Small business owners looking for a business loan from a bank will often be asked for a set of cash flow projections, but what exactly is the bank expecting to see in your projections?
There are 3 things that the bank wants to see in your forecast:
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Do your projections pass the “sniff test”?
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Are your projections in line with historic performance?
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Do you have some wiggle room?
Let’s dig into each of these a bit more.
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The Sniff Test – One of the first things a banker is going to look at when reviewing your financial projections is whether your projected gross profit margin and net profit margins seem to be within the realm of possibility. A good way for you to check whether your projections are realistic is by using a tool called BizStats. Using BizStats you can look up average margins for your industry. For example, for a restaurant or bar, the average gross profit margin is around 27% and the average net profit margin is around 6% according to BizStats data. If you are projecting 60% gross profit margins, the banker is going to know that your projections are unrealistic.
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Historic Performance – The next thing that a lender will look at is your historic performance. If you have historically sold $10,000 per month and now you are projection to sell $100,000 per month you better make sure that you can back that growth up with reasonable assumptions. Likewise, they will look at your historic gross profit margins and if those are very different from your projected margins that will raise red flags.
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Wiggle Room – Finally, the bank is going to test your projections to see how much wiggle room you have. For example, what happens if you lose your largest customer that represents 30% of sales. Can you still make your loan payment? What happens if your customers pay you late, do you have another source of cash flow to make your payments? They might look at things like Debt Service Coverage Ratio which is a banking term to determine whether you have some room for things to go wrong and still make your payments.
It all comes down to cash flow, do you have the cash flow to repay the loan, but these 3 tests should help you understand the mind of a banker when looking at your cash flow projections. Good luck! Now give ProjectionHub a try to create your cash flow projections.
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