• SBA’s 7(a) Loan Guaranty Program: This program is the SBA’s primary lending program and was designed to meet the majority of the small business community’s financing needs. In addition to general financing, the 7(a) program also encompasses a number of the SBA’s specialized loan programs summarized in the table below:

• SBA’s Microloan Program: This program works through intermediaries to provide small loans from as little as $100 up to $25,000. Under this program, the SBA makes funds available to nonprofit intermediaries; these, in turn, make the loans.
• SBA’s Certified Development Company (504 Loan) Program: This program, commonly referred to as the 504 program, enables growing businesses to secure long-term, fixed rate financing for major assets, such as land and buildings. A certified development company is a nonprofit corporation set up to contribute to the economic development of its community or region. The program is designed to enable small businesses to create and retain jobs; the CDC’s portfolio must create or retain one job for every $35,000 of debenture proceeds provided by the SBA.
• SBA’s Certified and Preferred Lenders Program

Test your skills at matching the loan request on the left with the
appropriate borrowing arrangement on the right.

Loans are one of the most common sources of funding for a small business, but obtaining a loan isn’t always easy.  Before you approach your banker for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider making you a loan. This lesson discusses some of the key factors that the bank uses to analyze a potential borrower. We have
included a self-assessment checklist at the end of this section for you to complete before moving ahead to Preparing a Loan Request.

KEY POINTS TO CONSIDER
Let’s begin by exploring some of the key points your banker will review:

1. Ability to Repay/Capacity
The ability to repay must be justified in your loan package. Banks want to see two sources of repayment — cashflow from the business, plus a secondary source such as collateral. In order to analyze the cash flow of the business, the lender will review the business’s past financial statements. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years because they have a financial track record. If the business has consistently made a profit and that profit can cover the payment of
additional debt, then it is likely that the loan will be approved. If however, the business has been operating marginally and now has a new opportunity to grow or if that business is a start-up, then it is necessary to prepare a thorough loan package with detailed explanation addressing how the business will be able to repay the loan.

2. Credit History
One of the first things a bank will determine when a person/business requests a loan is whether their personal and business credit is good. Therefore before you go to the bank, or even start the process of preparing a loan request, you want to make sure your credit is good.

First get your personal credit report. You can obtain a report by calling TransUnion, Equifax, TRW or another credit bureau. It is important that you initiate this step well in advance of seeking a loan. Personal credit reports may contain errors or be out of date. In many cases, people find that they paid off a bill but that it has not been recorded on their credit report. It can take 3 to 4 weeks for this error to be corrected — and it is up to you to see that this happens. You want to make sure that when the bank pulls your credit report
that all the errors have been corrected and your history is up to date.

Once you obtain your credit report, how do you know what it says? Many people receive their credit reports yet have no idea what the strange numbers signify. The following should help in interpreting and checking your personal credit report.

First, check your name, social security number and address at the top of the page. Make sure these are correct. There are people who have found that they have credit information from another person because of mistakes in their identification information.

On the rest of your credit report you will see a list of all the credit you have obtained in the past - credit cards, mortgages, student loans, etc. Each credit will be listed individually with information on how you paid that credit. Any credit where you have had a problem in paying will be listed towards the top of the list. These are the credits that my affect your ability to obtain a loan.

If you have been late by a month on an occasional payment, this probably will not adversely affect your credit. However, if you are continuously late in paying your credit, have a credit that was never paid and charged off, have a judgment against you, or have declared bankruptcy in the last 7 years, it is likely that you will have difficulty in obtaining a loan.

In some cases, a person has had a period of bad credit based on a divorce, medical crisis, or some other significant event. If you can show that your credit was good before and after this event and that you have tried to pay back those debts incurred in the period of bad credit, you should be able to obtain a loan. It is best if you write an explanation of your credit problems and how you have rectified them and attach this to your credit report in your loan package.

Each credit bureau has a slightly different way of presenting your credit information. You can get specific information on "how to read the report" form the appropriate company, but here’s a few tips to get you started:

TRW
In the last few years TRW has prepared credit reports with words and not numbers. Good credits should read "Never Late", "Paid as Agreed". Poor credits will read as

TransUnion
On the right side of the page on the credit report are number and letter combinations. "I" means installment credit. "R" means revolving credit. The key information is in the numbers. A "1" means perfect credit since you have always paid your bills on time. "2" or "3" means you have been 2 to 3 months late in paying your bills. Too many of theses will hurt your chances in obtaining credit. A "9" means delinquency in paying your bills and a charge
off. This could make it difficult in obtaining a loan.

If you need assistance in interpreting or evaluating your credit report you can ask your accountant or a friendly banker. If your credit report has a few problems on it, you may find that another bank may evaluate your credit report differently.

3. Equity
Financial institutions want to see a certain amount of equity in a business. Equity can be built up in a business through retained earnings or the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than 4 times the amount of equity. (Or stated differently, when you divide total liabilities by equity, your answer should not be more than 4.) Therefore if you want a loan you must
ensure that there is enough equity in the company to leverage that loan.

