Every business needs some resources to function properly. It’s important in credit assessment to get a feel for how well these resources are managed and maintained. These resources can be broadly classified as;
- Physical resources; this would typically be property, plant and equipment, vehicles and so on
- Financial resources; for example, capital and access to external funding such as bank loans, and
- Human resources; this of course would be skilled workers, unskilled workers and staff
Let’s take a look at some of the key components of these internal resources and some of the questions we might ask. For the moment we can leave the financial resources out of the discussion as we will come to that when we consider the business’s financial position in later posts.
Property; we will be interested to know whether the property from which the business operates is owned or leased and whether it’s in good condition and suitable for the purpose of the business’ operation. The reason for this is that, if the property is owned by the business, it might give us an opportunity to obtain some tangible collateral. To explore this possibility further, we would want to know the current market value of the property and whether there is already a mortgage bond registered in favour of another lender. Even if we don’t require collateral, any surplus value in the property will certainly serve as a potential secondary source of repayment should something go wrong with the business’s cash flow in the future.
If the property is leased, important questions to consider are the length of time remaining on the lease, the current lease payments and the annual escalation clause, if any, so that we can get a sense of current and future financial commitments and whether the lease payments will put a strain on future cash flow.
Finally, whether the property is owned or leased, we would want to ask whether there will be a need to expand or to move to alternative premises in the near future.
Plant & machinery; is there a need to replace plant and machinery? Is it well maintained and is it reasonably up-to-date technology? What will be the cost of replacement and has the business made any provision for replacement?
Vehicles; does the business own a fleet of vehicles and, if so, is it in good condition and well maintained? Is there a need for replacement or for additional vehicles in the near future?
Labour; we will want to know about the labour component as far as it might impact on the business’ operations. For example, if the workforce is highly skilled because the business provides a very technical service to its customers, its continued operation would be reliant on the workforce being retained and fully functional. There is a risk in this case that, if there are generally very few people available with the necessary technical skills, the current workforce will wield more power over the management than would normally be the case and it may be difficult for management to implement policies and procedures that may not be to the advantage of the workforce. Also, consider how close the business is to its labour resource – does the workforce have to travel long distances to get to the business and is there a supply of labour available?
Operational capacity; this refers to whether the business is operating at full capacity or can still increase its operational output without requiring additional resources such as factory space, warehouse space, labour and so on. This will give us an idea of whether the business can grow its revenues without additional investment in fixed assets or working capital as doing so will enable it to generate additional free cash flow.
Forex; does the business deal in foreign currencies, either by making sales overseas or buying materials and inputs from a foreign supplier? Are forward exchange contracts used to fix the local currency value at the time of order/sale? Are Letters of Credit required for imports of raw materials or other inputs? Is there a danger of transfer risk or convertibility risk?
In our e-book, Business Lending Essentials Part 1; Assessing Business Risks, we set out some background to this analysis and provide some tools and techniques to enable analysts to apply a logical approach to the assessment of a business. The ebook is free and can be downloaded from www.businessbankingcoach.com by clicking here.