
unexplained item)
Account balance of asset ÷ Total assets

9. Restructuring liabilities: Accounts payable DOH

(Accounts payable ÷ Cost of goods sold) x 365

10. Unprofitable operations

(Net profit after taxes ÷ Net sales) x 100 % % %

11. Outlays for dividends

(Cash dividends ÷ Net profit after taxes) x 100 % % %

12.One-time expenses (look on income statement for losses

and large or unusual expenses) $ $ $

© Omega Performance Corporation. All rights reserved. Job Aids 73

74 Reference Guide © Omega Performance Corporation. All rights reserved.
 Risk Assessment Worksheet

Industry Characteristics Business Characteristics and Relevant Future Scenarios and

Strategy Assumptions
• Cost Structure • General • Economic
• Profitability • Product−Market Match • Industry
• Maturity • Supply • Strategic
• Technology • Production • Management Control, Action,
• Cyclicality • Distribution and Reaction
• Dependence • Sales • Financial Performance
• Globalization • Management Hypotheses
• Vulnerability to Substitutes • Overall Strategy • Most Likely:
• Regulatory Environment − Downside
• Operations − Sensitivity
Which characteristics have and will For each significant characteristic in How should the impact of this
most significantly affect all column 1, what is this company’s characteristic and strategic response
companies in this industry? business strategy for mitigating risk (or lack of response) be anticipated in
or capitalizing on opportunity? scenarios of future performance?

Characteristic: Business Strategy: Future Impact:

Characteristic: Business Strategy: Future Impact:

Characteristic: Business Strategy: Future Impact:

Characteristic: Business Strategy: Future Impact:

© Omega Performance Corporation. All rights reserved. Job Aids 75

 Risk Assessment Worksheet Page 2

Strategy for competitive advantage:

Characteristics and goals:

Management analysis:

Product–Market Match
Risks and strategies Future Impact

Supply and Production

Risks and strategies Future Impact

Distribution and Sales

Risks and strategies Future Impact

76 Reference Guide © Omega Performance Corporation. All rights reserved.

 + -
Quick Cash Flow (in $000s) WI (U) S
Company Name: GFA (U) S
Year 1 Year 2 Year 3

Net profit
Plus: Depreciation, amortization expense
Plus (or less): U Working investment
Equals: Cash after operating cycle

Plus (or less): U Gross long-term assets

Equals: Cash after capital investment cycle

Less: Dividends declared

Equals: Cash available for all debt repayment

Less: Current portion long-term debt (prior year)

Equals: Cash available for other debt repayment

Change in working investment BEGINNING ENDING

Accounts receivable (net)
Plus: Inventory
Less: Accounts payable
Less: Accrued expenses
Equals: Working investment

Beginning working investment

Less: Ending working investment
Equals: U Working investment Year 1

Change in working investment BEGINNING ENDING

Accounts receivable (net)
Plus: Inventory
Less: Accounts payable
Less: Accrued expenses
Equals: Working investment

Beginning working investment

Less: Ending working investment
Equals: U Working investment Year 2

Change in working investment BEGINNING ENDING

Accounts receivable (net)
Plus: Inventory
Less: Accounts payable
Less: Accrued expenses
Equals: Working investment

Beginning working investment

Less: Ending working investment
Equals: U Working investment Year 3

Are any changes in income taxes payable, interest payable, prepaid expenses, investments, or
miscellaneous other accounts large enough to distort quick cash flow?

© Omega Performance Corporation. All rights reserved. Job Aids 77

78 Reference Guide © Omega Performance Corporation. All rights reserved.
 + -
Cash Flow Summary (in $000s) A (U) S
Company Name: L/E S (U)

Line Number Year 1 Year 2 Year 3

Sales revenue (net) (1)
U Accounts receivable (2)
1 Cash collected from sales (3)

Cash cost of goods sold (4)

U Inventory (5)
U Accounts payable (6)
Cash paid for production (7)
2 Cash from trading activities (3) + (7) = (8)

Cash SG&A expense (9)

U Prepaid expenses (10)
U Accrued expenses (11)
Cash paid for operating costs (12)
3 Cash after operations (8) + (12) = (13)