Don’t be misled into thinking that start-up businesses can obtain 100% financing through conventional or special loan programs. A business owner usually must put some of her/his own money into the business. The amount an individual must put into the business in order to obtain a loan is dependent on the type of loan, purpose and terms. For example, most banks want the owner to put in at least 20 - 40% of the total request.

Example: A new business needs a $100,000 to start. The business owner must put $20,000 of her own money into the new business as equity. Her loan will be $80,000. The debt to equity ratio is 4:1. Note also that this is only one of many factors used to evaluate the business — just having the right debt/equity ratio does not guarantee you’ll get the loan.

The balance sheet indicates the amount of equity or net worth of a business. The net worth of the business is often a combination of retained earnings and owner’s equity. In many cases, owner’s equity will be shown as a loan from shareholders and therefore a liability. If a business owner wishes to obtain a loan, she will be obligated to pay the bank back first and not herself. Consequently, it may be necessary to restructure the liability so that it becomes owner’s equity or subordinate the loan. If the current debt to net worth
is 4 or over it is unlikely that the business will be able to obtain additional debt/loan. For more information on understanding your balance sheet, check out
Understanding Financial Statements.

4. Collateral
Financial institutions are looking for a second source of repayment, which often is collateral. Collateral are those personal and business assets that can be sold to pay back the loan. Every loan program, even many microloan programs, requires at least some collateral to secure a loan. If a potential borrower has no collateral to secure a loan, she/he will need a co-signer that has collateral to pledge. Otherwise it may be difficult to obtain a loan.

The value of collateral is not based on the market value. It is discounted to take into account the value that would be lost if the assets had to be liquidated.

The following table gives a general approximation on how different forms of collateral are valued by a typical bank and the SBA:

COLLATERAL COVERAGE RATIO
The bank will calculate your collateral coverage ratio as part of the loan
evaluation process. This is calculated as follows:
 

 

Total Discounted Collateral Value
Total Loan Request

5. Experience
A client that wants to open a business and has no experience in that business should not seek financing let alone start the business unless they intend to hire people who know the business or take on a partner that has the appropriate experience. Regardless, the client should be advised to take some time to work in the business first and take some entrepreneurial training classes.

QUESTIONS YOUR BANKER WILL ASK
The key questions the banker will be seeking to answer are as follows:

1. Can the business repay the loan? (is cash flow greater than debt service?)
2. Can you repay the loan if the business fails? (is collateral sufficient to repay the loan?)
3. Does the business collect its bills?
4. Does the business control its inventory?
5. Does the business pay its bills?
6. Are the officers committed to the business?
7. Does the business have a profitable operating history?
8. Does the business match its sources and uses of funds?
9. Are sales growing?
10. Does the business control expenses?
11. Are profits increasing as a percentage of sales?
12. Is there any discretionary cash flow?
13. What is the future of the industry?
14. Who is your competition and what are their strenghts and weaknesses?.

COMMERCIAL LOAN EVALUATION FACTORS
The following factors indicate the "ideal" situation for going to a bank for a small business loan. If you cannot respond "yes" to all of these factors, it does not mean that you cannot obtain financing. Lenders look at these factors in the aggregate. In other words, if you are weak with respect to one factor but strong in another, your overall situation may allow you to obtain a loan.

Applicant Factors

1. Credit: excellent ratings and no personal or business bankruptcy.
2. Arrest: no arrest for fraud, theft, embezzlement, or drug/alcohol abuse.
3. Cash: applicant has 20% or more of cash needed for the project.
4. Net Worth: applicant has net worth (for use as collateral) greater than 100% of the loan amount.
5. Income: applicant does not need to draw income from the project for a period of time. Fixed payments per month (house, car, credit cards) do not exceed 40% of net income. (A working spouse who can cover living expenses is highly desirable. Must provide three years of tax returns to verify income and standard of living.)
6. Experience: applicant has three to five years general management experience as a minimum, and, preferably, one or more years industry specific experience.

Business/Financial Factors

1. Buying an existing business

   a. Profitability - must have good track verified by 3 years financials and tax returns.
   b. Gross Sales — should be in excess of $100,000 per year.
   c. Asking Price — should have a thorough valuation, including appraisals.
   
   d. Market Position — should have a good market position.
   e. Financial Ratios — should compare favorably to industry standards.

2. Starting a new business

   a. Market– must have a thorough market analysis.
   b. Location — must be a clearly good location.
   c. Experience — applicant must have excellent experience.

3. Expanding a business

   a. Profitability — good track record.
   b. Cash Injection — must have at least 10% cash needed.
   c. Financial Ratios — better than industry standards.

4. Any business

   a. Liquidity ratio –1.0 or better.
   b. Coverage ratio–1.2 or better.
   c. Debt/equity ratio–3 or better.
   d. Detailed business plan, including three years pro forma statements.

SELF-ASSESSMENT CHECKLIST
Whether you are applying for a micro loan, SBA loan or a traditional bank loan,
there are certain factors that improve your ability to obtain financing. The
following is a simple checklist to do before you begin to seek capital.

