Setting Credit Limits & Making Informed Credit Decisions © Presented by: Jim Menard, CCE email: [email_address] Western Region Credit Conference

Credit is like a puzzle … … the more pieces you have, the clearer the picture

… the more pieces you have, the clearer the picture

The Credit Puzzle The pieces fit together to form a picture The more pieces you have, the clearer the picture It is possible to understand the essence of the picture without having all of the pieces in place Although no one piece is enough to make you comfortable, you can become uncomfortable based on a single item.

The pieces fit together to form a picture

The more pieces you have, the clearer the picture

It is possible to understand the essence of the picture without having all of the pieces in place

Although no one piece is enough to make you comfortable, you can become uncomfortable based on a single item.

Establishing Credit Lines The credit line is: An investment A loan But most of all – a privilege

The credit line is:

An investment

A loan

But most of all – a privilege

Credit Line A credit line must coincide with your firm’s Terms of sale Desired level of market penetration Appetite for risk

A credit line must coincide with your firm’s

Terms of sale

Desired level of market penetration

Appetite for risk

Extension of Credit Your credit extensions will be linked to your customer’s: Capacity for growth Ability to withstand adversity in the economy and the market place Credit worthiness Need for your product matched to the ability to repay the debt

Your credit extensions will be linked to your customer’s:

Capacity for growth

Ability to withstand adversity in the economy and the market place

Credit worthiness

Need for your product matched to the ability to repay the debt

Granting a line of Credit Percentage of Net Worth Percentage of Cash Flow from Operations Percentage of Working Capital Based upon Dun & Bradstreet rating Supplier references Bank references Personal / Corporate guaranty Security

Percentage of Net Worth

Percentage of Cash Flow from Operations

Percentage of Working Capital

Based upon Dun & Bradstreet rating

Supplier references

Bank references

Personal / Corporate guaranty

Security

SOME FACTORS INFLUENCING LENDERS’ COMFORT LEVEL QUALITATIVE Character / credibility . past payment history . support from present lenders . reputation with past customers . moral standing and integrity . business style

QUALITATIVE

Character / credibility

. past payment history

. support from present lenders

. reputation with past customers

. moral standing and integrity

. business style

SOME FACTORS INFLUENCING LENDERS’ COMFORT LEVEL -2 Proven ability to grow / adapt . successful problem identification / resolution . strategies to keep abreast of the times . ability to manage complexity . balance of key managerial functions

Proven ability to grow / adapt

. successful problem identification / resolution

. strategies to keep abreast of the times

. ability to manage complexity

. balance of key managerial functions

SOME FACTORS INFLUENCING LENDERS’ COMFORT LEVEL -3 Depth of experience / talent . degree of competence in critical areas what must they do well ? what is company’s real business ? . competent to manage in adversity as well as prosperity

Depth of experience / talent

. degree of competence in critical areas

what must they do well ?

what is company’s real business ?

. competent to manage in adversity as well as prosperity

Industry Inherent risk compared to other industries State of maturity . growing . flat . declining Present Stage of Industry Cycle Position within industry . market share . trend Competition within industry . domestic / international . entry / exit barriers . cost structure . energy sensitivity

Inherent risk compared to other industries

State of maturity

. growing . flat . declining

Present Stage of Industry Cycle

Position within industry

. market share . trend

Competition within industry

. domestic / international

. entry / exit barriers

. cost structure

. energy sensitivity

Industry - 2 Margins within the industry Seasonality Vulnerability to inflation Vulnerability to business cycle Vulnerability to sources of supply Vulnerability to obsolescence . stage of product maturity

Margins within the industry

Seasonality

Vulnerability to inflation

Vulnerability to business cycle

Vulnerability to sources of supply

Vulnerability to obsolescence

. stage of product maturity

QUANTITATIVE - Financial Cash Flow - pays loans . income . non cash expenses consistency diversity Liquidity - ease of converting assets to cash . working capital Leverage - varies by industry . total liabilities vs: tangible net worth overstated understated relative to transaction Performance during hard / difficult times

