Business growth is a balance between investing so your business can generate more revenue and waiting until it expands so you can use the profits to pay for more growth. This circular problem is the conundrum many business owners face: the need to invest for growth versus keeping money for operational costs. Taking a smart risk and applying for a business loan may be the best option to get a high return on investment, especially for small businesses. However, before applying for a business loan, there are some factors that can affect your application that you should know about.
1. Cash Flow
First and foremost, lenders will assess your business cash flow to determine if you can afford the loan. Forbes’ guide on how to get a business loan explains that the amount to be loaned should be carefully calculated. Too little and the business will struggle with managing liquidity, but too much and the loan will be rejected. It is recommended that business owners take preventative measures by calculating cash flows quarterly to come up with accurate figures before applying for loans, which will increase the chances of approval. Lenders will generally accept a debt coverage service ratio of 1, which means that your cash flow is equal to your monthly loan payments. However, it is better to have a ratio of 1.35 or higher to demonstrate a buffer in your business finances that will allow you to cover the monthly payments more easily.
2. Credit History
Though lenders will consider your business credit score, for small and new businesses, they will typically use your personal credit history for reference as well. This is why as a small business owner, you shouldn’t forget to factor in your personal credit score before applying for a loan. Petal Card’s guide to improving your credit score enumerates the different factors FICO considers when creating your score. This includes your payment history, credit utilization, credit limit, how frequently you apply for credit, among others. To build and maintain a good credit score, it’s crucial that you pay your bills on time, avoid opening new credit, and set up debt consolidation plans if you have numerous monthly minimum payments. Those with low credit scores can still apply for loans after improving their scores through lower credit utilization, reviewing credit card reports, and setting up automatic payments to stay on schedule. There are also independent financing partners that offer more flexibility compared to banks since they understand that credit scores can be caused by emergency situations and are not representative of your entire credit history.
3. Type of Business
Creditors will also look at the type of business you run. Riskier businesses may need to pass through more screening with financial partners who will likely charge higher interest rates. To secure your loan, illustrate your business’ potential for returns and back it up with solid data using market research. Getting the loan partner on your side is essential for this step.
4. Business Plan
Lenders will typically expect a detailed business plan to justify your need for a loan, and if it’s impressive enough, you can expect the approval process to go more quickly. When drafting up your business plan, be sure to detail what the loan will be used for and how it contributes to your overall business goals, mission, and vision.
5. Age of the Business
The U.S. Bureau of Labor Statistics reports that 21.9% of new businesses failed in March 2020, a reality that makes lenders wary of which small businesses to lend money to. This is why banks and lenders factor in the age of a business – time demonstrates how well potential borrowers can properly pay off credit and loans. Annual percentage rates for small businesses typically run higher, but once they see more business activity, better interest rates are likely to follow. If you’ve only been in business for a couple of years, use the time to build your credit profile as suggested above to show lenders your business has a higher likelihood of succeeding, especially if granted the loan.
Finances are the bloodline for your business. While our guide on How to Be a Successful Business Owner discusses sticking to your budget along with setting your goals and building your network, part of business success is also understanding when you should take risks. Knowing the factors that affect your business loan application can help you prepare for the process, have it approved, and ultimately grow your business to reach your goals.