Research indicates that good personal credit history is one of the most important factors in identifying borrowers that will repay their commercial loans. Many loan programs require perfect personal credit in order to qualify. For further information refer to Key Points to Consider - Credit History.

Lenders and government loan programs alike want to see that an individual has met their tax obligations for both filing and paying taxes. For SBA loans tax verification is obtained from the IRS before a loan is closed.

Many of the loan programs are in partnership with government agencies. These loan programs do not look favorably on individuals who have unpaid income taxes.

(For existing businesses) If the business is profitable, then there are demonstrated profits to repay some amount of new debt. If a business is not profitable, then it becomes very important to prove how it will be profitable in the near future so that a loan can be repaid.

(For start-up businesses) It is very important that you find as many data on comparable businesses or industry statistics in order to "prove’ the revenues you intend to generate and the expenses you anticipate incurring.

(For existing businesses) The net worth of the business should be positive. If there are loans from shareholders on the balance sheet and you are able to subordinate these (not pay the shareholders) while you pay the bank loan back, you may consider these loans from shareholders as equity.

(For existing businesses) Businesses that have too much debt will find that their profits are directed at paying back loans and not building retained earnings in the business that can fund future growth. Consequently, banks and government loan programs look more favorably at loan requests that do not add too much debt to the business. Banks often look for a debt to net worth ratio of 4 or less (total liabilities divided by equity).

(For start-up businesses) All loan programs require that the business owner put their own money in the business. This owner equity injection shows that the owner believes in the business enough to risk their own money. Some microloan programs require only 10% owner equity, other programs require at least 30% and will look more favorably on a loan request the more equity is in the business.

Business and personal assets can be considered collateral, or a way to repay the loan if the business defaults on a loan. Most collateral is valued at an amount less than face value based on a variety of factors. For more information see Key Points to Consider - Collateral.

Most business owners are asked for a personal guarantee in order to obtain their first business loans.

(For existing businesses) As businesses expand, they need more sophisticated management as it relates to strategic planning. marketing, recordkeeping, inventory control, personnel, etc. When you apply for a loan, your banker will consider the qualifications of your management team and advisors in order to determine if they are capable of leading your business to the next level of growth.

If there are sectors of your business that you need assistance with, we strongly recommend that you attend entrepreneurial training classes, visit a women’s business assistance center or Small Business Development Center in your area, or contact your regional SBA office for information on local resources.

(For start-up businesses) For a new business especially, it is important for the business owner to demonstrate that she has experience in the industry and/or entrepreneurial experience. If you have never owned or operated a small business before, we strongly recommend that you attend entrepreneurial training classes.

STOP! If you cannot answer yes to all the questions above, then you may have difficulties obtaining financing at this time. We suggest that you evaluate the needs of your business and take advantage of local business assistance centers.

Personal Financial Information:

Personal Financial Statements (signed and dated)

Copies of Personal Tax Returns (including all schedules for 3 years)
Source/Amount of Owner’s capital injection Credit Report for owners of 20% or more, (dated within 90 days with all derogatories explained.)
Resumes from Principals, Partners or Proprietors
Financial/Business Information:
Business Plan
Description/History of the Business
Benefits from the loan
Articles of Incorporation or Assumed Name Certificate

Credit Report for the business and owners of 20% or more (dated within 90 days with all derogatories explained.)
Cash Flow Projections (For one year by month. Second and third years may be done by quarters.)
Projected Profit and Loss (For one year by month. Second and third years may be done by quarters.)
Notes to Financial Projections (Assumptions)
Balance Sheet and Profit & Loss Statement (For the interim period dated within 90 days, each page signed/dated. Start-ups should include opening balance.)
Balance Sheet and Profit & Loss Statement (For last 3 years, each signed and dated.)
Copies of Business Income Tax Returns (for 3 years)
Copy of Existing Facility Lease (s)and/or Lease(s) to be acquired
Schedule of All Business Term Debt (Notes, Contract & Leases Payable)

Aged Accounts Receivable

Collateral Requirements:
Schedule of Fixed Assets to be acquired with loan and their cost.
Appraisal on real estate and most recent Tax Appraisal.
Franchise:
Franchise Agreement and FTC Disclosure Report* Construction, Including Leasehold Improvements:Construction Contract* by the contractor, architect, or other, with “turn-key” firm cost quotation. Copy of performance bond*

Additional Information:

Partnership Agreements*

Employment Agreements*
Change of Ownership/Business Acquisition* ( Copy of Buy-Sell Agreement and Copy of Escrow Instructions.)
Real Estate Acquisition* (copy of sale/purchase agreement, signed/dated, copy of escrow instructions, to include legal description.)
Hazardous Waste Assessments Report(s)* - (PHASE 1 or 2, must have for existing gas stations and frequently polluting industries.)
Real Estate Refinancing or Debt Payment* - (Copies of notes, escrow instructions and Settlement Sheet.)

*If applicable

USING THE POWER OF LEVERAGE

Leverage is an important concept to understand as an entrepreneur. Leverage allows you to expand beyond the limits of your own resources by using the resources of others. It is usually used in talking about capital (using your collateral as assets to "leverage" capital from other sources).

