My Loan Application Was Rejected - Malaysia

The Five “Cs” of Lending

2008-09-01T01:27:00.000-07:00

Although a commercial loan is a financial transaction, it’s ultimately a relationship between borrower and lender. It is, therefore, at its base, more of an art than a science. Lenders are responsible for making decisions which are consistent with the business parameters and limitations of their institutions. They test each loan application against five elementary lending criteria to determine the overall soundness of the proposal. For the request to be considered seriously, the lender must be comfortable with the combined strength of the borrower with regard to these criteria. For instance, if the borrower has a weakness in one area, the deficiency may possibly be overcome with a stronger position in one of the remaining determinants. These lending criteria include capacity, capital, collateral, credit, and character.

The borrower’s capacity is a measure of their qualification to receive the loan requested. The lender will attempt to ascertain whether the borrower is operating within his or her abilities and not attempting to accomplish something beyond their limitations or means. Position in the market, experience in the industry, and track record in business will determine, in the lender’s eyes, if the borrower is a qualified candidate.

Capital is defined as the portion of the total cost of the deal which must be contributed by the borrower. Lenders will always limit their leverage in a transaction by requiring that the borrower also have a meaningful amount of capital at risk, thereby insuring the business owner’s commitment to the deal as well as reducing the lender’s exposure to loss. Different lenders have different capital requirements for borrowers in different situations, based on their use of proceeds, the availability and value of the borrower’s collateral, and the nature of the business operation.

Sufficient collateral shows the borrower’s ability to guarantee the loan with tangible assets as a secondary source of repayment. Lenders generally prefer collateralized assets to be valued on a discounted basis. This discounted value gives the lender a safe margin to cover the time and costs of converting those depreciated assets into cash, should the need ever arise.

Studying the borrower’s credit history provides a picture of how the business or its owners have handled previous financial dealings. The credit report also discloses whether the business has any civil judgments against it, any unpaid tax liabilities, liens against their assets, or if it has filed for bankruptcy protection. While not an exclusive indicator of how the business will perform in the future, credit information does relate to how the borrower and the business have performed in the past.

Although certainly the least quantifiable, character may well be the most important assessment that the lender can make about the prospective borrower. Regardless of the positive attributes of capacity, capital, collateral and credit that the borrower may show, if he or she does not demonstrate integrity and trustworthiness, any loan proposal will be declined. Character is important because, among other things, it can reveal intent. If the lender senses that the borrower is somewhat cavalier toward fulfilling responsibilities with regard to the deal, and even toward the business, the lender will most certainly back away from the proposal. The lender must be made to believe that, in addition to the legal agreement, the borrower feels a certain moral obligation to repay the loan.

The subjectivity of business lending cannot be overly stressed. Although there certainly are concrete, quantifiable things which the lender looks for, in the end the decision whether or not to make the loan will quite often come down to subjective measurements, the comfort level that can be forged between the two sides.

Don't Give up after Being Denied Credit

2008-08-24T04:27:00.000-07:00

Getting a loan may be very easy for some people, while others have all kinds of difficulties with the process. Loans are a large part of our lives today. With the current economy on shaky ground and the cost of living continually rising, many people are seeking loans for a not only a home or car, but also for many personal or household purchases as well.

When you apply for a loan, the first thing the lender will have you do is fill out an application so that they'll know a little about your life and financial situation. The application will tell them your family size, address, employment history, income and debts. Once they have the application, they'll usually order a credit report (CTOS, CCRISS, FIS) from one of the major credit reporting companies. The credit report will show them all debts you now have and have had in the last seven- to ten years.

The credit report will also indicate the types of debts you've had – such as a mortgage, personal loan, credit card etc. It will show the maximum amount borrowed, your monthly payment amount and how you paid the debt. The report will have a score, which can range as low as below 400 for poor credit to as high as 800-plus for excellent credit (depending on service providers). The credit score is used by the lender to help determine what kind of risk you are as a borrower.

If you've filed for bankruptcy, had a judgment placed against you or experienced other delinquencies, the lender will usually turn you. However, if the lender is performing their job thoroughly and conscientiously, they'll question you about some of your accounts to make sure that they're accurate. They'll also want to know if there were any extenuating circumstances that led you to becoming delinquent.

When you're turned down for a loan or any type of credit, you have the right to know what credit report agency was used to help the lender make their decision. You also have the right to contact that credit report agency and obtain a free copy of your credit report within sixty days of being denied credit. Your would also ask from the bank on what was the basis of rejection. When you receive your report, be sure to look it over carefully to ensure that there are no mistakes. Mistakes are not uncommon, such as a paid debt that's still being reported as unpaid or another person's debts on the report. This latter case often happens in situations where there are a 'Junior' and 'Senior' members in the same family. Even though the individual's Social Security number is meant to be the primary determinant, errors still occur.

If your credit report is not accurate, discuss this with the lender. If you can demonstrate that you have the ability to repay a loan, the lender may reconsider. Sometimes, if you tell the bank you are going to try elsewhere, they may also have a change of heart (especially if your financial situation is borderline). However, if they stick with their denial, you can at least learn from it. In most cases, the lender will give you the reasons why they turned you down. This makes it easier for you to correct the situation or discuss it with your bank. The important thing is to not give up; getting a loan after being refused may be a bit difficult, but it's certainly not impossible.

