Buying, Selling, Renovating, or Refinancing?
Terms to know when meeting with your lender.
When it comes to financing your funeral home, several questions will arise. What type of loan suits my needs? What questions should I ask my lender? What should I be prepared to tell my lender?
Jargon used by lenders is not typically used in your daily work. This can make the loan application process tedious and intimating. On the other hand, terminology of a funeral home business may not be familiar to every banker! Working with a lender who understands business financing and the funeral industry can facilitate the process.
Familiarizing yourself with the following terms will help you prepare for conversations with your lender.
The period of time over which the loan is to be repaid.
The period of time over which the loan payments are calculated. A loan’s payments may be calculated over a period that is longer than the loan’s term.
A large single payment required at the end of the term to repay the remaining principle balance of the loan.
A loan with a ten year amortization and a five year term will balloon in five years, requiring a.) the remaining five years of principle to be repaid at the end of the term or b.) the loan to be refinanced. A loan with a balloon leaves the borrower at risk for higher interest rates when the term ends. Furthermore, the borrower will have to repeat the loan process to refinance the remaining loan amount.
Expenses assigned to cash flow to normalize a profit and loss statement. Normal add-backs include interest, taxes, depreciation, amortization, one-time expenses, personal expenses, and adjustments to owner’s compensation.
Add-backs enable a lender and buyer to have a better understanding of profits and losses since certain expenses will not continue under new ownership. Only documented expenses will be added back to cash flow, so is vital that sellers keep accurate records of such expenses.
Earnings Before Interest Taxes Depreciation and Amortization; commonly used for valuation purposes.
Net Operating Income (NOI)
The funeral business’s income after Cost of Goods Sold (COGS) and other operating expenses are deducted from revenues, but before income taxes and interest are deducted. NOI is often referred to as cash flow and includes EBITDA + add-backs + owner’s compensation.
Operating expenses may include utilities, lawn care/snow shoveling, advertising, accounting expenses, and supplies but exclude wages for full time employees, purchase of a vehicle or other equipment.
Net Operating Margin (NOM)
A measurement of profitability (NOI/ Revenue) and an indicator of how well a business controls its costs. A typical NOM for a high performing funeral home is approximately 26%.
Debt Service Coverage Ratio (DSCR)
Cash available to service debt (NOI) divided by the total debt service for all interest, principle, and lease payments (NOI/total debt service). For example, a DSCR of 1.50 indicates there is 50% more income than is required to repay all debt, or $1.50 available to pay each $1.00 of debt. Conversely, a DSCR of 0.90 would indicate there is only 90 cents available to pay each $1.00 of debt.
An individual who pledges to repay the debt if the actual borrower defaults or is unable to repay the loan amount.
Ownership in assets after all debts are paid off. Equity is an important element in developing expansion and acquisition plans.
Leverage refers to the amount of debt used to finance a business’s assets. A funeral home with more debt than equity is considered highly leveraged and therefore more susceptible to default should there be an adverse change in circumstances. For example, if a funeral home is highly leveraged and experiences a year of low death rate, it could become difficult for the funeral home to pay its bills.
Intangible assets such as the company’s reputable name, customer loyalty, and good employee relationships, also known as “blue sky.” While goodwill can be difficult to price, it undoubtedly adds to a company’s value.
Understanding the terminology lenders use will help you prepare to obtain financing. Whether you are looking to renovate your current location, refinance existing debt or buy or sell a funeral business, educate your lender about your unique situation and needs and build a team focused on your long term success!