Eventually, it becomes impossible to operate your business out of your own personal resources. You must seek outside capital and borrow money to finance growth. If you are already practicing good cash management techniques and have positive cash flow, your chances of obtaining outside capital are greatly improved.

However, you should be careful to not get too highly leveraged. That occurs when your level of debt service exceeds cash flow. It is why bankers are so concerned with the debt to equity ratios of a business.

As a business owner you will want to make sure that you don’t have too much leverage as this can negatively impact your rate of return on investment.

The following two examples show the power of leverage in terms of accelerating growth and return on investment.

Example of Positive Financial Leverage

An entrepreneur is considering an investment opportunity to purchase a new machine for $250,000. The new machine will produce a new line of goods which the entrepreneur believes will generate a profit of $75,000. If the entrepreneur who has $250,000 of cash available, purchases the machine with the cash (100% equity, no leverage), her return on equity will be 30%.

Return Equity

=

$  75,000 $250,000

=

30%

The entrepreneur’s banker offers to provide a $125,000 loan to finance 50% of the investment at a rate of interest of 12%. The entrepreneur can now purchase the machine with $125,000 cash and $125,000 debt. The entrepreneur’s return on investment is unchanged (30%). But now, the entrepreneur has a change in his/her return on equity because he/she has only $125,000 equity invested, not $250,000. The debt will cost $15,000 per annum in interest expense from the $75,000 profit, the profit left remaining for the entrepreneur is $60,000. The return on equity has risen to 48%. (Note this example ignores income tax effect.)

Return Equity

=

$  60,000 $125,000

=

48%

The return on equity has risen because the entrepreneur has replaced equity dollars originally earning 30% return with relatively cheap debt dollars costing only 12%. The result is that the return on the remaining equity is increased by not using all the cash. Financial leverage has increased the entrepreneur’s return on invested equity.

Financial leverage may also increase the total profits of the business. With no leverage and $250,000 of equity, the entrepreneur can purchase one machine which will generate $75,000 profits. With 50% financial leverage, and fully investing the $250,000, the entrepreneur can purchase two machines. Each machine will earn $60,000 after deducting interest expense. Financial leverage has
allowed the entrepreneur to increase profits $120,000 by employing the $250,000 cash equity matched with an equal amount of debt. If the entrepreneur had employed the $250,000 cash without leverage, profits would have risen only $75,000.

The Effect of Different Interest Rates on the Rate of Return on Owner’s Equity

This example illustrates the concept of both negative and positive financial leverage. Leverage involves securing funds for investment at a fixed rate of return to the funds’ suppliers, with the intent of improving the business owners return.  If the assets in which the funds are invested can earn at a rate of return greater than the fixed rate required by fund suppliers, the leverage is
positive.

If there is no debt, the return on total assets will equal the return on owner’s equity. For example, let’s assume that the net income before interest and taxes is $12,000 for a business with $100,000 in assets and $100,000 in equity. The return on equity is equal to 12 percent.

But what if you borrow $40,000 for five years at 12 percent interest to help you finance your business?

My Company, Inc.
Balance Sheet
June 30, 19XX
 

Again, let’s assume that the net income before interest and taxes is $12,000. The interest expense of $4,800 (12 percent of $40,000) will be used first to pay the creditors, leaving $7,200 as net income to the owner. Your rate of return on owner’s equity is $7,200 divided by $60,000 or 12 percent. Both your creditors and you, the owner, receive a 12 percent return on your respective investments.

If you can borrow at 10 percent instead of 12 percent, interest amounts to $4000, leaving $8,000 as net income. Your rate of return on owner’s equity is now $8,000 divided by $60,000 or 13.3 percent. Your return on equity is higher than when the business had no debt!

If you borrowed $40,000 at 10 percent interest, you earned a higher rate of return on the $100,000 invested in the business. The additional 2 percent interest saving; or $800, the business earned on the creditor’s $40,000 goes to you, not your creditors.

However, negative leverage is possible as well.  If you borrowed at 14 percent, the net income after interest expense is $l2,000 less $5,600, or $6,400. The rate of return on owner’s equity is $6,400 divided by $60,000 or 10.67 percent. The business is paying the creditors more than it can earn on the $40,000 loan. You lose under this scenario.

EFFECT OF DEBT ON RATE OF RETURN

(Adapted from Financial Management for Small Business, University of Wisconsin Small Business Development Center by Charlotte Taylor, Venture Concepts, in association with New Jersey Association of Women Business Owners, Inc., 5/97)

Whether you are just getting started or have been in business for a number of years, chances are that you will need the expertise of an attorney. One of the most common complaints that lawyers make is, "why didn’t you get me involved
before you signed…?" Some small business owners think that by doing without legal help they will save money. In reality, they may pay much more in the long run. Its wiser to seek advice on the front end in order to minimize the risk of costly mistakes or litigation later on. This section addresses some of the many ways in which a lawyer can help a small business owner.

