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You sell a product. The banker sells loans. So you and your banker probably have the same perspective when it comes to business, right? Well, not quite. Selling loans is different than selling a product. Let’s think about it for a minute.

How do you work with customers? You deliver the product, they pay you, the transaction is completed. What the customer does with your product after that is important to you, but not critical to the survival of your business. You do not ask your customer to return the product when he is done with it. In fact, the last thing you want is to get the product back; if you do, that means there is a problem.

How does the banker work with you? He gives you his product (the loan), you use it, you return it to him when you are done, and you pay for the product (in the form of interest) when you are done with it. What you do with the product/loan while you have it is of great concern to the banker, and he very definitely wants you to return it when you are done using it. The last thing the banker wants is for you to keep the loan proceeds; if you do that means there is a problem. To make sure you give it back, the banker requires you to sign a loan agreement, a personal guarantee, and a pledge of your personal assets.

Can you imagine if you tried that? What if you could say to your customer: “Please buy my product. You will? Here it is and, oh by the way, you know I want it back when you are done, right? Yes, you paid for it, but you still need to return it to me when you are finished.”

Here is the crucial factor: You have to get rid of your product to achieve your target return on investment. The banker has to get his product back to achieve his target return on investment. Why is that? It has to do with leverage.

A bank is a very highly leveraged business entity. This is a fancy way of saying that the bank’s owner only uses about 10% of his own money in the business; the rest is borrowed. Can you do that? Of course not! As a general rule, most companies must have at least 30% of their own money as capital if they are going to survive over the long term.

Being highly leveraged means the bank cannot absorb any significant loss. It takes only a few unpaid loans to wipe out a bank’s capital. You can better absorb a loss than the banker can, assuming you and the banker are properly capitalized. Here’s an example, assuming you are 30% capitalized and the bank is 10% capitalized (a bit high, as many banks’ capital ratio is between 5-10%):

If only five $2,000 loans are not paid, the bank’s capital is gone. Zero. If you lose $10,000, you still have $20,000 in capital. A $10,000 loss and the bank’s capital goes from 10% to 0%. A $10,000 loss for you means your capital goes from 30% to 22%.

This is important for you to know and understand when you approach a banker for financing. Since they cannot afford significant losses, they are not going to make loans they consider risky, i.e., won’t be repaid. You need to make it as easy as possible for the banker to understand that you are a good credit risk. Keep in mind the banker looks at many deals every day, searching for the few that are low risk.

How do you make it easy for the banker? By remembering that there are three basic questions the banker needs answered:

1. What is the purpose of your loan? Once you receive the funds, exactly how will you use them? What caused the need for you to borrow in the first place?
2. How will you repay the loan? This deals with amount, source and timing. Will you repay the loan in one lump sum at the end of a specific period of time? Will you be making periodic payments and, if so, how often and how much? Regardless of amount and timing, what exactly is the source of funds for repayment; in other words, where will the money come from to repay the loan?
3. What collateral can you offer? The best laid plans can go awry. If your primary repayment source is no longer available, what alternative sources of funds do you have? Savings? Personal funds from a guarantor? Liquidation of assets?

So the next time you need financing for your business, remember the banker’s perspective. Give him the information he needs so you can get the loan you need. When you show you understand his requirements, you make it easy for him, and easy for him to grant your loan request.

For more articles on Credit Management, visit Kaufmann’s Capital Comments.