A bank’s main goal is to protect their capital. They strictly assess business loan applications to determine the viability of the business and the borrower’s capacity to repay the loan. As such, they have stringent requirements and look at a number of factors when reviewing bank loan applications.
Here are the main factors that banks use to assess a loan application for a business:
1. Your credit rating
First and foremost, banks want to be repaid so you need to prove to them that you have been responsible with your credit. Your credit rating is also a good barometer of how reliable you are likely to be. Hence they will not lend money to those who have very little credit history, or poor credit.
Having a bad credit is a deal breaker for banks. You can’t even get past the first step if you don’t have good credit. It is best to spend your time raising funds elsewhere rather than banks.
2. Financial Statements
The most relevant part that will weigh in your bank loan application will be your financial statements. They will look at your financial documents and ask, “What could go wrong?” These are the documents that are of paramount importance to banks and carefully reviewed to determine whether they will give you a loan or not:
- Cash Flow Statement = if you are an existing business, you need to submit cash flow statements for at least the 12 months; for a startup, you need to submit a projected cash flow statement for the first 12 months
- Income and Balance Sheets = projected statements for the next 12 months for startups; and income and balance sheets for the past three years for existing businesses
Banks want to know how their money will be used, and whether your business will earn sufficient income to repay the loan. Before they even think of repossessing your collateral, banks look at whether your business can have available cash to operate the business while repaying the loan. Cash flow, which is sales less expenses as well as cash from investments or financial activities, is a critical barometer for banks when reviewing loan applications.
3. Your Financial Ratios
Banks assess the credit worthiness of a business by looking at its financial ratios. Some examples of these ratios include:
- Debt to Equity = it measures the degree to which the assets of the business are financed by the debts and the shareholders’ equity of a business.
- Current Ratio Helps measure the solvency of your business by comparing current assets (like unpaid invoices) to current liabilities (unpaid bills):
- Quick Ratio = a measure of how well a company can meet its short-term financial liabilities.
4. Other items
There are a number of non-balance sheet items that banks consider when reviewing loan applications. The most critical of these are:
- Your experience in the business and in the industry
- The potential value of prospective customers
- Documentation needed for that specific type of loan (e.g. if bank loan is for land financing, then you need to include information about the real estate you are interested in purchasing)
- Business plan (note though that this is more critical for startup loans, rather than loans for existing businesses where a statement of intention may suffice instead).
Recommended Books on Getting Financing:
- Financing Your Small Business: From SBA Loans and Credit Cards to Common Stock and Partnership Interests (Quick Start Your Business)
- How to Get the Financing For Your New Small Business: Innovative Solutions From the Experts Who Do It Every Day
- Get Your Business Funded: Creative Methods for Getting the Money You Need
- How to Raise Capital : Techniques and Strategies for Financing and Valuing your Small Business
- Finding Money – The Small Business Guide To Financing
- Pros and Cons of Financing a Business
- 12 Tips for Getting Your Bank Loan Approved
- Why You Can’t Get a Bank Loan for Your Small Business
- How to Raise Money to Finance a Franchise
- Evaluating Financing Options for Your Business: Myths and Facts