1. Form of organization and business name

   A lawyer can help you
   determine the form of organization that is best for your business and assist you with the necessary paperwork, whether you’re just starting your business or have been in business for a while. In addition to sole proprietorships, corporations and partnerships, most states permit limited liability corporations. The form of organization you choose may affect many aspects of your business, including estate planning, tax planning and liability in litigation. A lawyer can also help you ensure that your business name is preserved for your use only.

2. Commercial leases

   Believe it or not, leases are frequently negotiable. A lawyer can review your lease to make sure that it fairly allocates rights and responsibilities between lessor and lessee and that it covers most of the situations that could cause problems in the future. For example, many leases do not include provisions allocating responsibility for repair of improvements and for upgrades to comply with new building codes. A lawyer can discuss with you such things as the advantages and disadvantages of a no-fault lease and the items that should be included in the definition of operating expenses.

   Read through the following material on leases in the Online Women’s Business Center and make a list of questions to review with your lawyer:

    

3. Contracts

   Many businesses enter into contracts with employees, customers, suppliers and others. As with commercial leases, a lawyer can assist with drafting and/or review of such contracts to make sure that they comply with applicable laws, that they are fair, and that they anticipate problems that could be caused by such things as price fluctuations, bankruptcy, war or natural disasters. A good lawyer may even be able to help you negotiate contracts setting up creative business relationships that could
   help your business financially.

4. Employer/employee relations

   This aspect of your business includes hiring, firing, working conditions, sick time, overtime, medical leave, employee benefits, and an employee’s privacy rights. A lawyer can assist with review and/or drafting of employee contracts, can help you develop employment policies, and can make sure that your business is complying with applicable employment laws.

5. Estate planning for your business

   If you die without a will or a trust dictating what should happen to your personal assets, those assets will probably remain in your family anyway, going to a spouse or a child. Unfortunately, depending on your form of organization, the legal system may not know what to do with your business when you die if you haven’t put your plans in writing. The administrator of your estate may be forced to sell off any assets of the business and let your employees go, even if you wanted your business to continue after your death. The solution is to do some estate planning for your business.

6. Intellectual property rights

   Intellectual property includes trade secrets and trademarks, as well as copyrights and patents. Something as simple as a customer list may be a trade secret if its confidentiality is maintained. A lawyer may be able to help you identify and protect your intellectual property rights.

7. Financing and credit

   As with other kinds of contracts, you may want to have a lawyer review loan agreements. In addition, a lawyer may be able to advise you about the laws governing debt collection practices.

8. Advertising

   Both federal and state laws limit unfair and deceptive advertising practices and prohibit discrimination in advertisements. For example, a product typically may not be labeled "new" after six months, you may not advertise a "fire sale" unless your business has had a fire, and
   you may not have a "going-out-of business sale" unless your business is really closing its doors. A lawyer can review any proposed advertising to make sure it is in compliance with applicable laws.

9. Compliance with regulations

   Depending on the kind of business you have. there may be specific regulations that apply to you. For example, many states regulate hair salons and tanning salons. There are also regulations that may apply to you if you are in the food service business. If you make or sell a consumer product, you must comply with the reporting requirements of the Consumer Product Safety Act. You may want to consult a lawyer to determine
   if any special laws apply to your business.

10. Litigation

    You probably know that you should seek legal assistance if you want to sue or are being sued. What many people don’t realize is that they have a much better chance of avoiding litigation if they seek timely advice from a lawyer about the many aspects of running their business, as suggested above.

There are many options and terms available when leasing office space. You may know precisely what you want in a lease. For those who do not, the following covers some of the areas which you will want to address in your lease negotiations. In addition make sure you review The Basics of Leasing.

