Banking

The Ultimate Glossary of Basic Banking Terms You Should Know

The Basic Banking Terms You Should Know

The banking world has a unique language that can leave even the most financially savvy person confused. If you’ve ever felt lost in bank acronyms and financing lingo, you aren’t alone! That’s why we’ve pulled together this glossary of terms that cover some of the core components of banking.

Here you will find all the words that bankers use on a regular basis along with their definition.

 

A

Automated Clearing House (ACH): a system operated by the National Automated Clearing House Association that banks use to process electronic transfers such as direct deposits and tax refunds.

 

Add-backs: These are expenses that are 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 owner’s benefits in excess of market such as compensation or rent.

 

Amortization: The way in which you pay off a business loan. If a loan is amortized, then you will make regular, scheduled payments that are of equal amount every time until the principal sum plus interest is paid off.

 

Annual Percentage Rate (APR): The amount of interest you gain from keeping money in an account in a year, not including compound interest.

Average Percentage Yield (APY): The amount of interest you gain from keeping money in an account in a year, including compounding interest.

 

B

Balloon Payment: A large single payment required at the end of the term to repay the remaining principle balance of the loan. 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. For example, for a loan with a 10-year amortization and a five-year term, the loan will balloon in five years, requiring the remaining five years of principle to be repaid at the end of the term.

 

Business Debt Schedule: If you currently own your business, we will ask for a business debt schedule detailing your current business loan, lease or line of credit obligations. This helps us get a full and accurate picture of the cash flow of the business.

 

Business Plan: Your lender may ask you for a detailed business plan.  This is a written description of your future plans for the business.  It could include things like history of the business, why you are interested in it, what is the business doing well right now and what are the opportunities?  You may detail out things like staffing plans, expense structure changes, transition plan between the buyer and the seller, or transition plan to a new location.  The plan should also include cash flow projections for the next several years, as well as assumptions behind those numbers.

 

C

 

Cash Flow: Cash flow is the difference between revenues (or sales) and expenses that a business incurs in any given period. If there is more cash coming in from revenues than going out from expenses, the cash flow is positive. Conversely, if expenses are higher than revenues, the cash flow is negative.

 

Cash Flow Statement: A documentation of all cash inflows and outflows that your business performs during a certain period of time. So, if you prepare a cash flow statement for last month, you denote how much income your business took along with all of the expenses your business had to pay.

 

Certificate of Deposit: Commonly known as a CD, an account in which you deposit money for a specified length of time. The account typically pays higher interest rates than standard savings and checking accounts.

 

Closing: Once your loan request has been approved, you will work with a Closer who will help gather all remaining documents in order to get the loan closed and get the loan funds to the appropriate party.

 

COGS (Cost of Goods Sold): Refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first- out (FIFO), last-in-first-out (LIFO).

 

Compound Interest: Interest that applies to the original deposit as well as any newly earned interest.

 

Collateral: Collateral is something pledged as security for repayment of a loan, to be forfeited in the even of a default.  Your lender will explain any collateral requirements related to your loan request.

 

5 C’s of Credit: This is a list of criteria that we look at when deciding whether to lend to you.

When you apply for a loan, a loan specialist will look at your cash flow, character, capital, credit and collateral to underwrite the risk of lending to you.

  • Credit: As history is the best predictor of the future, a lender will examine the personal credit of all borrowers and guarantors. Good personal credit is a must. Any problems must be thoroughly explained.
  • Character: Lenders need to know the borrower and guarantors are honest and have integrity. Additionally, the lender needs to be confident the applicant has the background, education, experience, and industry knowledge to successfully run the business.
  • Capacity: The business should have sufficient cash flow to support its business expenses and debts comfortably while providing the principals salaries that will support personal expenses and debts.
  • Collateral: A lender will consider the value of the business’s assets and the personal assets of the guarantors securing the loan as a secondary source of repayment if the loan cannot be repaid. Collateral is an important consideration for a conventional loan, but not as imperative with a SBA loan.
  • Condition: The lender will need to understand the condition of the business, the industry, and the economy. Are current conditions likely to change, deteriorate, or improve?