Source: FinWeb.com
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Crisis spreads past subprime loans

2008-08-18T06:57:00.000-07:00

NEW YORK: The credit crisis is no longer just a subprime mortgage problem.

As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.

The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one.

Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit.

"This collapse in housing value is sucking in all borrowers," said Mark Zandi, chief economist at Moody's Economy.com.

Like subprime mortgages, many prime loans made in recent years allowed borrowers to pay less initially and face higher adjustable payments a few years later. As long as home prices were rising, these borrowers could refinance their loans or sell their properties to pay off their mortgages. But now, with prices falling and lenders clamping down, homeowners with solid credit are starting to come under the same financial stress as those with subprime credit.

"Subprime was a symptom of the problem," said James F. Keegan, a bond portfolio manager at American Century Investments, a mutual fund company. "The problem was we had a debt or credit bubble."

The bursting of that bubble has led to steep losses across the financial industry. The American International Group said on Monday that auditors found it may have understated losses on complex financial instruments linked to mortgages and corporate loans.

The running turmoil is also stirring fears that some hedge funds may run into trouble. At the end of September, nearly four per cent of prime mortgages were past due or in foreclosure, according to the Mortgage Bankers Association.

That was the highest rate since the group started tracking prime and subprime mortgages separately in 1998. The delinquency and foreclosure rate for all mortgages, 7.3 per cent, is higher than at any time since the group started tracking that data in 1979, largely as a result of the surge in subprime lending during the last few years.

An example of the spreading credit crisis is seen in Don Doyle, a computer engineer at Lockheed Martin who makes a six-figure income and had a stellar credit score in 2004, when he refinanced his home in Northern California to take cash out to pay for his daughter's college tuition.

Doyle, 52, is now worried that he will have to file for bankruptcy, because he cannot afford to make the higher variable payments on his mortgage, and he cannot sell his home for more than his US$740,000 mortgage.

"The whole plan was to get out" before his rate reset, he said. "Now I am caught. I can't sell my house. I'm having a hard time refinancing. I've avoided bankruptcy for months trying to pull this out of my savings."

The default rate for prime mortgages is still far lower than for subprime loans, about 24 per cent of which are delinquent, or in foreclosure.

Some economists note that slightly more than a third of American homeowners have paid off their mortgages completely. This group is generally more affluent and contributes more to consumer spending and the economy relative to its size.

Unlike subprime borrowers, who tend to have lower incomes and fewer assets, prime borrowers have greater means to restructure their debt if they lose jobs or encounter other financial challenges. The recent reductions in short-term interest rates by the Federal Reserve should also help by reducing the reset rate for adjustable loans.

Still, economists say the rate cuts and the US$168 billion (US$1 = RM3.24) fiscal stimulus package are unlikely to make a significant dent in the large debts weighing on many Americans, because banks have tightened lending standards and expected rebates from the government will not cover most house payments.

The problems are most acute in areas that experienced a big boom in housing - California, the Southwest, Florida and other coastal markets - and in the Midwest, which is suffering from job losses in the manufacturing sector.

And it is not just first-mortgage default rates that are rising. About 5.7 per cent of home equity lines of credit were delinquent or in default at the end of last year, up from 4.5 per cent a year earlier, according to Moody's Economy.com and Equifax, the credit bureau.

About 7.1 per cent of auto loans were in trouble, up from 6.1 per cent. Personal bankruptcy filings, which fell significantly after a 2005 federal law made it harder to wipe out debts in bankruptcy, are starting to inch up.

On Monday, Fitch Ratings, the debt rating firm, reported that credit card companies wrote off 5.4 per cent of their prime card balances in January, up from 4.3 per cent a year ago. The so-called charge-off rate is still lower than before the 2005 law went into effect.

Banks are responding to the rise in delinquencies by capping home equity lines of credit in areas with falling real estate prices. A few credit card companies have also moved to reduce the credit limits of customers they deem more risky.

Bank of America, Citigroup, Countrywide Financial, JPMorgan Chase, Washington Mutual and Wells Fargo are expected to announce at the Treasury Department that they will offer both prime and subprime borrowers who are more than three months behind a chance to halt foreclosure proceedings for 30 days and work out new loan terms.

In a conference call with analysts in December, Kenneth Lewis, the chief executive of Bank of America, said more borrowers appear to be giving up on their homes as prices fall, noting a "change in social attitudes toward default".

"You don't mind making a US$2,000 payment when the house is going up in value", said Steve Walsh, a mortgage broker in Scottsdale, Arizona, who has seen several clients walk away from their homes because they couldn't refinance or sell.

"When it's going down, it becomes a weight around your neck, it becomes an anchor."

Home prices in the North Las Vegas neighbourhood of Brenda Harris, a technology analyst at a casino company, have fallen 20 per cent to 30 per cent. The builder who sold her a new three-bedroom home on Pink Flamingos Place for about US$392,000 in 2006 is now listing similar properties for US$314,000. A larger house a block down from Harris was recently listed online for US$310,000.

But Harris does not want to leave her home. She estimates that she has spent close to US$40,000 on her property, about half for a down payment and much of the rest on a deck and landscaping. "I'm not behind in my payments, but I'm trying to prevent getting behind. I don't want to ruin my credit."

