Stronger Financial Statements Earn Better Financing Options
Obtaining the most favorable financing depends on having the kinds of financial statements that lenders want to see. Before seeking funding for a de novo build, an upgrade to an existing imaging center, or new modality purchases, it is important to understand the commonly used types of financial statements, the kinds of financing typically considered by imaging centers and how they affect financial statements, and the key factors that impress lenders enough to make them offer the best financing options. Financial Statements The balance sheet, the profit-and-loss statement, and the statement of cash flow are the common financial statements expected by lenders. Taken together, they give the lender an overview of the organization’s strengths, weaknesses, and probable ability to repay a loan. Obtaining financing depends on presenting convincing financial statements, so great care should be taken to ensure their accuracy. The balance sheet constitutes a snapshot of the center at a fixed point in time (Figure 1). It indicates the financial strength of the organization and outlines its equity, assets, and liability. On the balance sheet, total assets will be divided into cash, fixed assets, and other assets. Total liabilities will include accounts payable, accruals, lines of credit, and long-term debits. Total equity includes retained and current earnings. Instead of covering a fixed time point, the profit-and-loss statement (Figure 2) covers a given period of time. It gives the lender an overview of the center’s profitability and includes revenues and expenses. The statement of cash flow likewise covers a fixed time period, and it gives the lender an idea of the center’s ability to generate positive cash flows. This statement incorporates a profit-and-loss statement, but this version is adjusted for noncash components. Once financial statements have been generated, lenders will apply seven ratios (Figure 3)to their content to evaluate the organization’s financial prospects. These ratios tell the lender whether the center has too much liability for its currents assets, whether it is likely to be able to make payments on future debt (given its current obligations), and whether any problems with day-to-day cash flow might impair its ability to remain a going concern.
Figure 1.
The ratio analysis applied to a potential borrower will probably include liquidity/solvency ratios (current assets to current liabilities and current liabilities to net worth); debt-management ratios (total debt to total assets, total liabilities to net worth, and earnings before interest and taxes to interest expense); and profitability (net income to net revenue and net income to average total assets). Asset Financing Because it may have significant effects on the practice’s financial status, both immediately and over the longer term, the type of financing that the center will seek should be considered carefully. In particular, the effect that today’s financing choices will have on the appearance of the future balance sheet should be remembered, because that balance sheet, in turn, will affect the kinds (and terms) of financing offered by lenders in the future. Asset-based financing can have varying effects on a financial statement, based on the type of loan involved. For example, factoring (borrowing against the future value of assets) does not lever up the balance sheet by adding debt, but leasing may, depending on the kind of lease chosen. A capital lease appears on the balance sheet (but the leased equipment is also treated as an asset); an operating lease is not shown on the balance sheet.
Figure 2.
Tangible or intangible assets may be used as security in asset-based financing. In essence, the organization uses what it can reasonably be expected to have at a future date to secure the cash that it needs now, through factoring or leasing. These arrangements have short-to-medium term lengths, since long-term financing would require a better prediction of future value than can be made reliably, in most cases. Factoring can be based on accounts receivable or on future credit-card receipts. In either case, the lender offers cash today in return for a percentage of the center’s future income. Accounts-receivable factoring is based on the known value of current receivables and is collected over the term of the loan, which generally lasts less than a year. The interest rate is often high, in the mid teens to low 20s.
Figure 3.
Credit-card factoring has similar interest rates, but may have a longer term (although it is still usually less than three years). It is based on the unknown value of future credit-card receipts, of which the lender takes a set percentage (often 5%). Factoring may have a harmful effect on future cash flow. Interest paid to the lender is imputed in factoring arrangements, so it may not constitute a tax deduction for the borrower. Leasing is a more predictable form of asset financing that is generally tied directly to the purchase of a tangible asset, such as a piece of equipment. In addition, some leasing arrangements will include the costs associated with the asset, such as scheduled maintenance and repair contracts. The term length of a lease will depend on the useful life of the asset being leased, and may be as long as five years. Effective interest rates for leasing generally range from the mid teens to the high teens. Leasing usually involves a fixed period of time, and it may be difficult for the center to withdraw from an established lease. Equipment that has been leased cannot typically be borrowed against for future financing. Debt Financing Debt-based lending is the most common form of financing, but it appears on the balance sheet, so it will affect the center’s ability to qualify for attractive financing offers in the future. Interest is tax deductible, with interest and principal clearly separated for payment purposes. Debt financing can be hard to terminate, with many arrangements incorporating penalties for early repayment (or restricting the borrower’s ability to pay off the loan ahead of schedule). Other borrower actions may also be prohibited or required through restrictions or covenants built into the loan. Assets are needed to secure debt financing, but these may be the facility itself; its furniture, fixtures, and equipment; or the personal property of the owners. Flexibility is a major advantage of debt financing, with many loan structures available. Origination fees are paid at the beginning of the term, but interest rates are often low (within a few points of the prime rate). While debt financing can take many forms, the most common are fixed loans, working-capital lines of credit, and revolving loans. Fixed loans are often secured by the asset for which they are sought, such as the equipment or building purchased with the loaned funds. The term length can be as short as overnight or as long as 30 years or more. A working-capital line of credit, in contrast, is not tied to a single event or purchase and can be used as needed during the lending period (or left unused, if never required). Its term is usually less than three years. A revolving loan is similar, being drawn upon and repaid as needed, but is intended to cover recurring events. It is an ongoing structure that may have an indefinite term length. Equity Financing Equity lending is generally used by large organizations and can be very costly, with interest rates in the 20s to 30s. It has a beneficial effect on the center’s financial statements because it does not lever up the balance sheet by increasing the debt side of the debt-to-equity ratio. Loans are generally made for mid-length to long terms. Small organizations may consider using equity financing when they need limited amounts of cash and do not wish to acquire it through traditional banking channels. If the funding is needed for a startup or a special project, the lender may require the center’s owners to make a precursor (qualifier) investment of their own before it will consider offering financing. The lender will typically expect a payout from retained earnings. What Lenders Seek The primary consideration for lenders in reviewing a facility’s financial situation is cash. The center’s cash status will probably be the deciding factor in the lender’s willingness to proceed with a transaction, whether that status is evaluated in the form of earnings before interest, taxes, depreciation, and amortization; free cash flow; or cash flow from operations. In addition, the opinion of lenders is influenced by the degree to which the center has performed due diligence, with thorough planning and independent research acting as favorable marks for the center. For this effort, strong leadership is needed. This may be available internally, but centers without such expertise available to them should not hesitate to seek help outside the organization. Lenders are looking for a healthy (or clean) balance sheet, without any instances where new debt has repeatedly been piled on top of older debt. It may surprise some of a practice’s physician-owners to learn that their own individual credit ratings are also of major importance to lenders in determining whether the practice itself is worthy of credit. Because many lenders will require personal guarantees from the physicians, their own personal finances must be strong statements in their favor. Max Reiboldt, CPA, is managing partner/CEO of the Coker Group, Alpharetta, Ga; This article has been adapted from Strengthening Your Financial Statement to Facilitate Financing for Your Imaging Center, which he presented on September 19, 2007, at the Diagnostic Imaging Leadership Forum sponsored by Washington G-2 Reports and held in Arlington, Va.