 

D

Depreciation: The decline in value of fixed assets with the passage of time, allocating purchase cost of asset over its useful economic life.

 

Debt Service Coverage Ratio (DSCR): Debt service coverage ratio (DSCR) is the cash available to service debt and the total debt service for all interest, principal, and lease payments. The business’s cash flow is an indicator of the financial strength of the business.

 

E

EBITDA: Earnings before interest, taxes, depreciation, and amortization. This is another way of indicating that your business’s financial health and measures your income without taking into account accounting decisions.

 

Equity: Ownership in assets after all debts are paid off. Equity is an important element in developing expansion and acquisition plans.

 

F

FIFO:  This stands for first-in, first-out and is an inventory costing method that assumes that the first items placed in inventory are the first sold. Thus, the inventory at the end of a year consists of the goods most recently placed in inventory.

 

FDIC: The Federal Deposit Insurance Corp. A government-run organization that insures customers’ bank deposits up to $250,000 if the bank fails. The National Credit Union Administration is the equivalent for credit unions.

 

G

Goodwill: 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.

 

Guarantor: An individual who pledges to repay the debt if the actual borrower defaults or is unable to repay the loan amount.

 

I

Interest Rate: The rate the bank pays on the money in your accounts.

 

L

Leverage: Leverage refers to the amount of debt used to finance a business’s assets. A business with more debt than equity is considered highly leveraged and therefore more susceptible to default should there be an adverse change in circumstances.

 

LIFO: This stands for last-in, first-out and is an inventory valuation method which assumes that the last items placed in inventory are the first sold during an accounting year.

 

Loan Term: The period of time over which the loan is to be repaid.

 

N

NOI: Net Operating Income, NOI, is often referred to as cash flow and includes EBITDA + add-backs + owner’s compensation.

 

Net Operating Margin (NOM): A measurement of profitability and an indicator of how well a business controls its costs. It is the ratio of operating income to net sales.

 

O

Online Bank: A bank that is operated entirely online. Most offer higher interest rates or lower fees because they don’t have to maintain branches.

 

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.

 

Personal Financial Statement: This should show your income, the value of your assets (such as your home, vehicles and savings accounts), outstanding debts, the amount of your debt payments and monthly overhead. This will give us a good idea of your personal cash flow and the amount of additional debt you can comfortably absorb.

 

P

Prepayment Penalty: Lenders with prepayment penalties, sometimes referred to neutrally as prepayment fees, will charge you for paying your loan off early.

 

Profit and Loss Statement, P&L or Income Statement: A document that shows your business’s income and expense over a specific amount of time. This will allow us to see how the business is performing year-to-date.

 

Projections & Assumptions:  Your lender may ask for cash flow projections and assumptions.  These are typically done in an excel spreadsheet, detailing out the first twelve months of revenues and expenses, followed by two or three years depicted on an annual basis.  This spreadsheet should be accompanied by a narrative explaining where you are getting your numbers.  For example, what are the sales price and the number of sales per month driving your revenue figure, and are these competitive and realistic in your market?  Projections should reflect the level of due diligence you’ve done in your market.  Your lender may provide you with a template if you need one.

 

Q

Qualification: During the qualification stage, your loan officer will request initial documents in order to determine if we can move forward with the loan request and issue you a proposal letter.  A proposal letter will outline the tentative terms and conditions of the loan.

 

R

Refinancing: A way of obtaining a better interest rate, lower monthly payments, or borrow cash on the equity in a property that has built up on a loan. A second loan is taken out to pay off the first, higher-rate loan.

 

Revolving Credit: A credit agreement (typically a credit card) that allows a customer to borrow against a pre-approved credit line when purchasing goods and services. The borrower is only billed for the amount that is actually borrowed plus any interest due.

 

S

Savings Account: An account that usually pays interest at a financial institution that holds money you want to keep for long-term goals or emergencies.

 

T

Terms: The period of time and the interest rate arranged between creditor and debtor to repay a loan.

 

V

Variable Rate: Any interest rate or dividend that changes on a periodic basis.