In addition to the declining value of her home, Harris, 53, will soon be hit with a sharply higher house payment. She has an option adjustable-rate mortgage, a loan that allows borrowers to pay less than the interest and principal due every month. The unpaid interest gets added to the principal balance. She is making the minimum monthly payments due on her loan, about US$2,400.

But she knows she will not be able to pay the US$3,400 needed to cover her interest and principal, which she will be required to pay once her loan balance reaches 115 per cent of her starting balance. And under the terms of her loan, which was made by Countrywide Financial, she would have to pay a prepayment penalty of about US$40,000 if she chose to refinance or sell her home before May 2009.

She said that she now wishes she had taken a traditional fixed-rate loan when she bought the home. At the time, she asked for a loan that could be refinanced after one year without penalty. She said her broker had told her a week before the closing that the penalty would extend until May 2009 and that she reluctantly agreed because she had already started moving.

A non-profit community group, Acorn Housing, is trying to broker a modification of Harris' loan.

Credit counsellors say many borrowers like Harris were cajoled or pushed into risky mortgages that they never had the ability to repay.

Others disregarded warnings about complex loans because they wanted to be a part of the housing boom, which like the technology stock bubble lured people in with seemingly instant and risk-free profits, said Mory Brenner, vice-president of Financial Firebird Corp, a company based in Pittsfield, Massachusetts, that publishes consumer debt information and refers borrowers to credit counsellors.

"I'd say, Let me tell you something, this is crazy," Brenner said. "You cannot afford this house, even if nothing happens and rates stay as low as they are today. And the response would be: I don't care." Lenders extended credit to people without verifying their incomes and allowing them to make little or no down payments.

But borrowers like Doyle say they are victims of their circumstances - housing prices collapsed and lending standards tightened just as they needed to sell or refinance.

In refinancing their home in 2004, Doyle and his wife were doing what millions of other homeowners did in the last decade - tapping into the rising value of their homes for home improvements, paying off credit card debt, college tuition and for other spending. - NYT

Copyright © The New Straits Times Press (Malaysia) Berhad, Balai Berita 31, Jalan Riong, 59100 Kuala Lumpur, Malaysia.

4 Important Questions That A Business Owner Should Ask

2008-08-17T06:32:00.000-07:00

By M Nazri, MBA, BCom(Acc), DipAcc, Evolve Maximus in cooperation with D&B

1. Structure and Operations

“Is my firm’s business structure designed for efficiency and performance?”

Objective: Understanding how the company is operationally and structurally positioned and ascertaining whether the current set-ups inhibits or facilitate the growth prospects of the firm.

2. Strategic Posture

"How effective have my strategies been and how will the future of my firm look like financially based on my existing strategies?"

Objective: The business owner should evaluate the past and current strategies of his/her firm and assess the implication on the firm’s indicative credit ratings and financial structure – past, current and future. The business owner should also identify areas to value-add to the firm, in terms of maximizing returns and minimizing risks and strengthen his/her firm’s balance sheet.

3. Business Conditions

“How will my current operational workflow and business operations affect the overall profitability, solvency, liquidity and efficiency conditions of my firm?”

Objective: For the business owner to evaluate how the firm conducts its operations, what have been the key issues (and the nature) or challenges faced and how the firm dealt with these in the past. To what extent have these been successful and the reasons why. The business owner should also assess this implication on the firm’s indicative credit ratings and financial structure.

4. Preliminary Recommendation

“What steps can I take to grow my firm, strengthen the structure, improve the financial ratings, creating a robust policy to manage cashflows in the future?”

Objective: Based on understanding the business and financial dynamics of the firm, in terms of its structure, operational processes, business conditions and strategic posture, the business owner should then prepare a set of preliminary recommendations. The basis of the recommendation is heavily tied to the prima facie information available to the business owner, who will then map these onto the following areas as detailed as possible:

• Fund raising – banks, investors, government
• Company structure
• Indicative financial ratings and ratings optimization
• Credit policies and strategies
• Financial optimization – profitability, solvency, liquidity and efficiency
• Business modeling
• Marketing mix review
• Cost rationalization
• Capitalization programme
• Taxation
• Risk – concentration issues
• Technical/functional support assistance

Answering the Lender's Objections

2008-08-13T09:36:00.000-07:00

Identifying the qualifications, exceptions and alterations (if any) of a lender's rejection of your loan proposal can help you to determine just why the lender said no. Below are listed some of the most common reasons that lenders use for rejecting a loan request and some logical responses to those reasons:

Objection: The business is undercapitalized. Lenders are much more comfortable when you the borrower have either contributed or earned a substantial portion of the business's net worth. In examining the total debt-to-equity ratio, there should be some reasonable part of the company's financing provided by a source other than the lender.

Response: There are measures that you can take to increase your equity in the business. For example, you could infuse more money into the company from such sources as savings, a second mortgage on your home, proceeds from liquidated investments, or the cash surrender value of a life insurance policy. Furthermore, it may be possible to convert any subordinated debt or notes payable to the company into equity. You can also attempt to reduce other liabilities of the company by a reasonable amount (and at a discount, if possible). Lowering the business's overall debt level will allow the lender to operate from a stronger perceived position with regard to the company's ability to repay the loan.