• Escalation clause.
  This clause spells out how much the rent will escalate with inflation. Ask for documentation on what the percentage has been over the last five years.
• Renewal option.
  Under this clause, you have the option of renewal under the original base rent.
• Maintenance.
  The lease should spell out what repairs or maintenance items you will be responsible for under the terms of the lease. For instance if the door lock jams, who is responsible to repair it? Is the lessor, or management company, responsible for the cleaning service; and how often do they clean? Even minor items, such as duplication of door keys should be addressed. If the building has a mandatory security system, who is responsible for paying for it and maintaining contact with the administrators?
• Insurance.
  Often, the lessor will request proof of insurance coverage before the move-in. The lessor must know that you are covered for any damage you may cause during the move-in, as well as have adequate liability coverage for injuries. After you move in the same usually applies. The minimum coverage the lessor expects should be detailed in the lease.
• Move-in/delivery regulations.
  If you move into a multi-occupancy building, it is possible that the
  management company will have rules regarding hours in which you may actually move-in and specific doors and elevators which you must use to do so. In addition, there may be restrictions on times and types of deliveries to your office once you have moved in.
• Storage Space.
  If you require storage space, you should determine if the landlord has such space available and the costs associated with its use. Or will you be allowed to build such an area in the space you lease (see Renovations).
• Sublease.
  The lease should clarify if a sublease is permissible, and the specific terms, if so.
• Restrictions on Use.
  The lease should spell out any restrictions for use within the lease space. For instance the landlord may restrict use of certain type of equipment within the space.
• Improvements.
  There may be improvements which you agree to as part of the negotiations and these should be reflected in the lease. The ownership of these improvements must also be addressed in the lease. It should specify what happens to them when the lease terminates. On the other hand, you may want to make changes within the space you have rented. The lease should address your rights, and the extent to which you can do so. This could be as simple as putting up a non-bearing wall, or installing a security system. If you should decide your space would better serve you with most of the walls removed, will you be able to do it? What will the restrictions be? Will you be required to reinstate whatever you remove at the end of the lease? The reality of many of these things depend on the length of the lease - the longer the lease the more you can ask for.
• Heating/Air Conditioning (HVAC).
  It is important that the hours of operation for the HVAC be addressed, especially if your office works outside the normal 9:00 to 5:00 hours and on the weekend. It is not unusual for some buildings to operate the HVAC until 7:00 p.m. during the weekdays, and not at all on the weekend. It’s a little hard to get much work done if you’re too hot or cold. It might be possible to request installation of an individual control thermostat for your space, or it may be provided by the lessor. The lease should also spell out your responsibility for the heating and air conditioning. Is it a percentage based on your square footage? Does it include the common areas? Even if you have an individual thermostat in your space, you will likely still be responsible for a percentage of the common areas. This is one of those items you should find out in your initial research.
• Renovations/Repairs.
  If there are items which you and the lessor agree should be done prior to, or even after, move in, these items should be included in the lease.
• Termination.
  The terms of your right to end the lease is crucial, as well as in which circumstances the landlord can do the same.

These are all items which are crucial to a lease which you can live with. It is unlikely that the landlord, or management company, will automatically cover most of them. You must know what your needs are and request that they be included in the negotiations and the final lease agreement.

Consultation with an attorney during the lease process is also important. Often the lease will contain language which is entirely foreign to you. You certainly want to have an attorney look over the lease prior to signing it; and it is in your best interest that you thoroughly brief the attorney on the items which are important to you and those areas which you and the landlord have agreed on (i.e. improvements), so that the attorney can make certain that everything is properly addressed in the lease.

Most importantly, make sure you understand the terms of the lease before you sign it. It is a legally binding agreement, and not usually subject to revisions after it is executed.

Confused by the various types of insurance and all the variations in coverage that are possible? This article describes three of the most common types of insurance and illustrates each with easy to understand examples.

PROPERTY COVERAGE

Property coverage can be divided into two segments in the business policy:

• For fixed property (buildings, fixtures, etc.) and contents (equipment, inventory, etc.) OR
• Purchased as a combined single limit (see Limits section).

Your property can be covered as:

• all risk OR
• as specified peril (see Limits section).

Almost all policies, exclude such events as wear and tear, as insurance is intended to cover sudden and accidental occurrences.

Example - If the motor in your 1952 copier suddenly ceases up and the copier dies, don’t expect coverage for the copier. However, if in its dying throes, the copier shorts out other equipment on the same line, there could be coverage for the other equipment (provided there are no exclusions for shorts) which is resultant damage of the copier wear and
tear; and it would be the same if a fire resulted from the copier.

The property section will cover the building (if other than your home) in which you do business:

• the fixtures utilized to run that business

  for example, commercial stoves, fixed racks, etc.

Contents used in your business are also covered here, if you elect this coverage. This includes all non-permanently affixed items:

• your computer
• your forms
• your inventory
• your stock, etc.

Example - A water pipe breaks and floods your office. The carpet, drapes, walls and ceilings would be covered under building coverage; the desks, computers, files, etc. would be covered under contents). There are also specific type of content policies which can be purchased to protect content, material on computer discs, ideas, etc.

Commercial Auto policies can include:

• collision
• comprehensive
• rental
• towing coverage for the automobiles owned by your business

Collision occurs when your vehicle hits, or collides, with another object (some policies, do not include hitting animals or falling objects under collision, but place damage caused by these in the comprehensive section), or if the vehicle overturns.

Example -Ace employee is rushing to make a delivery and hits a pothole, damaging the undercarriage of the car. This is considered collision, just as if he had hit a telephone pole or another car). Comprehensive picks up all covered losses that are not considered collision.

Example - Someone sneaks in and keys scratches into the paint on all of your company vehicles, comprehensive coverage pays to restore the cars to pre-loss condition. Or, if your vehicle is caught in a hail storm, or catches fire, the resulting damage is also covered by comprehensive coverage.

Personal Injury Protection (PIP) and Medical Payments (MedPay) are also part of property coverage. In an automobile, these coverages exist to cover medical expenses regardless of who is at fault. State law vary on which policy is primary for these coverages, if the driver of the automobile is other than the owner.

Example - Your employee slams his finger in the car door, PIP coverage pays for the medical treatment cost, with no discussion on who is at fault.

For business policies, MedPay is usually available to pay for medical expenses incurred due to injury occurring on the premises of your business - again regardless of fault.

