Getting finance to buy a home is not as easy if you have your own business. The stringent credit criteria applicable to self-employed individuals, coupled with bad accounting practices and undeclared drawings, are the major contributing factors to the banks finding it difficult to identify sufficient income to service a home loan.
If you own 20% or more of your company, you are considered by most banks to be self-employed, and the banks will request the financial statements and 6 months bank statements of your company.
Property Factor, which specialises in procuring finance for this category of home buyers, often comes across financial statements that either have been drawn up incorrectly or are not a true reflection of the financial position of the enterprise. Entrepreneurs are the creative minds behind their organisations, but they seldom pay attention to, or do not understand, their financial statements.
While the profitability of the company is important, it is the balance sheet that tells it like it is and hides no secrets. The banks will look at the liquidity of the company by comparing the total current liabilities with the total current assets. Ideally, for a company to be in a healthy, liquid position, the current assets must be double the current liabilities. Should the current assets be less than the current liabilities, the company will be considered illiquid. It will be difficult to raise finance under such circumstances.
Gearing is the measure of the degree to which a company’s activities are financed by debt (long-term liabilities) or the owner (capital employed/owner’s equity). The higher the gearing, the higher the risk, because the company will need to continue servicing its debt irrespective of a drop in turnover.
Other items in the balance sheet will be scrutinised with the following questions in mind:
- Shareholder’s/member’s loans. Is the owner required to fund the enterprise year-on-year or is it self-sustaining?
- Is there long-term tax liability outstanding?
- Is stock being replenished or is it being depleted?
In the income statement, the following will be subject to scrutiny:
- Turnover. The bank will look at whether the year-on-year turnover is increasing or decreasing. A decrease in turnover will have to be motivated.
- Cost of sales as a percentage of turnover.
- Depreciation. At times, depreciation, which is not a cash flow item, may be added back to the company’s net profit. However, this can be done only if all the assets have been fully repaid and there is not a liability outstanding on these assets.
- Remuneration of members/directors. This must be shown separately and not included in staff salaries. The salaries declared will be compared with the deposits made into personal bank statements of the members/directors.
- Profitability. All declarations made in the financial statements will be compared with what is actually reflected in the business and personal bank accounts. Any huge discrepancies will require some explanation. Alternatively, the banks reserve the right to call on tax returns for both the applicant and the organisation.
Finally, the cashflow statement completes the picture. It records all the cash transactions flowing in and out of the company, whether the transaction is of a capital nature or a that of profit and loss. For example, if debtors repay their trading accounts, it will reflect as funds flowing in, as is the case with the selling of an asset. A company operating in a negative cashflow situation will not sustain itself for much longer and will soon require a cash injection. As the saying goes, "Revenue is vanity; profit is sanity; cashflow is reality.''
While the banks seldom approve an application based on the figures in management accounts, they will call on them as well. Management accounts are similar to financial statements, with the only difference being that they reflect the figures as per the trial balance and they have not been closed or signed off. The management accounts must not be older than two months.
When procuring home loan finance for self-employed individuals, a professional, such as Tess Rodrigues of Property Factor, with a thorough understanding of accounting practices is required. We may have to arrange a meeting with you and your accountant to obtain a better understanding of your business and then position the home loan application correctly in order to secure a positive outcome.
Gone are the days that completing an application, supported by an income letter from an accountant, would suffice.
Published in:
Independent Online
My Property
Times LIVE
"There is no such thing as the banks not providing home loans to self-employed individuals. Approximately 70% of our clients are self-employed and they all obtained a home loan. You could too!"