Business loans are only intended for business purposes. It may be used to pay expenses or fund startups. Business loans are taken out by companies and business owners to meet the capital needs of their business.
The cash flow from a business loan can go into expansion or meet other incidentals arising out of business transactions.
An application for a business loan can be made to lenders such as banks, small business administrators or through other lenders. But any lender you choose, they will ask four questions, if you are a business owner. The questions are:
For how long has the applicant been in business?
This is the first question that a lender looks at when you apply for a loan as a business owner. It is better if you have been in business for long. This means that the business is sustainable, and you will be able to pay back the loan amount. This also means that the business will not just go down, and the lender will not lose money.
In the United States, around 50% of small business close down within the first five years. If your business has gone beyond that time period, then the lenders will be confident that the business will be in operation for enough time to pay back the loan.
But if you haven’t been in business that long then consider alternative channels. Think about getting a loan on your personal credit. If you can hang on for two years, then it will be easier to get a business loan. Try to maintain good business and personal credit scores if you are waiting to hit the 5-year mark.
What is the amount of money the business makes and what potion is kept by the applicant?
The lender always will want to know about your revenues or sales and profits. Total/gross revenue means the sum received from buyers before you deduct the costs, such as the purchase of equipment, overheads and payment of the debt. The profit or net profit/net earnings/net income is the amount left after subtracting expenses from gross revenue.
Profit or net profit matters a lot to lenders because it depicts the income kept by the business owner. It is possible to have good revenues but not good enough of a profit when expenses are too high. This isn’t a feasible scenario if you are applying for a loan.
How well is the cash managed by the business?
Bank balance and financial statements are analysed by lenders to understand how well you have managed cash flows. This is different from profitability as profitable companies can be suffering from cash flow problems. A cash flow statement can underline how much cash you have at any point in time.
To understand this clearly, imagine a business owner has $120,000 in annual profits. He takes out a loan where the monthly payment is $2,000 per month. It looks like repayment is possible. But what if the business owner’s maximum profits show up only in the 4th quarter? This means that the rest of the months (the 1st few), the business owner may not be able to make any repayments.
The cash flow and bank statements will prove to lenders whether you can make timely payments or not.
What is debt repayment history?
When lenders decide on financing a business, they look at business and personal credit scores. Credit scores are a parameter that tells lenders if the business is capable of shouldering the loan or not.
If you don’t have five years in the business, then personal credit scores will matter a lot, as it’s the only thing the lender can look at. If you have been in the business for a good period of time and have a decent business credit score, lenders will look at your personal credit as a sign of overall trustworthiness and reliability.
Usually, a credit score of 780 is excellent, a personal score ranging between 661-780s very good and one between 601-660 is fair.
You don’t have to have an amazing score to get financing. Usually, a score of 620-660 is good enough. But if your score is higher, then you can qualify for a variety of loans, and you will get lower interest rates as well.
Business loans can infuse new life in your business if you are strapped for cash. But be prepared and do your due diligence before you apply.