Example - An elderly customer seems to fall for no particular reason. You are not necessarily at fault, but for good will purposes, you take care of the doctor visit. MedPay takes care of the cost.

It is important to note that most of these coverages (first party coverages which apply to property owned by you, or within your control) require that you choose a deductible. The deductible is the monetary portion of the damages which you, as the insured, will bear when a loss occurs. Deductibles vary according to the choice of the insured. The good news is the higher the deductible, the lower
the premium; however, know that if you choose a $1,000.00 deductible, the insurance company will pay for all

A thorough discussion with your agent will determine which particular coverages best fit your needs. There is no such thing as "full coverage". Your policy coverage is as complete as the coverage you choose. Don’t assume something is covered - ask to be sure. Also don’t assume that coverages are packaged together in premium costs. For instance, comprehensive and collision
coverages are, most often, sold together, but carry individual premium costs. Make certain that your agent spells out all the details.

LIABILITY COVERAGE

Liability insurance covers claims as a result of actions for which your business is legally liable (responsible). It is important to point out that you can be held liable for the actions of people acting on your behalf, paid or volunteer, under the doctrine of respondent superior. Under this doctrine the business (the master) can be held vicariously liable for its employees (servants or agents) misdeeds if the employee is operating within the scope of their duties. If you, or your employee, is at fault for an accident - or someone claims that you are, you may be expected to reimburse the cost of damages to another person for their injuries or loss of property resulting from that accident.

This includes incidents involving your vehicles, as well as those which may occur on your businesses premises (i.e. slip and fall), as a result of your products (product liability, as in the Tylenol scare), or your actions (professional liability, as in liable, malpractice, etc.).

Example - Your own a florist, someone forgot to turn off the hose watering the Azaleas, Customer A comes in and slips and falls, crashing into the refrigerated glass case. Customer B witnesses it all. Much blood and an emergency room visit later, Customer A is now treating with the Skull and Bones Chiropractic Clinic and is represented by Dewey, Cheatum and How. They have Customer B’s sworn statement about how negligent you were in leaving the
water running. They only want $15,000 (so what if Customer A only has $1,000 in medical bills, he’s had a lot of pain and suffering!) to settle, or they’ll file suit. If you have liability insurance, the insurance company is already handling the demands of the attorney; and if suit is filed, the insurance company will handle your legal defense against the suit.

OR

Your part-time worker is distracted as she delivers those brochures the insurance company replaced, and rear ends a brand new Lexus. The other driver isn’t hurt, but she is livid that she no longer has a trunk. She also uses her car in her real estate business, so needs a comparable rental vehicle. Ouch. And the U Wreck ‘Em, We Rack ‘Em body shop is delighted - her son needs braces. If you have adequate liability insurance, you hand the whole issue over to your insurance company and relax.

It is important to know that if you use your personal vehicle in your business, there is a strong possibility that your personal auto policy may not cover liability claims for damages resulting from an accident during the conduction of business activities. You would be wise to look into a Commercial Auto Policy, or a business endorsement to your Personal Auto Policy.

Liability can also be purchased for non-owned vehicles. In instances where an employee delivers, or performs some other functions, for your business in their own cars. Most Personal Auto Policies exclude liability coverage when the covered auto is used for business. Unless, you choose to take your chances and go bare in these instances, call your insurance company or read your policy

There are many instances in which your business could become liable - legally responsible - for another person’s claims of damages (including products liability, defamation, etc.) resulting from your actions or the actions of those working on your behalf. If you have the proper insurance, the insurance company takes the problem off your hands and pays for the damages up to the limits you have chosen for each policy coverage (See Limits section). In addition, if you are served with a lawsuit, the insurance company absorbs all defense costs (including hiring an attorney on your behalf) and basically takes over the handling of the all legal issues. Even if the suit is frivolous. In most states, the cost of defense if over and beyond the policy limits you have chose for the policy.

Example - In the florist example, the insurance company determines that Customer A’s demand of $15,000 is unreasonable. Customer A rejects the insurance company’s counter offer and sues you. You turn the suit papers over to the insurance company within the specified time (varies state to state, but do it as soon as you are served). The insurance company hires the appropriate attorney and an answer is filed on your behalf. Defense costs in the amount of
$8,000 are incurred since it goes to trial. The judge enters a judgment in the favor of the plaintiff (Customer A) for $4,000. To make matters worse, the witness is now making a claim citing that he was hit with flying glass when Customer A fell through the glass case. The policy limits you have chosen is only $10,000. No problem. The plaintiff is paid $4,000 and your policy still has $6,000 in coverage to deal with Customer B (the witness).

You can, always, involve your own counsel at any time in the process.

In summary, liability insurance takes care of claims for injury, or damage to property, to other people not associated with your business. And it protects you in the event one of those people decides to sue you - no matter the merit of the lawsuit. You simply hand the whole ordeal over to the insurance company. However, no policy covers every event; and every policy varies. You must
take a look at your operation and discuss possible exposures from which you need protection:

• Do you operate off-site?
• Serve alcoholic beverages at functions?
• Sell products that could cause harm?

