Your Guide to Prudent and Successful Borrowing for Your Small Business

When you want a business loan, your lender gives you a loan application form to fill out, and then carries out their own research to determine whether or not your loan will be approved. In this article, David Wicks talks about some of the ways you can improve your chances of approval, and simultaneously get credit whose repayments won’t cripple your business in the future. These tips will also help you to carry out an informal assessment of your business’s financial status.

Step 1: Assessing Your Business

  1. Appreciate risk

Understanding the concept of risk will help you appreciate where your lender is coming from. Lenders are always looking to minimize risk. For instance, if you’re considered likely to default (e.g. based on your credit report or other financial obligations), they will approve a smaller loan with higher interest rates to ensure their amount is recovered sooner. Lenders will love anything you bring to minimize their risk.

  1. Update your paperwork

Don’t go to your lender with half-cooked books. Ensure your financial statements and income tax returns are as close as possible to your time of borrowing. You should have adequate reports for at least three years or since the business began. Carry along your bank statement for the last year and any existing loan statements to prove you’re not a lending risk. Presenting all this information upfront without being asked may show the lender that you’re confident in your creditworthiness, and you’re meticulous about your books.

  1. Have a plan

Unless you’ve been in business for many years, a lender will be generally skeptical about your financial savvy. Therefore, it helps to have a plan for the loan detailing exactly what you want to do with it, and possible returns from it. Avoid simply borrowing personal loans without a plan- you may end up repaying a loan that didn’t benefit your business in any way. In addition, the banker will be interested in your business plan, particularly if your financial statements don’t cover at least three years.

  1. Find out your creditworthiness

Some businesses are worth larger loans than others for many reasons. Perhaps you have more assets to post as collateral, or you’ve been in business longer and have proved to be creditworthy and prudent in borrowing. First, ensure you have an idea what your personal and business credit reports state about your history. Have an explanation ready for any unpleasant entries and contest anything you think shouldn’t be on the report.

Do not overstate your net worth; the bank will value your assets for itself, and you’ll lose credibility if you seem to be trying to fool them. Make a list of your assets – business and personal – as well as liabilities. Subtract your total assets from total liabilities to get your net worth.

Second, understand profit as your banker sees it – this is different from taxable profit or the profit in your financial statements. The banker’s profit figure is calculated by taking the income statement profit and adding back depreciation/amortization, interest and income tax.

  1. Research your lenders

Before setting about researching lenders, you should already have your own assessment in place. This will prevent you from getting sucked in by loan terms you don’t need and into borrowing more than you need. If you find a lender whose terms are much better than the current loans you’re servicing, you can also speak to them about getting a debt consolidation loan so as to reduce your overall interest expense. This will mean more profit for them, so they will probably be agreeable provided you can prove creditworthiness.

You will need to interview the lender’s commercial manager and have gone through their loan application guidelines, criteria, interest rates and other terms. Visit up to 3 or 4 lenders before making a final decision. Bear in mind that you don’t necessarily have to borrow from a bank. Consider using commercial brokers, even though you’ll pay a fee to get the best lender. You can offset any fee to them against the interest savings you’ll make compared with sourcing the loan yourself.

Step 2: Filling in the application form

Every loan form has five main portions: how much you’re worth, how much you make, how much you want, contact information and repayment plan. Here are some tips on filling some of the sections:

  • Contact information – Write down your business name and registered office location. It should match what’s on your letterhead and on the internet. If your business is more than one entity e.g. if using a trust, draw a diagram to explain all related entities, their roles, shareholders, directors and trustees as relevant. You want to make your business as easy to understand as possible for the lender. Include the contact information for the closest relative that doesn’t live with you.
  • Repayment plan–You should provide three repayment plans at least. The first is the regular repayment of interest and principal over the life of the loan, the second and third should detail payment in special circumstances e.g. sale of some business assets or intervention by your guarantors.
  • Queries – Every lender will have follow-up questions about your form. Do your homework so that you can easily and quickly provide answers. If you need to research, try to get back to them before 24 hours, or call them and explain why it might take longer than that.
  • Statutory forms – Every application form has a set of statutory forms that need to be signed. Ensure they are signed by the correct person and attached to your application at the time of submission.

Step 3: Loan processing

  1. Debt coverage

A lender will first analyze how much debt you have in total. This is a ratio of your total assets to total liabilities, and the higher it is the better for your application. Most lenders consider 1.5 or higher as a healthy margin, but different lenders have different specific terms.

  1. Interest cover

The lender will analyze your total interest expense, including interest on the new loan. This is done by calculating the adjusted profit described above with the interest on the new loan. Just as with the debt coverage, a higher margin is more preferable. Therefore, aim for an interest cover of at least 1.5, but 1.75 may make the application more likely to sail through.


Author bio:

The author has over 20 years’ experience in business accounting and debt management fields, including debt consolidation loans and other credit counseling areas. In his free time, he reads science fiction novels and plays video games with his children.

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