Cash Flow - pays loans

. income

. non cash expenses

consistency

diversity

Liquidity - ease of converting assets to cash

. working capital

Leverage - varies by industry

. total liabilities vs: tangible net worth

overstated

understated

relative to transaction

Performance during hard / difficult times

SECONDARY FACTORS - QUALITATIVE Access to additional financial resources Proven ability to raise equity . return on equity in excess of capital costs Other lenders’ present willingness to make commitments Liquid net worth of corporate parent or major stockholders Prevailing phase of business cycle

Access to additional financial resources

Proven ability to raise equity

. return on equity in excess of capital costs

Other lenders’ present willingness to make commitments

Liquid net worth of corporate parent or major stockholders

Prevailing phase of business cycle

Environmental factors Vulnerability to change . regulatory . social . political

Vulnerability to change

. regulatory

. social

. political

SECONDARY FACTORS - QUANTITATIVE (Collateral) Ease of perfecting security interest Degree of equity in real property . loan to quick sale value ratio Historic value fluctuations over the term . vulnerability to cyclicality . risk of technological obsolescence Ease of liquidity / remarket ability . mobility . market . identifiable . measurable

Ease of perfecting security interest

Degree of equity in real property

. loan to quick sale value ratio

Historic value fluctuations over the term

. vulnerability to cyclicality

. risk of technological obsolescence

Ease of liquidity / remarket ability

. mobility

. market

. identifiable

. measurable

SECONDARY FACTORS - QUANTITATIVE (Collateral) - 2 Incremental revenue / profit expectations attributable to acquisition Diversity of customer base . dependence on limited number of customers . dependence on limited number of industries Lenders exposure to similar credits Need for portfolio diversity

Incremental revenue / profit expectations attributable to acquisition

Diversity of customer base

. dependence on limited number of customers

. dependence on limited number of industries

Lenders exposure to similar credits

Need for portfolio diversity

LIKELY DEAL KILLERS - OBJECTIVE Fire history Large tax liens Creditor judgments Criminal conviction Negative tangible worth Qualified auditors opinion Viability as on-going concern Speculative business practices Recent Chapter 11 re-organization Major litigation threatened or pending

Fire history

Large tax liens

Creditor judgments

Criminal conviction

Negative tangible worth

Qualified auditors opinion

Viability as on-going concern

Speculative business practices

Recent Chapter 11 re-organization

Major litigation threatened or pending

LIKELY DEAL KILLERS - SUBJECTIVE Name dropping Lack of openness Disreputable affiliates Low morale / high turnover Pressure for rapid credit decision Arrogance rather than cooperation Unavailability of internal information Criticism of present lenders or auditors Evasive answers regarding performance High style personal corporate living habits

Name dropping

Lack of openness

Disreputable affiliates

Low morale / high turnover

Pressure for rapid credit decision

Arrogance rather than cooperation

Unavailability of internal information

Criticism of present lenders or auditors

Evasive answers regarding performance

High style personal corporate living habits

REASONS FOR CAUTION Rapid growth Changing banks Heavy cash usage Debt rescheduling Changes in auditors Slow trade payment Previous turndowns Criminal indictment

Rapid growth

Changing banks

Heavy cash usage

Debt rescheduling

Changes in auditors

Slow trade payment

Previous turndowns

Criminal indictment

REASONS FOR CAUTION No dominant lead bank Deteriorating financial ratios No regional bank involvement Acquisitions (friendly / unfriendly) Change in ownership / management

No dominant lead bank

Deteriorating financial ratios

No regional bank involvement

Acquisitions (friendly / unfriendly)

Change in ownership / management

REASONS FOR CAUTION - 2 Continuous restating of previous year’s statements. Previously troubled credits that appear to have turned around Reported payment history inconsistent with trade reference comments

Continuous restating of previous year’s statements.

