In the first series we discussed Know Your Banker (KYB) or Suffer Your Banking (SYB), the importance of understanding where your bank slots you in their segmentation and the beginning of a bank’s lending principles.

We continue with another principle of lending, almost the touchstone of lending, known as ‘source of repayment’. As elementary as it may sound, this is missed frequently by borrowers and often by lenders, causing delays in approval and often delay in repayment, to the detriment of all stakeholders. Bankers lovingly call this the First Way Out and as the phrase implies, it is the first way by which the loan is repaid.

The classic example of such facility is the discounting of a post-dated cheques. These are dues of the borrower arising from sales done or service rendered. The bank holds on to the cheques and on due date gets paid directly from the realisation of the cheques. Another similar example is assigning dues from debtors so that on due date the bank is clear with a high element of certainty as to where and from whom are the funds emanating to settle the dues. The repayment is not dependent on the borrower’s intent or action but independent of that. This is known as sales-side funding.

Understandably, not all businesses are be able to provide such an opportunity, particularly if the commercial and competitive terms are not conducive or debtors are spread across continents with payment risk borne by the borrower in the absence of any underlying instrument of payment such as a Letter of Credit or postdated cheque. However, if a means is found to provide such repayment, even partially (in your total facilities if a portion is carved so as to build in a direct repayment to the bank, preferably in a legally binding form) then the chances of the lender willing to provide the facilities increases significantly. This also strengthens your negotiating power to seek a lower lending rate as you have lowered the risk of repayment for the lender.

Need a golden bullet to inflate your P&L, Balance Sheet and get extra funding? That bullet is called Inter-Company receivables. Beware though, that this can work both ways; it can return back to puncture a hole in your ability to borrow. Inter-company dues are an anathema to the lender. All that you as a borrower need to do is raise an invoice, credit the sales account, debit the debtors account and voila! There is growth and there is need to borrow. Lenders regard this with utmost suspicion and shy away from credits with large intercompany dues. In many cases, however, the need is genuine; such as a new market where you trust only your associate entity to hold the inventory and assume the local risks. Your approach then is total transparency and offering recourse to the lender on the receivable.

First, clarify the nature of the dues — that these are indeed trade dues and secondly, explain what the underlying receivable represents. For instance, does the due represent inventory held by the associate, or is the underlying due representing customer dues of the associate? The lender would rework the working capital cycle based on this assessment. On the comfort side, try and offer a legally enforceable corporate guarantee of the associate so that the lender has, on paper, recourse to the assets of that company.

Additionally, have your auditors consolidate or combine the financials of all entities so that the lender gets a true picture of the financials after all inter-company balances are netted out. But be prepared to raise your equity and pare your banking limits if your business indeed has high intercompany transactions and the clarity or comforts are not forthcoming.

Once you have explained your business model and structured your lines such that there is clarity in the end use of funds, source of repayment and addressed inter-company issues, you help your banker in helping you to obtain the requisite funding. Once again, recall the principle of KYB or SYB! In the next session we shall focus on the favourite financial X-rays (read ratios) your bank loves to see, to diagnose your worthiness.

— Akshay Dasani, a seasoned corporate banker is a director at Clover Banke and Resurgent Consulting