For some people borrowing from a bank is a mystery ­ but it shouldn't be. Although each bank may have lending criteria they weigh differently, the fundamentals of forming a positive and lasting banking relationship with a family-owned business are surprisingly similar. Most banks will measure a family business against the following "10 Point Check List."

1. MANAGEMENT SUCCESSION PLAN: One of the first issues for a banker when presented with a request from a family-owned business is succession planning. Be prepared to answer the following questions:

• Do you have a management succession plan? If you do not, you will likely be asked to carry key-man life insurance and pledge the insurance to the bank.
• Does the plan require your successors to buy the company? The bank will need evidence that your heirs will have the financial capacity to make the purchase.
• Do you plan to withdraw any portion of the company's capital base when you leave?
• Are your heirs prepared to take over?

2. FINANCIAL APTITUDE: The family management team must be financially astute. This does not mean that each member must be trained as an accountant or hold a degree in finance. But, it is expected that the owners understand and play an active role in the company's financial reporting and internal financial systems.

Owners should design internal checks and balance systems to ensure the safety and reliability of their financial reports. They should review the financial reports regularly and address any inconsistencies quickly.

3. CASH FLOW: Revenues do not repay loans, cash does. It is precisely because of this that banks look at earnings leverage (cash flow to debt service requirements) rather than traditional leverage (debt to worth).

A company may have a very low leverage (typically thought of as debt to worth of less than 1:1), but still may not satisfy debt obligations because earnings are not resulting in a positive cash flow.

4. MANAGING MARGINS: Margins are the difference between what you pay for your inventory, or personnel in the case of a service providing business, and what you receive (not to be confused with charge) for your goods or services.

There are two factors at play here ­ pricing and costing. Although often used interchangeably, they are not the same.

Pricing relates to the amount you charge. This can be the most dangerous tightrope act you perform each day. You must set your prices to remain competitive, but still cover costs with a positive margin.

Costing relates to how much it costs you to acquire, produce and deliver your product. Many companies focus solely on the cost of their raw materials or other inventory purchases. This is a piece of the puzzle but you need also consider storage, manufacturing, shipping, financing costs, obsolescence, and administration. We see many companies that think they are making money, but when they peel back the layers and see what their product really costs, they find that they aren't. That brings you back to pricing. Can you adjust your price to cover your costs and remain competitive?

5. PERSONAL FINANCIAL MANAGEMENT: The way an owner manages their personal finances is indicative of how they will manage their business. A debt adverse person is not comfortable if their company is highly leveraged. The reverse is also typically true. A person with excessive personal debt and a credit report which reveals chronic past due payments is often the bank customer with repetitive overdrafts and past due business loan payments.

A bank will look to your personal financial management as evidence of your responsible use of debt.

6. GROWTH PLANS: Most businesses plan to grow over time. A business either grows or runs the risk of being eliminated by competition. In some cases owners have reached the maximum achievable profit. They found that adding revenues either didn't add to the bottom line or actually reduced it due to additional costly resources (e.g. additional personnel, larger facility, and expensive equipment).

The company that does plan to grow must quickly address the issue of financing. Banks will only be interested in financing your growth if it translates into profits

7. SOPHISTICATION AND ACCOUNTABILITY: Nearly all bank relationships require timely financial reporting. A bank will want to see that the sophistication and reliability of the financial statements reflect the size and complexity of the company. As your company grows, so will this requirement ­ from company prepared statements, to compilations, to CPA reviews, to annual audits. Part of your job is to know when it is time to bring in additional staff or professional partners (e.g. attorneys, CPAs, tax specialists, trust administrators.

The second part of this is accountability. Being forthright with your bank and suppliers should never be taken for granted. A bank will expect you to perform to the levels you present in your projections and to raise your hand if something goes awry. There is no need to be embarrassed or worried. Bankers and vendors are very aware that any business, from time to time, may experience problems.

If there is to be a change in your company, whether this is a management or earnings change, don't let your banker be the last to know. It is easier for bankers to accommodate these changes up front rather than deal with them after the fact. Think of your banker as your personal spokesman in a large corporation. They will be more effective as a spokesman if they have ample information. Your banker can easily lose their credibility if they don't know what's going on. Remember that their goal is to represent you.

8. SECONDARY REPAYMENT SOURCE: The primary source of repayment on most business loans is the earning stream of the company. Banks will, however, look for a secondary repayment source. These are typically assets like A/R, easily saleable inventory, equipment, real estate, or personal guarantees.

Be prepared to provide documentation to back up the value of your secondary repayment source. This may be in the form of A/R agings, inventory listings, or an appraisal of your equipment or real property. For inventory or A/R, you may need to provide monthly or quarterly updates so that the bank can verify that the value of the collateral does not decrease beyond some acceptable level.

In the case of personal guarantees, you will be asked to provide personal financial statements that detail your annual sources, uses of cash, as well as your personal assets and liabilities. A "strong" guarantor will have liquid assets sufficient to cover all personal debt requirements, with excess available to support business debt payments.

9. INVENTORY CONTROL: Inventory can be a company's most manageable cost, but is often the most mismanaged and costly asset. When a bank takes inventory as collateral, they look for assurance that the inventory number reported on your balance sheet reflects an accurate and reliable value. They will want to assure that the balance sheet does not contain obsolete inventory and is regularly adjusted for shrinkage.

Do you really know what you have in your warehouse? Some forms of inventory are prone to theft, obsolescence, or are perishable. You should have a physical inventory regimen and inventory reconciliation system appropriate to the type and number of inventory items you carry. Many companies perform weekly, or even daily, spot item checks, or cycle counts.

10. INDUSTRY RISK: Each industry has its own inherent risks. Bankers will want to see that you are on top of trends in your industry. They will also ask you how you hedge against risks for which you may have little control, like changes in state or federal regulations, or economic swings.

One of the most obvious and universal risks today is technology risk where new products and existing product improvements occur at a blinding rate of speed.

No matter what you manufacture or what service you provide, there is another business trying to do it better, faster, cheaper, or is on the brink of inventing something which could render your product obsolete. Because of this, banks feel more comfortable with companies that have at least some product diversity.

Technology changes apply not just to the product you sell, but to the way you advertise and sell it. The Web has opened up an entirely new channel of distribution for businesses to either contend with or embrace. No matter what your comfort level is in dealing with the Internet, it is a fact of business reality and it's here to stay.

Qualifying for credit in a family-owned business is not as simple as meeting a satisfactory current ratio. Bankers are interested in your family business financial story. Work with your banker by telling them where you plan to take the business and how you plan to get it there. Use your banker as the family's advocate when you find the need to take the next financial step.

Jan Jemelka is a vice president with Bank One, Texas.
For an expanded copy of this article, please contact Nancy Pledger at 800.406.1112 or Jan at 214.290.2615 or by email jan_l_jemelka@mail.bankone.com