Objection: The business has yet to make a profit. Lenders will typically expect that a borrower who has a track record of business success will be able to implement the business strategy put for in a proposal and repay the funds advanced. If a company has perpetually lost money, however, most lenders may reason that additional financing will simply compound those losses and the borrower will be unable to repay the loan.

Response: Your explanation of the financial history of the business was probably not sufficient or not reasonable (as far as the lender was concerned). If your business has failed to earn a profit, it's important to demonstrate the reasons for this and explain how you will correct the problem. Be sure to provide candid and detailed documentation explaining the periods in which a profit was not earned. In comparing those loss periods to periods in which the business did earn profits, you can explain how the operations may have been different. You should then detail how the loan proceeds will be used to position the business in such a manner that profits will be assured.

For example, at times acquiring better and more efficient assets is all that's needed to achieve profitability. Lenders can usually accept this strategy if you can provide substantive evidence that increases in productivity will indeed shift your balance sheet back into the black.

Objection: The proposed loan is too large. Lenders often attempt to lessen loan request amounts by either reducing the marginal funds or trying to force the borrower to spend less in a particular area of the proposal. The intent is to control their risk exposure and also perhaps to get the loan balance down with regard to the amount of collateral being offered.

Response: It's important to remember that only you can decide if your proposed strategy can be achieved with a lower amount of funding. Furthermore, only you will know how much extra financial cushion, incorporated into your original request, can be lowered without materially affecting the business. Your response, therefore, must be based on how much money is actually needed and how an expenditure can be reduced without causing a negative impact on your business plans. Alternatively, offering to provide additional collateral may persuade the lender to reconsider the restriction, since by doing so you'll reduce the lender's perceived risk in the transaction.

Objection: The business strategy isn't sound. Loan officers will often test your ideas against their collective knowledge and experience (or inexperience) in order to evaluate whether the business has a reasonable chance of succeeding. If the lender has significant reservations about your prospects, the financing will be turned down.

Response: Keep in mind that lenders are not always right, and they are almost always of a conservative nature. Perhaps you didn't explain the strategy sufficiently, or maybe the lender has an incorrect or incomplete understanding of exactly what you're trying to accomplish. Review the business strategy carefully with the lender, making absolutely sure that it fully describes each detail of the plan. Don't hesitate to add emphasis and support to your ideas with articles, surveys, marketing and demographic studies, etc.

Objection: The business is too risky. Some lenders altogether exclude particular industries from their lending market because the risks inherent (whether real or perceived) in those businesses are beyond the lender's acceptable parameters. Such exclusions may apply only to the local lender, or they may be generally common among most lenders, depending on the particular industry involved.

Response: It's possible that you didn't effectively communicated how some of the risks might be eliminated, or at least limited. For example, by accepting tighter terms or providing additional collateral, you could structure the transaction to give the lender greater protection from excessive exposure to potential loan losses.

Objection: There's not enough collateral. This is probably the most often-used reason by lenders for rejecting a loan request. Lenders typically desire a minimum ratio of 1:1 collateral-to-debt coverage, and that based on a discounted valuation of the collateral. They'll often attempt to use collateral leverage to encumber virtually every asset that a borrower owns, even if those additional assets contribute little actual value toward securing the loan.

The quantity and quality of the collateral offered can often overcome many objections, because lenders are usually only too glad to rent the borrower his or her own money – which is, in essence, what's taking place when collateral is taken for a loan. It's actually a small matter that the money is presently tied up in the asset; it can be seized for liquidation should the loan not be repaid.

Response: Your response as a borrower should be based on an honest and accurate recognition of the true value of the collateral you're offering. You should also be aware of its worth in liquidation. Lenders are often inclined to sell repossessed assets at substantially less than market value, seeking merely to recover their outstanding loan balance rather than getting the full worth of the resources.

It's therefore wise to know the market for selling assets similar to those that you've offered as collateral. If necessary, order an appraisal from a used equipment dealer or auctioneer. The dealer should be able to quickly judge what the equipment would likely bring in a timely sale or auction. This information can be very useful in determining the leverage that the lender will give you on those assets. Additionally, real estate assets should also be valued by appraisal. Lenders will typically advance a standard amount of the market value of real estate, thereby providing themselves a margin to cover the time and associated cost of selling the property in the event of default.

If the lender has not valued your collateral adequately, you can provide additional information to prove its' greater worth. But you'll only be able to challenge the lender's assessments with a different value that has been documented. Then, when asked to review their calculations, they should at least come to a compromise value based on the evidence that you provide.

If, after your own valuations, the assets are indeed insufficient, be prepared to offer more collateral to the lender. And, as an additional word to the wise: it's a good idea to have a backup strategy of how to accomplish your goals with fewer dollars, just in case you can't raise sufficient supplementary collateral and you're forced to settle for a somewhat smaller funding amount.

Objection: The financial projections are unreliable. Lenders will pay particular attention to the financial projections of a loan proposal to determine exactly how the borrower intends to repay the loan. Based on contributing factors and past experience, the lender might not always agree with the proposal's conclusions about revenue production or the cost of operations, and as such, the borrower's ability to service the debt may be called into question.

Response: Examine the projections carefully and ensure that the expectations have been reasonably arrived at and effectively communicated. Reviewing the data on which the projections are based, you should ensure that this evidence is documented clearly and accurately.