Previously troubled credits that appear to have turned around

Reported payment history inconsistent with trade reference comments

SUBJECTIVE Poorly managed Absentee management Family dominated company Anything out of the ordinary Company with one person rule Significant changes in operations

Poorly managed

Absentee management

Family dominated company

Anything out of the ordinary

Company with one person rule

Significant changes in operations

SUBJECTIVE - 2 Heavy fixed costs or other operating rigidities Alterations in corporate emphasis and objectives Large, complex corporate and financial structures Marginal borrowers with down market positions in their industries

Heavy fixed costs or other operating rigidities

Alterations in corporate emphasis and objectives

Large, complex corporate and financial structures

Marginal borrowers with down market positions in their industries

Example of a Policy Exhibit “A” Company Policy on establishing a Credit limit for your customers…

Exhibit “A”

Company Policy on establishing a Credit limit for your customers…

Example – Credit Limit Policy ABC, INC. Policy #CC1002 CREDIT & COLLECTION POLICY/PROCEDURES Page 1 of 7 Effective Date: September 21, 2007 Subject: CREDIT LIMIT CRITERIA Approved by: Joe Credit I. Scope - ABC, Inc. and all subsidiaries, worldwide II. Objective - To establish a consistent procedure in approving open account credit lines.

Example – Credit Limit Policy - 2 III. Procedure It is the responsibility of the individual Credit Representative to assign credit limits and terms of sale to each customer within their own account assignment. The accounts are to be reviewed, minimally on an annual basis. A. Establishing credit lines: 1. The credit line is an investment, a loan, but most of all a privilege. 2. The Five "C's" of Credit a. Character - who is the business owner / does he pay b. Capital - the financial strength of a risk c. Capacity - the ability to pay when due d. Conditions – the general economic conditions e. Collateral – is there backup should the capacity fail

Example – Credit Limit Policy - 3 3. A credit line must coincide with our firm's terms of sale, desired level of market penetration and appetite for risk. 4. Credit extensions will be linked to our customer's capacity for growth, ability to withstand adversity in the economy and in the market place. 5. To properly control your total credit extensions in the majority of our customer's cases, their credit lines should not be greater than their need for your product - the credit line should cover the customers needs during the next 6-12 months. 6. The credit line is based upon the customer's ability to repay - not their product needs.

Example – Credit Limit Policy - 4 7. Credit investigation is to include - but not limited to: a. Length of time in business / expertise of the principals b. payment pattern (s) c. economic conditions (industry and geographical) d. bank and vendor references e. credit reporting agencies f. financial information (to be obtained at least annually - see Section # V) I. Ratios II. Tangible Net worth III. Sales / Profitability IV. Leverage (debt positioning) g. Security (guaranty / letter of credit / Purchase Money Security Instrument, etc.) Generally ABC will allow 10% of the customers tangible net worth (TNW) for a credit limit. We will allow a higher percentage, based upon the volume of ABC’s business by the firm.

Example – Credit Limit Policy - 5 B. ABC will add to the base credit limit for the following: 1. Stand By Letter of Credit 100% 2. Purchase Money Security Agreement (UCC) without subordination -or- + 20% TNW with subordination to the bank + 10% TNW 3. Blanket Security Agreement (UCC) First position + 25% TNW Second position + 15% TNW Third or more + 5% TNW 4. Personal guaranty of principals & spouse + 15% TNW (required on new or closely held corporations to include personal financial statements) 5. Prompt Pay - pays within terms of Net 30 + 10% TNW 6. In business more than 5 years + 10% TNW 7. Debt to Worth greater than 2:1 - 10% TNW 8. International - local financial standards +10% to +40%TNW

Example – Credit Limit Policy - 6 C. Financial Statements: 1. To be obtained a least annually from our customers whose credit limit is >$20k. 2. Audited statements on all customers, where possible, unaudited statements have limited value. 3. International financial statements to be obtained within 60 days of publication. 4. Domestic financial statements to be obtained within 30 days of publication. 5. Domestic public companies to furnish quarterly as well as annual reports (10Q / 10K / Prospectus - SEC reports). 6. Parent company financial statements should be obtained at the same time as the subsidiary's. 7. High Risk Accounts* - monthly financial statements. (* as determined by the Credit Manager)

Question time……….. Time to ask your questions… … and thank you for attending this presentation …..

Time to ask your questions…

… and thank you for attending this presentation …..