Microloan Readiness Series Profit and Loss Today’s Agenda: Financials’ Role in Lending ABCs of P&L Tools for P&L Analysis What a lender looks for

Understanding Financials Increase your ability to see what a lender wants Quality of your referrals affects your agency’s relationship with lenders Prep clients so that they have a good chance of succeeding – don’t want to discourage

What Can Financials Tell Us? Profitable Pricing to cover all costs Managing inventory well Sufficient equity in business Which products contribute most to the bottom line Can business finance its own growth or need financing If yes: how much, what type, does biz qualify And much more!

Which “financials”? Example levels of financial information required 1.Loans under $15,000: 2 months bank statements, one pay stub, one year tax returns 2.Loans between $15,000 - $50,000: 3 bank statements, 2 years tax return, one year P&L 3.Over $50,000: 4 bank statements, 3 years tax returns, 3 years P&L, 3 years Balance Sheets Each level requires increasing skills to create quality financials and to interpret for credit analysis.

Two Caveats QuickBooks P&L – high bar for start-up micro  Microlenders often just use bank statements, pay stubs, tax return  Smart phone apps for basic income and expense: Freshbooks, Wave, SageOne Takes more than one hour webinar  The how and what for creating a quality P&L  How to interpret for lending capacity as well as business decisions

What are lenders looking for? Accurate: Clean P&L with proper set up and consistent data input Business success: Growing sales, margins good for industry, smart expenditures… Net Profit and Cash Flow

Getting to Quality P&L Know proper QuickBooks set up* Know Profit & Loss and Balance Sheet rules/structure Data entry accurate and consistent Might need to create new QB company *Includes knowing what other reports owner needs for management

Common QB Mistakes Overlapping income/expense accounts Too many income/expense accounts Relationship between COGS and inventory Debt: entered as income; principle/interest not split Balance Sheet accounts on P&L Equity accounts don’t match legal structure

Profit and Loss The Profit and Loss Statement measures revenues and expenses over a period of time Measures profitability: whether the business is making a profit on what it sells

Profit and Loss Shows the ability to successfully manage the buying and selling process. Measures the ability to grow, support owner and repay debt service. Important report from accounting software program

Profit and Loss Structure Basic formula + Sales - Cost of Goods Sold = Gross Profit - Overhead = Net Profit

Sales Income = Sales = Revenue The revenue earned from the sale of goods and services.

Cost of Goods Sold Expenses incurred that are directly associated with the production or service delivery for sales in that period. Also called variable expense.

Cost of Goods Sold Manufacturing: Direct materials, direct labor, shipping Retail: Wholesale cost of inventory, shipping Service: Usually don't have COGS, but in some cases labor and other costs are directly associated with service delivery.

Gross Profit Gross Profit = Sales - COGS Demonstrates the ability to control direct production costs: Labor and materials Also indicates viability of pricing

Overhead Those expenses which do not vary directly with production. Also called fixed expenses. Everything except direct expenses. All expenses needed to run the business, keep the doors open, etc. Tailored to each business Don’t use QB suggested accounts without editing – keep total P&L to one page

Net Profit Net profit = Gross Profit - Overhead Pays for (sole proprietor) Owners Draw Future expansion Principal Loan Repayment Income Taxes

Bad Company Let’s look at a poorly structured P&L, typical of many microenterprises How many errors can you find? Could a lender proceed with this? How would you help this borrower get to clean P&L?

Key P&L Indicators Sales: Growing COGS: Stable / Falling Gross Profit: Rising Net Profit: Rising Cash available to pay new debt service beyond owner’s draw, taxes and existing debt

Covering Debt Service Global Cash assessment (Oct. 16 th ) Looking for 1.25 coverage for monthly loan payment

Trend Analysis Trend Analysis: Create spreadsheet to compare last 3 years to see trends Dollar Analysis: Measure progress by looking at total sales, expenses and net profit side by side in a spreadsheet

Margin Analysis Convert the P&L numbers into percentages of total sales for more complete analysis. COGS/Sales = COGS margin Overhead/Sales = Overhead margin Net Profit/Sales = Net Profit margin Again, each year, side by side in a spreadsheet

Trend & Margin Analysis Track productivity Analyze business management Set goals Bring more $ to bottom line Best way to test for debt service capacity for larger deals Ideally have three years of financials for trend and margin analysis

Good Sample P&L Let’s look at a accurate, well-structured P&L Let’s analyze at dollars, trends and margins to gauge business performance and “lendability”

Borrowing ‘Red Flags’ Use short-term financing or operating cash for long-term assets Don’t invest in such a way as to increase productivity, efficiency and profitability Use loan funds to compensate for low profitability - credit card

Discussion  Questions? Other perspectives to offer?  If you would like more in-depth training on financial statements and credit analysis, please contact me. Susan Brown,