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Adding up the commercial benefits

One of the fundamental questions asked by commercial lenders when assessing loan applications is whether the business is profitable and represents an acceptable risk.

For brokers operating in the commercial mortgage market, it is beneficial to understand what lenders look for. This doesn’t necessarily require an accountancy qualification but rather familiarity with the terminology and the primary calculations involved.

Most brokers are aware that gross profit is a basic figure derived from total sales or turnover minus the cost of sales or production. Gross margin is expressed as gross profit divided by turn-over multiplied by 100.

When assessing the viability of commercial deals, a steady or increasing trend in gross margin should be evident from business accounts.

But gross profits or margins don’t paint the complete pic-ture, so lenders also look at net profits and margins before tax, which show the effect of fixed costs and overheads on applicants’ business.

The ideal is an increasing trend in net margin before tax. A stable gross and falling net margin before tax simply means fixed costs are increasing, which can be determined by a swift analysis of firms’ profit and loss schedules.

To assess the risks associated with a declining trend in margins, it’s important for full status lenders to seek two or preferably three full-year trading figures. Self-cert or non-status lenders expect accountants’ declarations of affordability in lieu of tangible trade accounts.

Sales growth is also examined to assess how businesses are expected to perform in the future. But forecast sales growth of more than 25% will be viewed cautiously unless a clear and con-cise explanation can be given as to why such increases are anticipated.

Another point to remember is that increased sales do not automatically generate extra profit. Indeed, an improvement in profit margins due to andy youngis chief executive of The Business Mortgage Companycost reductions will be more beneficial than sales growth unaccompanied by a profit margin increase.

Key to any lender’s decision to support a commercial or semi-commercial mortgage application is serviceability – the ability to repay debt over a real- istic term. Typically, when presented with accounts, a status lender will determine a business’ ability to repay by assessing net profit before tax plus depreciation minus dividends after tax.

In the commercial mortgage market, having a grasp of these accounting basics will allow brokers to identify viable deals and select appropriate lenders before going ahead with applications. It will also help them to avoid cases that are likely to fail.

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