Other income (expense) (14)

U Other current and noncurrent accounts (15)
Income tax expense (16)
U Deferred income taxes (17)
U Income taxes payable (18)
Taxes paid and other income (expense) (19)
4 Net cash after operations (13) + (19) = (20)

Interest expense (21)

U Interest payable (22)
Dividends declared or owners’ withdrawals (23)
U Dividends payable (24)
Cash paid for dividends and interest (25)
5 Cash after financing costs (20) + (25) = (26)

Current portion long-term debt (prior year) (27)

6 Cash after debt amortization (26) + (27) = (28)

U Long-term assets (29)

U Investments (30)
U Intangibles (31)
Cash paid for plant and investments (32)
7 Financing surplus (requirement) (28) + (32) = (33)

U Short-term debt (notes payable) (34)

U Long-term debt (35)
U Preferred stock (36)
U Common stock (37)
Total external financing (38)
Financing surplus (requirement) +
8 Total external financing (33) + (38) = (39)

PROOF: U Cash and marketable securities (40)

© Omega Performance Corporation. All rights reserved. Job Aids 79

80 Reference Guide © Omega Performance Corporation. All rights reserved.
 Financial Drivers Worksheet Borrower: ( ) = use
of cash

Cash Impact of Change in Sales ($000’s) Year 1 Year 2 Year 3

Sales
Sales change %
Times: Beginning A/R
Equals: Impact on A/R

Cash COGS
Cash COGS change %
Times: Beginning inventory
Equals: Impact on inventory

Cash COGS change %

Times: Beginning A/P
Equals: Impact on A/P

TOTAL OPERATING CYCLE IMPACT OF CHANGE IN SALES

Cash Impact of Change in Turnovers Year 1 Year 2 Year 3

Average daily sales
Times: Change in ARDOH
Equals: Cash impact of change in ARDOH

Average daily cash COGS

Times: Change in INVDOH
Equals: Cash impact of change in INVDOH

Average daily cash COGS

Times: Change in APDOH
Equals: Cash impact of change in APDOH

TOTAL IMPACT OF CHANGE IN TURNOVERS

Cash Impact of Change in Margins Year 1 Year 2 Year 3

Cash COGS as % sales in prior year
Cash COGS as % sales in this year
Change in cash COGS as % sales
Times: Sales this year
Equals: Cash impact of change in
cash COGS as % sales

Cash SG&A
Cash SG&A as % sales in prior year
Cash SG&A as % sales in this year
Change in cash SG&A as % sales
Times: Sales this year
Equals: Cash impact of change in
cash SG&A as % sales

TOTAL IMPACT OF CHANGE IN MARGINS

Cash Impact of Change in Fixed Assets Year 1 Year 2 Year 3

Beginning net fixed assets
Less: Depreciation expense for this year
Equals: Expected ending net fixed assets

Actual ending net fixed assets

Less: Expected ending net fixed assets
Equals: Cash impact of change in fixed assets

TOTAL IMPACT OF CHANGE IN FIXED ASSETS

© Omega Performance Corporation. All rights reserved. Job Aids 81

82 Reference Guide © Omega Performance Corporation. All rights reserved.
 Projection Hypotheses
Company name:

Account Year 1 Year 2 Year 3

1. Sales
2. Cash cost of goods sold
Other:
3. Cash SG&A expenses
Other: Depreciation and amortization
Other:
Other:
4. Cash balance
5. Accounts receivable DOH
6. Inventory DOH
Other:
7. Other current assets and prepaids
8. Net fixed assets
Net investments
Net intangibles
9. Other noncurrent assets
10. Notes payable or line of credit
New short-term debt
11. CPLTD (existing debt)
CPLTD (new debt)
12. Accounts payable DOH
13. Accrued expenses
14. Other current liabilities
15. Existing long-term debt
New long-term debt
16. Other noncurrent liabilities
17. Capital stock
18. Average interest rate
19. Income tax rate
20. Dividends or payout ratio

© Omega Performance Corporation. All rights reserved. Job Aids 83

84 Reference Guide © Omega Performance Corporation. All rights reserved.