How banks analyze a business to interpret its cash position.

• Position: TREASURY

The phrase "beauty is in the eye of the beholder" is widely credited to author Margaret Wolfe Hungerford, although various forms of the expression have been circulating since the third century B.C. Like beauty creditworthiness is ultimately in the eye of the lender.

Though there may be common borrower characteristics that will universally appeal to bankers--robust cash flow, large amounts of liquid collateral--the particular importance that each lender assigns to each credit metric may vary considerably. Some banks may view larger business borrowers more favorably; others are impressed by a consistent track record of operating results.

Further, banks often specialize in underwriting particular market segments, some targeting commercial real estate loan production, while others concentrate on agricultural lending or residential and consumer credit.

Given the wide disparity of borrower types and their varying credit needs, bankers' approaches to analyzing businesses are best governed by rules of thumb rather than hard-and-fast criteria. A trend of increasing sales would be meaningful for most industries, but for others, the top line doesn't tell much of the story.

Farms and gas stations illustrate the point: given the volatility of feed and gasoline prices, revenues for these businesses can easily rise by 50 percent in a matter of months, but cash flow may not concurrently benefit due to rising input costs.

"Ultimately, it's cash flow that matters most," says Steve Faulhaber, regional vice president of Peoples State Bank in Menomonie, Wis. Because most of his bank's borrowers are also using the bank as their primary place of deposit, Faulhaber doesn't need to wait for updated borrower income statements to get a sense of a company's operating performance. Most of the time, he can discern changes in a company's health by simply tracing fluctuations in its account balance.

Faulhaber notes that declining balances are a reliable leading indicator for predicting delinquencies. After all, he says, "as long as the borrower still has a deposit balance, he shouldn't be missing a loan payment."

When he reviews financial data, Faulhaber prefers to review tax documents in lieu of company-prepared statements, for a simple reason: it's a conservative way to underwrite. While some borrowers might be tempted to overstate their income in order to qualify for a bigger loan, they are certainly less inclined to do so on tax returns, where the practice would...