Also, be prepared to make modifications to correct any errors that might have been discovered by the lender or to revise any calculations where necessary. Then, when comparing the new numbers against the debt service to pay back the loan, you'll need to determine if the deal is still feasible. When you've re-run the numbers and are confident in them, present them again with a line-by-line discussion to convince the lender of the soundness of the new expectations.

Of course, responding to any (or all) of these objections won't guaranty that the lender will change the decision, but it's certainly the logical "next step" to take after the loan has initially been rejected. Since considerable effort has been invested in educating this particular lender about your business, you should attempt to address his or her concerns before completely starting anew with a new proposal to a new lender.

Credit to: finweb.com

Calculating Repayment Capacity Of A Business

2008-08-10T10:57:00.000-07:00

Maybe some of you do not know exactly what Debts to Service Ratio (DSR) is.

Well it portrays your business's cash flow capacity toward repayment of credit facilities. Bankers must know this ratio very well just like eating their staple foods daily. Below is the calculation. It may not be the exact formula based on the accounting theory but rather simplified for benefit of laymen.

Cash-Flow Projection - Monthly

Projected Sales i.e. 1,000,000
less Average COF @ 70% = (700,000)
less Average SGA @ 10% = (100,000)
Plus Average Depreciation say 5,000

Thus Pre-Tax Profits = 205,000 (A)

Interest and instalments for existing loans say 50,000
Plus new interest or instalment for this new application say 5,000
Thus total commitment is 55,000 (B)

Therefore Expected Debt Service Ratio (DSR) = A/B
which is 205,000 / 55,000
= 3.73

DSR Ratio of more than 2 indicates better cash flow or repayment capacity.

The point here is, even though working capital calculation (discussed earlier in previous topic) justified to your capital requirement, DSR will sometime in opposite.

Businessmen, please consider this ratio very seriously especially in increasing your gearing.

Writing a Partnership Agreement

2008-08-08T21:56:00.000-07:00

Adapted from content excerpted from the http://www.open.americanexpress.com/

When you're in a partnership, it's highly advisable to have a formal, written partnership agreement. While it is not required by law, a partnership agreement can give you a framework for defining each partner's obligations, and settling the conflicts, disagreements and other difficult-to-resolve issues that naturally occur in nearly every business relationship. Ultimately, it will help ensure the long-term well-being of your business.

Create your written partnership agreement with the assumption that anything that can go wrong with your partnership will. Friction between partners over things such as money, power or ego frequently undo these business relationships. Your partnership agreement should prepare you for all possible "what-if" situations, and set methods for resolving them. You will find that it pays to be extra cautious.

You can save money by drafting your own version of the key parts of your agreement, then taking it to your firm's attorney to be reviewed, clarified, modified and finalized. It is important to have an attorney review the contract, because you want to make sure it complies with the partnership laws of your state. Finally, each partner might want to have his or her own lawyer look it over, since your firm's attorney can't represent the interests of each individual partner.

Below are some of the key areas you will want to cover in your written partnership agreement:

Basics

What is the name of the partnership?
What is the purpose of the partnership?
What is the duration of the partnership?

Responsibilities, performance and remuneration

What is each partner's role?
What are each partner's responsibilities within the company, and what level of performance is expected?
Are partners expected to make a full-time commitment to the venture, or are business activities permitted?
What will be the income of each partner, and how will profits or losses be distributed?

Contributions

What will each partner be contributing to the partnership in terms of cash, assets, loans, investments, and/or labor?
If a partner loans the company money, what will be the terms or repayment?
Will the partners be expected to make additional contributions to the partnership, and if so, how will that be handled?

Withdrawal of partners/admission of new partners

What guidelines should be followed if one partner wants to leave the partnership?
Will partners be allowed to sell their interests in the business to outsiders?
On what grounds can a partner be expelled from the partnership (misconduct, non-performance of duties)?
How will new partners be admitted to the partnership?

Buy-out procedures

What guidelines should be followed if one partner wants to retire or leave the partnership?
What happens if a partner is incapacitated or dies?
Will the partnership take out "key man" life insurance to ensure the surviving partner is able to buy the deceased partner's shares from his/her heirs?
Will partners who leave have to sign a non-compete agreement?

Dispute resolution

What methods will be used to settle disputes that can't be otherwise resolved?
What procedures should be used in the event of a tie vote between partners on crucial partnership decisions?
Will you use mediation or binding arbitration?
If disputes can't be resolved, is there a mechanism in place for dissolving the partnership?

Financial arrangements

What banking arrangements will be made for the partnership?
Which partners will have check signing privileges?
Who will be authorized to draw on the partnership's accounts?
How will the books be kept?

Method for dissolving the partnership

When can the partnership be dissolved?
What happens to the partnership if the partners decide they can't work together?

Valuation

What methods will be used to determine the value of the business in the event of a sale, dissolution, death, disability or withdrawal of a partner?

CREATIVE ACCOUNTING (WINDOW DRESSING)

2008-08-07T07:55:00.000-07:00

Well it goes by its name.

The phenomenon of Creative Accounting is closely associated with corporate failure. Normal accounting conventions already allow some latitude to companies that are trying to present accurate accounts. One can therefore understand the temptation of companies in trouble to adopt cosmetic accounting techniques to show a better position in the hope that matters will soon improve.