BUSINESS INTERRUPTION (Loss of Income) COVERAGE

What happens if your business is shut down?

This could happen due to natural catastrophe (flood) or accident (fire). No matter, if you are unable to bring in an income, what happens to your livelihood?

Depending on the type of policy you choose and the type of perils the policy covers, if you are unable to conduct business, insurance can pay the income you lose as the result of a loss (catastrophic or accidental). There is also
keyman (see this section) coverage to cover key people in your business.

The most common mistake that small businesses make, particularly during startup, is to carry inadequate liability coverage, which insures against bodily injury or property damage to others, Fairbrother says. It’s a misconception to believe that because your business has little revenue or assets, that a judgment won’t hurt you. "You may not be able to pay a $2 million judgment, but you’d
better get your checkbook out and pay tens of thousands of dollars for legal representation," Fairbrother says. "If you are covered by liability insurance, the insurance company represents you in court, so in a way, you are also buying legal representation."

What kind do I need?

Common types of insurance coverage frequently purchased by small business owners include property insurance, liability insurance, and, if you employ others, workman’s compensation insurance. If you have a business loan, your banker also may require "key man" insurance.

• Property insurance covers the building or buildings and contents of the business. Outdoor signs, crime coverage, property of others, glass coverage, etc., can be covered as well, depending on the needs of your business.
• Liability coverage covers sums you could be obligated to pay due to bodily injury or property damage to others. If you do not own your building, your landlord normally would need to be added as an additional insured on the policy in order to protect her. Liability covers the premises and operations of the insured, as well as her products and completed operations.
• Workman’s compensation insurance protects your employees if they suffer job-related injuries. The policy pays the medical bills for the employee who is injured on the job. If there is time off from work due to that injury, the insurance pays disability income to the injured worker.
• Key man insurance protects key individuals in a business. If you are operating with a business loan, your banker may require "key man" insurance (or life insurance) as a way for the bank to get its money back if you are incapacitated in some way. Sole proprietors generally don’t carry key man
  insurance; however, a partnership may have key man insurance.

Another scenario in which you might want key man insurance is if you employ one sales person who generates 80 percent of all your revenues. If that person is incapacitated, it may take you two or three months to replace her. Key man insurance would cover the difference in the revenue you produce until the person can return to the job or is replaced.

Other types of insurance may be necessary or unique to your particular business. For instance, if you operate a desktop publishing business out of your own home, you may assume that your homeowner’s insurance will cover any theft or destruction of computer equipment. Some homeowner’s policies may, but others may
set a limit on claims for computer equipment that is much less than you have invested. Check your policy or confer with your agent if you’re unsure. A freelance writer who works from home may not need liability insurance separate from her homeowner’s policy — unless she has customers or clients visiting frequently. On the other hand, a book author may want to carry a policy that will protect her from libel or plagiarism lawsuits. Again, you should consult your agent if you have any questions.

For more on the types of insurance, including practical examples, go to Understanding Types of Insurance

How much insurance do I need?

Don’t make the mistake of many start-up businesses or small business entrepreneurs by skimping on liability insurance. Besides shielding you from a costly judgment, your policy gives you access to legal representation — your insurance company — which will fight to resolve any lawsuit on your behalf. If you own a building and carry property insurance, carry enough to rebuild the physical structure and replace its contents. You need not insure the total value of your land (the building may be destroyed, but the land will still be there).
An appraisal can clear up any doubt about the value of the property. It’s best to insure your property (building and contents) for 100 percent of its value, and, if necessary, reduce the expense of the insurance policy by requesting a higher-deductible. Entrepreneurs should shop for insurance, and shop frequently, says Gene Fairbrother, lead small business consultant for the National
Association for Self Employed. "You may be surprised to find how inexpensive it is," he says. Check with your profession’s trade or industry groups, which frequently have arrangements with underwriters to provide excellent-priced insurance to the group’s members.

In the absence of a trade group, you may want to work with an independent insurance agent, or broker, who is familiar with your type of business. An agent should take the time to analyze your operations and coordinate all types of insurance coverage. She should be willing to obtain quotes from several companies to see that you obtain the most affordable coverage possible. And she should make sure that the insurance company offering the policy is solvent.

UNDERSTANDING BASIC FINANCIAL STATEMENTS

How to Use this Tutorial

This Tutorial is designed to help the small business owner learn how to use financial statements as a roadmap on their journey to economic success. Using numbers as navigation aids can steer you in the right direction and help you avoid costly breakdowns. Most business owners don’t realize that financial statements have a value that goes far beyond their use to prepare tax returns or loan applications. In this Tutorial we’ll help you discover this value with:

1. Descriptions and examples of the components of basic
   financial statements,
2. Key Ratios and Financial Quality Indicators and what they
   tell you about your business,
3. A list of questions to ask yourself about your monthly
   financials, and
4. A Case Study for a small business.

TABLE OF CONTENTS

This lesson on effective use of financial statements has been divided into 5 parts as shown below. Use the links at the bottom of the Table of Contents or the Books in the margin to jump to other sections.