As a commercial loan officer you will see many different types of businesses. You will also meet many different types of business owners. The question is; why are they sitting across from you? What do they want or need?
Before I continue, let me introduce the concept of rate of return. The amount of money or percentage rate you make on an investment. For a business owner that might be the net income he or she makes on the amount of money they put into the business.
For example, let's say I start a Christmas Tree lot. I use my savings and buy $1,000 worth of trees. I sell the trees for say $1,400. I did have some expenses such as renting a small space on the corner to sell the trees. That
rent was $100; so my profit or net income was $300. My return was 30% on the $1,000 I invested. Most business owners want to make meaningful returns because they are taking meaningful risks with their money.
Let me change this example up a little bit: In this example I have $500 in savings to buy trees. I also have a commercial loan officer acquaintance that has offered to lend me $500 to buy trees. With the loan and my savings I can buy a total of $1,000 worth of trees. After I sell the trees, I will need to pay her back the $500 I borrowed plus $30 of interest (6% interest rate.) I still needed to rent the space for $100.
When you do the math on all of this I end up with $270 of profit. When you consider that in this scenario I only had to invest $500, my return goes up to 54%. This is a simplified example of rate of return for illustration purposes.
This concept of improving a return on a business investment by borrowing money from a bank (using leverage,) often puts business owners and bankers at odds. The business owner wants to borrow as much as possible and the banker wants to limit borrowing or leverage because that helps lower the risk for the banker. The business owner controls everything, and the banker needs to wait for the business owner to succeed in order to get their money back. A business owner’s return can increase with the use of leverage while a banker's return is set by the interest rate they charge.
One of the most important activities a commercial loan officer engages in is uncovering the real reason a business owner needs to borrow. It is not always a desire to increase their return.
In my next blog post I will introduce all of you to the business concept of “Working Capital”. I’ll cover why it is so important to business owners and bankers; and why working capital may be the reason that business owner is sitting across from you.
“Keep asking the question; Why?”