The key focus for a banker is to be able to recognise:

when creative accounting is taking place
the impact on the financial statements
the motive of the directors in using such techniques

In some cases banks offer products to its customers to help them Window Dress.

Example of Creative Accounting
Account Receivables - Fail to disclose debts which are long overdue and almost certainly bad.

Inventory & Work-In-Progress

In many cases these are shown at director's valuation and accepted by the auditors without verification.
Fail to disclose the slow moving/obsolete lines of stocks
Change the bases of valuing stock and take the surplus into normal trading profits rather than disclose as "extra ordinary item"
Change costing system so that more production overheads are included in closing stock valuation
In long term contracts recognise profit early by loading advice fees or manipulating the costing

Fixed Assets

Revalue of fixed assets without valid commercial justification
Sale and lease back to reduce the level of on balance sheet borrowing and perhaps increase Tangible Net Worth if assets sold in excess of book value
Depreciation policy. In some cases depreciation is not charged on idle assets
Amortisation policy are intangible

Revenue Expenditures
Capitalise expenditures such as research and development, pre-operating expenses or advertising and write off over a number of years. Good example is in oil and gas exploration companies...

Subsidiaries

Avoid consolidating unprofitable offshoots
Re-classify an associate company as an investment then its losses need not be disclosed
Instruct subsidiaries to increase dividend to parent company
Each year progressively bring in more results from subsidiaries to the consolidated accounts. First companies 100% owned, then 75% owned, then 50% owned
Run part of the business in the form of a partnership. There is then no need to reveal any information other than shares of partnership profits in "parent" accounts.

Gearing

Use operational leasing to improve the apparent gearing
Transfer debts to a associated company, which reduces, on balance sheet borrowings although contingent liabilities may be increased if guarantee is given
High cash balances may suggest that the net gearing position should be considered but this assumes that the cash is instantly available to reduce the borrowings.

Directors/shareholders' loan

Inject money on the final day of the financial year end and withdraw on the first day of the next financial year

Sales

Fail to record some cash transactions - very common for a family owned business
carry forward sales invoices into the next accounting period thereby depressing profit or bring back from a subsequent period into the current year
Include unenforceable sales agreements of goods on sales or return basis

Costs

Delay or advance costs from the next year
Increase/decrease provisions more than is required by the business
Take a pension holiday

Reserve Accounting

Material adjustments for prior years and extraordinary items should be separately identified in the profit and loss account that can be seen
Taking them directly to reserves or adjusting the opening balance of retained will conceal them
transfer from reserve to profits will improve apparent distributable earnings and it is often difficult to tell whether such reserves are legally available for dividend payment.

Quasi Equity / Long Term Funds

Some items are described as capital or long term funds but maybe payable in the short to medium term such as:

Convertible bonds. The may be converted to equity or become payable
Redeemable shares could become a claim on the company depending on their conditions
Subordinated loans rank behind creditors and senior debt in a gone concern basis but may be repayable soon

Working Capital / Ratio Juggling

Take in short-term funds overnight to improve liquidity at balance sheet date
Liquidate stocks a few days before the year end to improve stock turn
Re-classify fixed assets, which are to be sold, as stock
Squeeze debtors and delay paying creditors immediately prior to year end to improve liquidity
Convert short term borrowings to medium term borrowings

Delay purchase and speed up submission of invoices prior to year end

SOME ADVICES
IF BANKERS SUSPECT BUT CANNOT CONFIRM CREATIVE ACCOUNTING, BANKERS' BEST PROTECTION IS TO TRACK THE CASH.

Leverage And Financial Factors - Vulnerable Signs

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Anything that grow rapidly;
Diminishing margin of profitability regardless of how they are computed;
Subsidiaries, affiliate, division, plants or other business segments or product lines that are or could be, a financial drag or the borrower's overall performance;
Uncompetitive cost structure;
Deviation from normal seasonal borrowing pattern;
Change in the market value of equity in relation to book;
Top-heavy fixed assets;
Significant growth or decline in sales;
Excessive inventories
Change of auditors
Delay in receipt of financial statements
Imaginative accounting;
Excessive dividends;
Poor financial controls;
Major sales of assets;
Decline in inventory turnover;
Built up in the ratio of receivables to sales;
Unfunded cash requirements, including large current or near-term debt maturity and inability/delay in seasonal cleanup;
Difficulty in raising debts or equity;
Poor allocation of financial resources;
Earnings growth with dilution of earning quality. Earnings can be inflated by inventory profits (which may not be real profits because of higher replacement costs). Allowances for doubtful accounts reduced without justifications;
High leverage, not only financial but also operational - for example high fixed costs;
Stretching payable;
Decline in net working capital;
Inability to finance outside the banking market;
Slowness in trade;
Violation of covenants or agreement - with creditors;and
Downtrend in the ratio of retained earnings to total assets.

When you see these signs or maybe you are trying to create these signs, put that in mind, your business is not in the right track...and bankers could smell these easily..

