Financial Lending Notes
October 30, 2009

Are Borrowers Getting the Right Service?

Along with an attorney, the banker and accountant are two members of what is often referred to as the small business owner’s triad of advisors. The partnerships between and among these advisors are crucial to a business’ success, which makes open communication and dialog between you and your client’s accounting professional crucial.

One common area of misunderstanding between bankers and accountants has to do with the type of service accountants provide to small business borrowers. Accounting firms offer three primary levels of assurance: compilations, reviews and audits. As a lender, you should find out which level of service your borrowers are receiving so you’ll know how to view the financial information you receive from them.

Levels of Assurance

Accountants providing compilations should be familiar with the accounting practices of the client’s industry and have a general understanding of the company’s business transactions and the form of its accounting records. The accountant assembles information supplied by the client into financial statement format, but no explanation or analysis of the data or degree of assurance as to its accuracy is provided.

If a borrower is receiving this level of service, you may wish to consider whether he or she has the expertise to analyze the numbers and keep you informed about the financial state of the business. If the borrower does not, it might be wise to advise the owner to talk with his or her accountant about receiving a higher level of accounting service.

With a review, the accountant provides a limited degree of assurance that no material modifications are necessary for financial statements to comply with generally accepted accounting principles (GAAP). He or she will make specific inquiries related to the financial statements and apply analytical procedures to test management assumptions and identify any unusual items.

One benefit of a review over a compilation is that it could potentially identify internal control weaknesses or departures from GAAP. The economic turmoil of the past couple of years has heightened the risk of fraud for many businesses, and tightening up internal controls is the most important step owners can take to minimize this risk.

An audit is the most comprehensive level of assurance an accountant can provide. The auditor will express an opinion as to whether the financial statements are free of material mis-statements and presented fairly in accordance with GAAP. The auditor tests underlying financial transactions and documents the client’s internal control systems. As part of the process, the accountant will also confirm assets and liabilities with outside parties, review and evaluate internal controls, and inspect transactions and supporting business documents.

Other Services

Note that there are other services that fall somewhere between these three primary levels. Tax returns may suffice for very small companies. And, for larger companies using compilations, field audits of certain accounts (such as accounts receivable or inventory) can provide an added level of assurance that the financial statements being submitted are accurate.

Especially in today’s tight credit environment, your bank likely has increased requirements regarding the level of assurance you need from many borrowers. While it won’t make sense for every small business to have an audit or review, you can encourage your borrowers to talk to their accountant about the potential benefits of receiving more comprehensive financial information, such as listings of accounts receivable and payable agings, cash flow projections and assumptions.

The key is to position this as a value-added benefit, rather than an additional cost. Quality financial information can help an owner run his or her business more profitably. This, in turn, will help make the company a better borrower.

Communication is Key

As noted earlier, communication between bankers and accountants is critical to a borrower’s financial success.

For example, bankers sometimes call their clients’ accountants to inquire about why they haven’t received a borrower’s financial statements or tax return yet. More often than not, the accountant is waiting on critical information, or even payment, from the borrower. This is potentially valuable information for you, as it may indicate financial or cash flow problems at the company that you weren’t aware of.

More importantly, with the right financial information, you can add tremendous value to your relationships with small business borrowers. Your understanding of their business and industry, combined with your knowledge of how the bank’s products and services can best help them, can help borrowers improve their financial performance and profitability.

Be proactive by getting to know the CPAs who prepare financial statements received by your bank and cultivating relationships with them. Ask your clients to authorize their accountant to speak with you about their business. This way, they’ll be more candid and responsive when you ask specific questions.

The bottom line: Working closely with your clients’ accounting professionals will make it easier for you to get the detailed information you need to underwrite small business loans. In today’s challenging credit environment, this is more important than ever.

Please contact our office to discuss how we can work together to provide added value to your clients.