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Most SMEs would need some form of business loan financing throughout its lifetime.
Asset acquisition, expansion, and working capital requirements are some typical financing reasons for small businesses.
A lender is going to assess your SME loan application based on a set of parameters so it’s good to know where you and your business stand.
Banks and financial institutions typically do not disclose their exact credit criteria to avoid borrowers gaming the system. Many SMEs could find their loan applications rejected as a result of this information barrier.
We will discuss and share some ways you can improve the chances of approval for business loan applications.
Establishing trust with your bankers will help with your financing application.
Don’t mince on information that might be important to your banker. Many business owners tend to cover up business issues and problems. It pays to be upfront about the cash flow gaps you're facing so your banker can offer accurate advise on the appropriate financing tools to plug these gaps.
Having a professional business relationship built on mutual trust with your lender can help when you require additional financing.
If your past repayment conduct has been prompt and you have a pending request to top up existing loans, your bank relationship manager could recommend an approval right away because of the relationship built. The recommendation of a company’s bank relationship officer definitely helps during credit evaluation.
In short, be transparent. Your banker will appreciate your honesty and might even give you valuable advice.
Most start ups statistically have a higher probability of failing. While no business owner would venture into business with the thought of failing, it pays to be prepared.
Having a well thought out plan of action will help improve business loan approval chances.
A lender will inquire about your growth plans, purpose of financing and how you means of repayment. A business plan includes a statement of your business goals, strategies to get there, timetable, and financial projections.
Other common risk concern banks might have over SMEs will be key man risk. Some SMEs have a buy-sell agreement or key man insurance in place. Essentially, this arrangement allows the business to continue operating after the death, incapacity, or retirement of any one of the owners.
Anticipate potential risk factors specific to your business and prepare the mitigation plans you have. This will definitely help allay the bank's concerns and is a net positive for your application.
5Cs of credit
Banks will not openly disclose their exact credit underwriting parameters. Further, no two banks have the exact same credit assessment for working capital loan.
It is perplexing for SMEs not in the know to guess what are the loan assessment factors of banks.
However, we can reference upon a classic old school credit assessment methodology which most business lending criteria is loosely based on.
Known as the 5Cs of lending, most financing matrix framework are influenced by this methodology.
Credit history conduct, is a barometer of an entity's credit character. Banks usually analyze your credit bureau report on payment conduct, your business's existing loans and any adverse payment conduct on dues such as government taxes, suppliers etc.
The amount of money that had been invested in the business by the borrower is a quick measure of how well capitalized a business is.
Of course, the higher the capital the more safety buffer lenders have in event of loan default. But if capital is negative, i.e. total liabilities exceed total assets, the borrower is deemed to be “negative equity”. This will be extremely adverse for loan assessment.
If unfortunately, a borrower defaults on a loan, then the bank has the legal rights to make claims on any assets, to compensate for the unpaid arrears. These assets pledged to the bank for facilities granted is known as collateral.
A strong collateral secures the trust of the lender and provides additional assurance. Government financing scheme such as the Temporary Bridging Loan with the government underwriting risk sharing with banks also act as an implicit and indirect collateral.
This can be understood as the borrower’s intent in acquiring a loan. It might be needed as a capital required for investment in a business, to expand your business or even to purchase new inventory and equipment.
Borrower's ability to repay the loan promptly. Banks want to know how you plan to pay your debt and how long it will take to service the loan. This can be calculated by analyzing your debt-to-income ratio.
Mainlining a healthy positive cash flow and adequate debt-to-income ratio will help.
Bank statements analysis
When applying for a business loan, the business's bank statement is a mandatory document all banks will require for credit assessment.
A bank statement gives the lender a preview of your business activity within a specified time range. Most banks will require latest 6 months bank statements.
Here are some information banks will glean and assess from your bank statements.
Basic verification and due diligence checks
Your bank statements would usually bear your company’s name, the name of bank your business is banking with and most importantly the mailing address where the bank statements are going to.
These are standard basic hygienic checks that all banks do to verify the authenticity of the bank statements and the company.
Positive cash balance
First off, it’s a given that your cash balance must be positive. A negative cash balance in a bank statement says you’ve poorly managed your cash.
It paints a picture of you as a potential delinquent borrower because you’ve allowed your cash levels to drop to uncomfortable levels. Whether this was a plain oversight or intentional, it still is a red flag.
Bank's credit approvers will also want to review your average daily cash float balance. The higher, the better here. Anything less than $10k average daily balances maintained would be considered low.
So what is the purpose of this exercise? The bank wants assurance that you have an effective cash handling management process in place and keep a healthy cash position most times.
A lender will always check the nature of deposits you have, where they’re sourced, and how often they occur.
Consistent and frequent deposits are one of the tell-tale signs that your business may be operating profitably. These deposits could be revenue from cash sales or receivables collected regularly.
It also suggests that business is brisk and that revenues come in steadily due to new and recurring sales transactions.
Returned cheques (bounced cheques) due to insufficient funds is also a critical red flag to almost all banks. If there are too many instances of returned cheques sighted, it’s quite certain the application will be declined unless there is strong mitigations.
Most banks will not be able to accept more than 2 returned cheques over past 6 months.
Returned cheques due to technical errors such as wrong dates or signature are fine and can be easily verified via the running balances reflected in bank statements.
If you find your bank statements constantly overdrawn and cheques being returned, you might like to take up a revolving line of credit such as business overdraft to buffer for such situations.
Approach main bank
If planning to apply for a loan, it is good to approach your main bank first because you already have a banking relationship.
Most SMEs usually maintain their current account with the 3 local banking giants and all 3 are active in supporting SME financing.
Banks might have a preference for borrowers who are already banking with them as banks have greater visibility on their cash flow over a longer horizon.
For loan servicing purposes, the banks will very much prefer for the loan servicing account to be also the borrower's main operating account.
Healthy cash flow position
You may need funding to purchase equipment, acquire a commercial space, fund working capital loans for your small business, or refinance an existing loan. Whatever your reason for borrowing money, discuss it in detail with your lender.
A lender will typically examine your cash flow projections. He will want to see whether the profit assumptions you’ve made are realistic based on industry standards and your actual profits, both current and historical. He will also check if you will be able to pay your amortizations on time and still sustain a healthy cash flow position.
Additionally, he will request for other relevant information such as tax returns, credit reports, and personal data.