MONEY LAUNDERING - Part 2

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Recognition and reporting of suspicious transaction
a) Recognition of suspicious transactions - which is inconsistent with a customer's known, legitimate business or personal activities or with the normal business for that type of account.

b) Monitoring types of suspicious transactions - An assigned senior management staff needs to continually overseen an suspicious transactions. Each banking institution should formally designate an officer to be responsible for money laundering recognition and reporting procedures.

c) Reporting suspicious transactions - banking institutions are required to report all cases of suspicious transactions which they come across to Bank Negara Malaysia (BNM).

d) Procedure for disclosure - each banking institution may have its own procedure for reporting to BNM.

e) Funds offer by non-account holders (occasional customers) - sometimes banks decline to open an account for a potential customer or refuse to have dealing due to serious doubt regarding the identity.

Examples of suspicious money laundering transactions
Examples can be broken into the following categories:
1) using cash transactions
2) using bank accounts
3) investment related transactions
4) international off-shore activities
5) involving financial institutions' employees and agents
6) secured and unsecured lending:
a) customers who unexpectedly repay problem loans
b) request to borrow against assets held by the banking institution or a third party, where
the assets' origin is not known or they are inconsistent with the customers standing
c) request by a borrower for a banking institution to provide or arrange for finance where
the source of the customer's financial constribution to a deal is unclear, particularly
where property is involved.
d) using fixed deposits as collateral of unclear source. Example, a small company with
yearly sales turnover of RM50,000 and Net Worth of RM70,000 offered a fixed deposit
of RM5.0M as collateral for its credit facilities. Seems the company cannot afford to
to have RM5.0M in-hand unless borrowered from somewhere. The duty is to track the
origin of the RM5.0M money.

One Of A Few Methods Of How Bankers Calculate Working Capital Requirement For A Business

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Projected Sales for a year / 12 = projected sales a month (A) say, 1,000,000
Average Cost of Sales in percentage, say 70%
Average SGA in percentage (which includes your sales and general administration costs or overhead) say 10%
Average Debtors Turnover in month, say 3 months
Average Stock Turnover in month, say 1 month
Average Creditors Turnover in month, say 2 months

Thus
Debtors = 1,000,000 x 70% + 10% x 3 months = 2,400,000
Stocks = 1,000,000 x 70% x 1 month = 700,000
less
Creditors = 1,000,000 x 70% x 2 months = 1,400,000
So the requirement = 1,700,000

To get projected sales turnover for a year, normally bankers will take average credit turnover in the applicant's current accounts maintained at all banks.

Average Cost of Sales (COS), SGA, Debtors Creditors and Stocks Turnovers are from the applicant audited account reports submitted during the application. Thus, most bank are reluctant to lend money to a newly set up company mainly because this company does not have any financial track record and risk is extremely high.

Bankers also use this formula to determine type of credit facilities required by any company depending on nature of business.

The main reason of this calculation simply because banks only provide financial requirements not business needs. It is risky to lend more than the requirements.

The Anti Money Laundering Act (AMLA)

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In July 2001, the AMLA was gazetted as law. BNM was appointed as the competent authority under the AMLA. Following this, a new department, the Financial Intelligent Unit (FIU), was established within BNM on 8th August 2001, to carry out the functions of the competent authority as provided by AMLA.

The AMLA come into force on 15th January 2002, concurrently with the appointment of BNM as the competency authority by the ministerial order. The AMLA provides for the FIU to collaborate with the relevant domestic regulatory, supervisory and enforcement agencies in intelligent gathering, analysis and dissemination. The national money laundering programme emphasises on terrorist financing. Any person funding terrorist is deemed to be abetting the terrorist and commit an offence under the Penal Code. Those receiving the funds also commit money laundering offences for dealing with proceeds from illegal activities.

FAMOUS REASON - DUE TO SEPTEMBER 11, 2001 ATTACKED ON WTC

What is Money Laundering?
Changing the identity of illegally obtained money into a legitimate source.

A common form of money laundering encountered by banks is cash deposits in the banking system or exchanged for value items. This is the key stage for detection of money laundering operations - where the cash first enters the banking system.

3 Stages of Money Laundering

Placement - the physical disposal of Cash proceeds derived from illegal activities
Layering - separating illicit proceeds from their source by creating complex layers of financial transactions designed to disguise the audit trail and provide anonymity
Integration - the turning of criminally derived wealth into legitimate funds

If the layering process succeeds, the integration phase places the laundered proceeds back in the economy in such a way that the funds re-enter the financial system as legitimate business funds.

Policies And Procedures Of Financial Institution
There is no legal requirement only a moral one to report to the appropriate authority and to not facilitate money laundering.

Source: BNM

Common Types Of Banking Facilities

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There are 2 types of banking facilities:

Fixed Loan
Short Term Financing

Fixed Loan

Normally extended to finance acquisitions of fixed assets and usually the financing tenure is above 5 years repayment term. Within the 5 years period, the banks are expected to earn some profits from the dealings. Anything shorter than 5 years would not benefit the banks' businesses. That is why the banks impose capping period of 5 or 6 years to restrict any premature settlement. Should the borrower insist, a penalty charge of 2.5% to 3.0% against the original loan amount is chargeable.

Short Term Financing

Normally extended to finance business working capital requirement and cash flow financing and the facilities are for a period of 12 months and subject to review by banks at its absolute discretion as and when to review the facilities depending on the performances or conducts of the facilities by the borrowers. Remember, bankers are scared of bad borrowers.

2 Types of financing purposes:

Working Capital Financing - to finance day to day business expenditures, purchases, overheads etc.
Cash-Flow Financing - normally to finance a project or contract, Bridging Loans i.e. prior to receipt of payments from contract awarding parties.

