Thinking about diving into the world of business or taking your current one to new heights? Securing a business loan can seem complex and daunting. But fear not! Below is a handy guide to help you through the process of qualifying for a business loan and getting on track for financial success.
Operating History
Having an established operating record is key. Financial institutions typically do not review a startup or a business that has less than two to three years of operations. Reason being, that without historical financial information, there is no way of knowing if a business is stable and how strong their cash flow is. Although three years is typically analyzed by a financial institution, most of the determining influence is given to the current operating year.
Operating Profit
In addition to having a steady and stable operating history, having positive cash flow is a must to qualify for a loan. If a business shows losses, that can be an indicator the business is having financial issues. And from a financial institution’s perspective, having strong operating profits determines if the business would be able to withstand an economic downturn.
Cash Flow
Another thing to consider is that profitable operating history will usually reflect positive cash flow. To qualify for a business loan, financial institutions traditionally require a 1.25:1 debt service coverage ratio. This means for every $1.00 in debt you should have $1.25 in cash flow to pay that debt.
Quality Financials
Make sure your business financials are of good quality. A borrower’s filed tax return is the primary source of information used in analyzing cash flow. It is highly recommended that your taxes be CPA prepared, and CPA reviewed or audited.
Sources of Repayment
The primary source of repayment for a business loan comes from the operations of a business. Financial institutions will also take into consideration a secondary source of repayment, which is generated from the owners/principals of the company.
Note the following are important elements financial institutions examine: good credit history, outstanding debt, liquidity, net worth and other outside sources of income that contribute to cash flow.
Collateral
Lastly, know that unsecured loans, without any pledged collateral, are riskier and harder to qualify for. Most financial institutions will look for sources of collateral as a form of repayment too. Examples of collateral can be used equipment, accounts receivable and fixtures, but ultimately, the best form of collateral is real estate.
Keep in mind that collateral is taken as a support to repayment and will never be considered as a primary source. Loans made to borrowers are based on the business’ ability to repay loans from the cash flow produced from business operations.
For more professional advice on business loans, reach out to the SESLOC Member Business Loans team at sesloc.org.
