Business Loans

When you start your business, it is unlikely that you will have the funds to pay for everything. Business loans are one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. Before you approach your bank for a loan it is best that you do you homework to ensure you get that loan first time round.

Below are some of the key factors that the bank uses to analyse a potential borrower.

Ability/Capacity to Repay
The most important thing the banker wants to know is you ability to repay the loan. This usually comes in the form of cash flow from your business plus a secondary source such as collateral. Banks will review your business past financial statements. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years because they have a financial track record. If the business has consistently made a profit and that profit can cover the payment of additional debt, then it is likely that the loan will be approved.
If however, the business has been operating marginally and now has a new opportunity to grow or if that business is a start-up, then it is necessary to prepare a thorough loan package with detailed explanation addressing how the business will be able to repay the loan.

Credit History
One of the first things a bank will determine when a person/business requests a loan is whether their personal and business credit is good. Therefore before you go to the bank, or even start the process of preparing a loan request, you want to make sure your credit is good.

Credits history can be obtain from past credit cards, mortgages, student loans, etc. Each credit will be listed individually with information on how you paid that credit. Any credit where you have had a problem in paying will be listed towards the top of the list. These are the credits that my affect your ability to obtain a loan.

If you have been late by a month on an occasional payment, this probably will not adversely affect your credit. However, if you are continuously late in paying your credit, have a credit that was never paid and charged off, have a judgment against you, or have declared bankruptcy in the last 7 years, it is likely that you will have difficulty in obtaining a loan.

In some cases, a person has had a period of bad credit based on a divorce, medical crisis, or some other significant event. If you can show that your credit was good before and after this event and that you have tried to pay back those debts incurred in the period of bad credit, you should be able to obtain a loan. It is best if you write an explanation of your credit problems and how you have rectified them and attach this to your credit report in your loan package.

Equity

Before approving a business loan financial institutions want to see a certain amount of equity in a business. Equity can be built up in a business through retained earnings or the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than 4 times the amount of equity. Therefore if you want a loan you must ensure that there is enough equity in the company to leverage that loan.

Don't be misled into thinking that start-up businesses can obtain 100% financing through conventional or special loan programs. A business owner usually must put some of her/his own money into the business. The amount an individual must put into the business in order to obtain a loan is dependent on the type of loan, purpose and terms. For example, most banks want the owner to put in at least 20 - 40% of the total request.

Example: A new business needs a $120,000 to start. The business owner must put $30,000 of her own money into the new business as equity. Her loan will be $90,000. The debt to equity ratio is 4:1. Note also that this is only one of many factors used to evaluate the business -- just having the right debt/equity ratio does not guarantee you'll get the loan.

Collateral

Financial institutions are looking for a second source of repayment, which often is collateral. Collateral are those personal and business assets that can be sold to pay back the loan. Every loan program, even many microloan programs, requires at least some collateral to secure a loan. If a potential borrower has no collateral to secure a loan, she/he will need a co-signer that has collateral to pledge. Otherwise it may be difficult to obtain a loan.

The value of collateral is not based on the market value. It is discounted to take into account the value that would be lost if the assets had to be liquidated.

Experience

A client that wants to open a business and has no experience in that business should not seek financing let alone start the business unless they intend to hire people who know the business or take on a partner that has the appropriate experience. Regardless, the client should be advised to take some time to work in the business first and take some entrepreneurial training classes.

Questions you bank will ask you

The key questions the banker will be seeking before approving your business loan are as follows:

Can you repay the loan if the business fails? (is collateral sufficient to repay the loan?)

• What is the future of the industry?
• Is there any discretionary cash flow?
• Can the business repay the loan? (is cash flow greater than debt service?)
• Does the business collect its bills?
• Does the business pay its bills?
• Does the business control its inventory?
• Are profits increasing as a percentage of sales?
• Are the officers committed to the business?
• Does the business have a profitable operating history?
• Does the business match its sources and uses of funds?
• Are sales growing?
• Who is your competition and what are their strenghts and weaknesses?.
• Does the business control expenses?