Indirect Costs and Loan Conditions

Besides the direct financial costs of a business loan, you'll also want to consider these indirect costs and conditions:

Periodic reporting. Lenders will typically require periodic reports on the status of your business. Reporting requirements on a small business loan can vary, but local community banks will probably require only quarterly and annual financial statements (your balance sheet and income statement) and annual personal financial statements and income tax returns. However, if the loan is secured by accounts receivable (or sometimes inventory), monthly reporting and aging statements on these items will be required.

Not all banks require that the reporting documents be prepared by a CPA, but even if they do, they may be satisfied if the professional has simply prepared the final compilations. Depending upon the bank's staff and the amount of lending done, banks vary on the degree of scrutiny given to the reports. Some smaller, local banks rarely confirm the accuracy of these financial statements by any type of independent audit, and as long as a quick review reveals no significant problems, the reporting requirements are usually considered pro forma. As one banker noted, "In 15 years, I've only had five loans where the bank became significantly concerned due to unfavorable financial reporting requirements, and all of the situations were resolved after conference with the borrower."


The lender needs monthly statements for a loan secured by accounts receivable because the accounts must frequently be "aged" to assess their value and because the loan-to-value amount is constantly changing. For instance, assume a bank gave you a small working line of credit for $30,000, secured by your accounts receivable. On receivables that are under 60 days old, the bank has agreed to extend 75 percent of the value of those receivables. Monthly reporting on the receivables is necessary so that the bank can ensure that the loan remains secured by at least $40,000 of receivables that are under 60 days old.

Financial covenants. Conventional lenders typically include a variety of covenants and restrictions in the loan agreement. Some banks may place restrictions on the use of loan funds, require proper maintenance of business facilities (e.g., insurance coverage), require maintenance of key financial ratios such as debt-to-equity ratio, current ratio, and coverage of fixed charges ratio, as well as minimum working capital balances, restrictions on the amounts of dividend payments and salaries, mergers and acquisitions, and limits on secondary or further pledges of assets.

Some smaller community banks are less demanding because they don't want to spend the time and money policing covenants. Often, the covenants required by community lenders will limit the use of financial ratios; instead, these lenders may include only boilerplate provisions governing maintenance of the collateral, requiring an informal depositor relationship and a subordination agreement, and restrictions on using the collateral as security for any other loans.

Subordination agreement. This agreement stipulates that all corporate obligations such as rights of shareholders, officers, and directors are subordinated (made lower in priority) to the bank loan. Default of these terms can mean foreclosure on secured assets. Nearly all small business commercial loans allow the bank to "call" the loan due if the bank feels that repayment is seriously threatened.

Personal guarantees. In addition to the requirements discussed above, your lender may require that you personally guarantee repayment of the loan.