Financial terminology and definitions to help small business owners better understand the loan process

Jim Terrell, Senior Vice President, Dallas, Comerica Bank

Donna Mittendorf, Senior Vice President, Houston, Comerica Bank

Applying for a loan can be confusing for a small business owner or aspiring entrepreneur, especially if you’ve never been through the process. In addition to being asked to provide a significant amount of information, you also may encounter unfamiliar terms when seeking financing for your business.
Smart Business spoke to Jim Terrell and Donna Mittendorf of Comerica Bank about understanding financial jargon you may come across when applying for a loan.
What are some common terms I should be familiar with?
Terrell: A few of the common terms that you may come across include the following:

  • Assets. This refers to what the business owns. Current assets are those that can generally be converted to cash within one year like cash, accounts receivable and inventory. Long-term or fixed assets include equipment and real estate.
  • Balance sheet. This is a financial statement that shows assets, liabilities and net worth. Total assets will always equal total liabilities plus net worth.
  • Cash flow. This term refers to the capacity of a firm to repay its debt. A company’s net earnings + taxes + depreciation and amortization expense should exceed its total debt service (current maturities of long-term debt + interest expense).
  • Liabilities. These are what a business owes. Current liabilities are those that are due within the next year like accounts payable, line of credit and current maturities. Long-term liabilities are anything that is due beyond one year.
  • Net worth. Also known as equity, an owner’s equity is determined by subtracting a company’s liabilities from its assets.

What is the aging of accounts payable/accounts receivable?
Mittendorf: ‘Aging’ is an analytical tool that lists the vendors to whom you owe money (accounts payable) or the customers who owe you money (accounts receivable), amount of money owed and due dates. The information is organized by due date or invoice date.
What is the difference between amortization and depreciation?
Terrell: Amortization is the process of paying off a debt over time through a series of payments. The amortization term of a loan is the number of years it will take to reduce the balance to zero. Depreciation is an accounting entry in which the cost of a long-term asset is expensed over its useful life. The accumulated depreciation is reflected as an offset to the cost of the asset on the balance sheet. The remaining value of the asset is its ‘book value.’
Is there a difference between collateral and leverage?
Mittendorf: Yes, collateral is an asset pledged against a loan in the event the borrower cannot repay the loan. Typically the asset financed is the collateral. In the event the borrower defaults on the loan, the bank could take possession of and sell the asset, minimizing its loss. Leverage is the amount of a firm’s debt compared to its net worth. This is typically reflected as a ratio. A low leverage position is indicative of strong capitalization relative to the company’s total debt.
Are there other common terms I may come across?
Terrell: While there are many terms you may come across in the loan process, a few more common ones include the following:

  • Current maturities. This refers to the principal portion of long-term debt that is due within the next 12 months.
  • Income statement. This is a statement detailing a firm’s revenue and its expenses. After subtracting expenses from income, the firm will show either a profit or a loss.
  • Line of credit. A line of credit is a type of short-term financing that allows a borrower to access funds as needed up to a specified amount. It is commonly used to finance a firm’s day-to-day operations.
  • Working capital. This term refers to the difference between current assets and current liabilities. A positive working capital number indicates that a company can pay off its current obligations by converting its short-term assets to cash.

JIM TERRELL and DONNA MITTENDORF are senior vice presidents for Comerica’s Texas Business Banking Division. Comerica Bank is the commercial banking subsidiary of Comerica Inc. (NYSE: CMA), the largest U.S. banking company headquartered in Texas, and strategically aligned by three business segments: The Business Bank, The Retail Bank and Wealth & Institutional Management. Comerica focuses on relationships, and helping people and businesses be successful. In addition to Dallas, Houston and Austin, Texas, Comerica Bank locations can be found in Arizona, California, Florida and Michigan, with select businesses operating in several other states, as well as in Canada and Mexico. Comerica reported total assets of $55 billion at March 31, 2011. To receive e-mail alerts of breaking Comerica news, go to www.comerica.com/newsalerts.