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Lending to Business Firms
and Pricing Business Loans

Ayesha Afzal
AsslsLanL rofessor
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Short Term Business Loans
Self-Liquidating Inventory Loans
Working Capital Loans
Interim Construction Loans
Security Dealer Financing
Retailer and Equipment Financing
Asset-Based Financing
Syndicated Loans
17-2
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Long Term Business Loans
1erm Loans
8evolvlng CredlL Llnes
ro[ecL Loans
Loans Lo SupporL Acqulsluons of CLher 8uslness
llrms
Cuesuon: WhaL are Lhe essenual dlerences
beLween varlous shorL- and long-Lerm buslness
loans?
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Sources of Repayment for Business
Loans
The Borrowers Profits or Cash Flows
Business Assets Pledged as Collateral
Strong Balance Sheet With Ample
Marketable Assets and Net Worth
Guarantees Given By Businesses
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Analyzing Business Loan
Applications
Common Size Ratios of Customer Over
Time
Financial Ratio Analysis of Customers
Financial Statements
Current and Pro Forma Sources and
Uses of Funds Statement
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Financial Ratio Analysis
Control Over Expenses
Operating Efficiency
Marketability of Product or Service
Coverage Ratios: Measuring Adequacy
of Earnings
Liquidity Indicators for Business
Customers
Profitability Indicators
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Expense Control Measures
Cost of Goods Sold/Net Sales
Selling, Administrative and Other
Expenses/Net Sales
Depreciation Expenses/Net Sales
Interest Expenses on Borrowed Funds
/Net Sales
Taxes/Net Sales
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Operating Efficiency
Annual Costs of Goods Sold/Average
Inventory
Average Receivables Collection Period
Net Sales/Net Fixed Assets
Net Sales/Total Assets
Net Sales/Accounts Receivables
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Marketability of Product or Service
Gross Profit Margin=(Net Sales-CGS)/
Net Sales
Net Profit Margin=Net Income After
Taxes/Net Sales
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Coverage Measures
Interest Coverage
Coverage of Interest and Principal
Payments
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Liquidity Measures
Current Assets/Current Liabilities
Acid Test Ratio
Working Capital
Net Liquid Assets
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Profitability Measures
Before Tax Net Income/Total Assets
After Tax Net Income/Total Assets
Before Tax Net Income/Net Worth
After Tax Net Income/Net Worth
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Leverage or Capital Structure
Measures
Leverage Ratio
Total Liabilities/Net Worth
Capitalization Ratio
Debt to Sales Ratio
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Types of Contingent Liabilities
Guarantees or Warrantees Behind
Products
Litigation or Pending Lawsuits
Unfunded Pension Liabilities
Taxes Owed But Unpaid
Limiting Regulations
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Comprehensive Environmental
Response, Compensation and
Liability Act
This Law Makes Current and Past
Owners of Contaminated Property,
Current and Past Owners and Prior
Operators of Businesses Located on
Contaminated Property and Those Who
Transport Hazardous Substances
Potentially Liable
17-15
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1$.2$-&-3 $+ ($4%)&0 "-5 60&0 $+ 74-50
(3"3&.&-3
Cash Flows from Operations
Cash Flows from Investing Activities
Cash Flows from Financing Activities
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Traditional (Direct) Operating Cash
Flows
Net Sales Revenue Cost of Goods Sold
Selling, General and Administrative
Taxes Paid in Cash + Non Cash
Expenses
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Indirect Operating Cash Flows
Net Income + Non Cash Expenses +
Losses from the Sale of Assets Gains
from the Sale of Assets Increases in
Assets Associated with Operations +
Increases in Current Liabilities
Associated with Operations
Decreases in Current Liabilities
Associated with Operations +
Decreases in Current Assets
Associated with Operations
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Methods Used to Price Business
Loans
Cost-Plus Loan Pricing Method
Price Leadership Model
Below Prime Market Pricing
Customer Profitability Analysis
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Cost-Plus Loan Pricing
Loan
Interest
Rate
=
Marginal
Cost of
Raising
Loanable
Funds to
Lend to
Borrower
+
Nonfund
Bank
Operating
Costs
+
Estimated
Margin to
Compensate
Bank for
Default Risk
+
Bank's
Desired
Profit
Margin
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Price Leadership Model
Loan
Interest
Rate
=
Base or
Prime Rate
+
Default
Risk
Premium
for Non-
Prime
Borrowers
+
Term Risk
Premium for
Longer
Term Credit
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Prime Rate
Major Banks Established a Base
Lending Fee During the Great
Depression. At that Time It Was the
Lowest Interest Rate Charged Their
Most Credit Worthy Customers for
Short-Term Working Capital Loans
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LIBOR
The London Interbank Offer Rate. The
Rate Offered on Short-Term Eurodollar
Deposits With Maturities Ranging From
a Few Days to a Few Months
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Below-Prime Market Pricing
Loan
Interest
Rate
=
Interest Cost
of Borrowing
in the Money
Market
+
Markup
for Risk
and Profit
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Customer Profitability Analysis (CPA)
Estimate Total Revenues From Loans
and Other Services
Estimate Total Expenses From
Providing Net Loanable Funds
Estimate Net Loanable Funds
Estimate Before Tax Rate of Return By
Dividing Revenues Less Expenses By
Net Loanable Funds
17-25
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Questions
What aspects of a business firms financial
statements do loan officers and credit analysts
examine carefully?
What methods are used to price business loans?
Suppose a bank estimates that the marginal cost of
raising loanable funds to make a $10m loan to one
of its corporate customers is 4%, its nonfunds
operating costs to evaluate and offer this loan are
0.5%, the default-risk premium on the loan is
0.375%, a term-risk premium of 0.625% is to be
added, and the desired profit margin is 0.25%. What
loan rate should be quoted this borrower? How
much interest will this borrower pay in a year?
17-26