McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved Chapter Seventeen Lending to Business Firms and Pricing Business Loans

17-2 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-3 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Long Term Business Loans Term Loans Revolving Credit Lines Project Loans Loans to Support Acquisitions of Other Business Firms

17-4 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Sources of Repayment for Business Loans The Borrower’s Profits or Cash Flows Business Assets Pledged as Collateral Strong Balance Sheet With Ample Marketable Assets and Net Worth Guarantees Given By Businesses

17-5 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Analyzing Business Loan Applications Common Size Ratios of Customer Over Time Financial Ratio Analysis of Customer’s Financial Statements Current and Pro Forma Sources and Uses of Funds Statement

17-6 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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 The Financial Leverage Factor as a Barometer of a Business Firm’s Capital Structure

17-7 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-8 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-9 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Marketability of Product or Service Gross Profit Margin Net Profit Margin

17-10 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Coverage Measures Interest Coverage Coverage of Interest and Principal Payments

17-11 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Liquidity Measures Current Assets/Current Liabilities Acid Test Ratio Working Capital Net Liquid Assets

17-12 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-13 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Leverage or Capital Structure Measures Leverage Ratio Total Liabilities/Net Worth Capitalization Ratio Debt to Sales Ratio

17-14 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Contingent Liabilities Guarantees or Warrantees Behind Products Litigation or Pending Lawsuits Unfunded Pension Liabilities Taxes Owed But Unpaid Limiting Regulations

17-15 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-16 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Component of Sources and Uses of Funds Statement Cash Flows from Operations Cash Flows from Investing Activities Cash Flows from Financing Activities

17-17 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Traditional (Direct) Operating Cash Flows Net Sales Revenue – Cost of Goods Sold – Selling, General and Administrative – Taxes Paid in Cash + Non Cash Expenses

17-18 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-19 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Methods Used to Price Business Loans Cost-Plus Loan Pricing Method Price Leadership Model Below Prime Market Pricing Customer Profitability Analysis

17-20 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Cost-Plus Loan Pricing

17-21 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Price Leadership Model

17-22 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-23 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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

17-24 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Below-Prime Market Pricing

17-25 McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 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