Type of Credit Facilities Under Short Term Financing Common)

Overdraft (OD) - is an excess in current account allowable by banks up-to a certain limit/amount and definite date or expiry.
Letter of Credit (LC) - sort of undertaking letter from bank to pay the LC's beneficiary on behalf of its borrower i.e. the client's to LC's beneficiary (sellers) subject to fulfilment of all terms and conditions stated in the LC. LC itself does not provide money to beneficiary. The facility was introduced merely because both buyer and seller don't trust each other. Usually LC is not for purchasing of fixed assets such as machines etc. It merely for stock purchases unless the nature of business of its borrower is trading in machines etc. LC also is not for paying services of a third party. 2 types of LC i.e. Usance LC and Sight LC.
Trust Receipt (TR) - is a credit facilities that provide financing (cash) to pay the LC upon receipt of documents from LC's beneficiary and all terms and conditions spelt in the LC are complied with. TR also are used to finance import collection bills and under "Open Account Basis". Collection bills means payments are made to sellers through sellers' banks without issuance of LC. While "Open Account" means payments are made directly to sellers without opening an LC. Collection bills and "open Account" were introduced merely because buyer and seller trust each other and had established business relationship for some times. The facility comes with its repayment term normally between 30 to 120 days. It can be extended until 180 days depending on nature of business and the borrower's cash conversion cycle (CCC). Bankers prefer a maximum tenor of 120 days only. Premature settlement is allowed. No minimum amount.
Bankers Acceptance (BA) - 2 types of BA i.e. Purchase BA and Sale BA. Purchase BA mean money are given to finance the purchases based on Delivery Order, invoices etc while sales are used to discount the Borrower's claims/invoices to its clients. It comes with financing tenor just like TR but premature settlement is not allowed as BA is one of Money Market instrument and shall be traded by a third party. I am not going to give the reason why no premature settlement is allowed for BA. It will be in my next topic. Minimum amount to use BA is RM50,000 but can be in multiples invoices. This facility is very famous among the businessmen and "Ah Long" as this is the easiest way to get money from banks which much cheaper interest rate. Compared to TR with interest rate is against the Base Lending Rate, BA is against the prevailing money market rate which is usually 2 or 3 times cheaper than TR's rate. Bankers only deals with documents and not goods/products. Ah Long comes into the picture because invoices or DO are easily be created among themselves and no actual goods are transferred. Therefore, most conservative banks restrict giving BA to small companies, sole-proprietorship firms and partnership firms to avoid manipulation.
Bank Guarantee BG) - is an undertaking by a bank on behalf of its borrower to a third party. Famous BG are Performance Bond, Tender Bond, Advance Payment Bond and Security Deposit for TNB, TM, Customs etc. It does not provide cash. It comes with liabilities period normally up-to 1 year or 5 years for government as beneficiaries.
Standby LC (SBLC) - it just like a BG but can be used internationally as a security for credit facilities.
Besides the above facilities, there are many others such as ECR, FBN, FBP, TOD, Block Discounting, End Financing etc etc etc. However, they are not as famous as the above mentioned credit facilities except the called revolving credit which is usually given to corporate clients.

For information, Hire Purchase, Leasing credit and charge cards are not parts of credit facilities hence do not attract stamping of legal documents at ad-valor em.

Assessment Of Management

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The success and long term survival of a business depends largely on management acumen. Experience tells us that management weaknesses or mistakes are, directly or indirectly, responsible for some 70% of all corporate failures. It is vital, therefore, that the creditors must make the afford to really get to know management in order to be able to assess their entrepreneurial skills.

Getting to know management is not simply a question of dining or launching with them often. Through regular visits, creditors must assess the management's understanding of the business, whether they appreciate the potential risk and whether they have a clear strategy. Simply because their company is successful today does not mean that it will be successful in the future. Capable management has vision and are transformational in character:

Many smaller companies, particularly family business, are driven by entrepreneurs or by the head of the family. Do they have sufficient professional support in key position or do the take all the decisions themselves?
Is there a strong person in the finance side, who understands the needs for proper controls and processes to be in place? It is possible the person is competent but is relatively junior and not able to or willing to stand up to the owner. This can often be seen in the title given to the person.
Companies are often successful when small but get into problems as they expand and when business becomes more complex.
Does the owner has a extravagant life style? Is the family well regarded within the local community?
Commence delinquency regularisation and monitoring.
Are senior management transparent and prepared to admit when there is a problem?[Are there sufficient control in place, or is too much autonomy given to subordinates, which could lead to abuses?
Has the owner set up a corporate structure that is excessively complicated?
As the original owner hands power to his children, are creditors satisfied that the children understand and committed to the business?

The key element is whether the creditors could trust them!

Do not assume that the quality of the company's management is sound just because, it is a public listed company. Listed companies in Malaysia are still largely family owned and run in a dominant manner, particularly when there is a strong owner /founder at the helm.

Creditors are to consider whether the company has lived through a number of economic cycles and if expansion plans, particularly into unrelated sectors or territories are justified - many groups have gone into untested sectors or countries that have caused them many problems.

Always be on the look out for early signal of troubles....

2008-08-01T21:50:00.000-07:00