Franchise Finance - What do the banks want?

Part Five - Profit Retention

Profit retention versus drawings is an interesting conflict of interest that is grappled with regularly in the business community across Australasia, if not the world. The business directors' responsibilities versus the shareholder/stakeholders want. Whose interests are paramount?

As directors of a company there are certain obligations on them and they are entrusted to manage the company to the best of their abilities and look after the best interests of the company. With shareholders' "hats" on they want to take the best returns that they can.

Throw in the implication of taxation regulations and it's no wonder that the majority of privately owned companies end up the losers, possibly showing a loss. The accountant to minimise taxation has manufactured this loss in a lot of cases. With the banks rules based lending all losses are treated as equal and will be a detracting feature in its lending decision.

Basically if the company is producing profits and is growing, then it is prudent to keep the company strong with good working capital to meet its obligations and fund future growth. As a general rule I would recommend 30% of net profit, before shareholders' salaries, be kept in the company as retained earnings. I appreciate that every company is different and in different cycles of growth, so it is stressed that a close liaison with your accountant, and banker should be maintained. Don't let your accountant leave your business with a manufactured loss at the end of the year, as you will end up paying for this with your bank. Banks hate companies showing losses. The profits may be kept in the company as shareholders current accounts, but the banks don't see this as company funds and does not show the commitment to the company by the directors that the banks would prefer.

Some profit retention is recommended for the following reasons:

It is noted that Accountants tend to look at the overall picture for their clients which includes tax minimisation and ease of administration - hence the reason why profits are often all paid out as shareholders' salaries.

This guide is focusing on what banks want and while a company may have kept liquidity up by credits in shareholders' accounts, they can be withdrawn. The company declaring a dividend can also pay out retained earnings. I would not recommend you asking your bank for lending facilities for this though, as in most cases this will not be well received. In the bank's eyes there is no commitment. They sometimes take a "Deed of Postponement" to formalise a shareholders commitment to not draw out their funds. Basically this is to subordinate company debt to shareholders, to behind the company debt to the bank.

• Part One - Segmentation
• Part Two - Structure of Borrower Page
• Part Three - Profitability Page
• Part Four - Security Page
• Part Five - Profit Retention Versus Drawings Page
• Part Six - Bank Account Conduct Page
• Part Seven - Management Page
• Part Eight - Risk Management Page
• Part Nine - Working Capital/Credit Lines Available Page
• Part Ten - Annual accounts, Ratios and Trends Page
• Part Eleven - Franchising Page