How Does A Bank Look At A Funding Request For A (Small) Business Loan?
The Key Players In The Request For Small Business Loans
Several parties are usually involved in applying for funding from a bank. Firstly the business itself often backed by an external accountant. Plus:
- An account manager/loan officer at the bank.
- A credit team within the bank.
- A lawyer or solicitor.
Before during and after the lending process other parties may be involved too.
For simplicities sake I'll discuss the situation that is often applicable with small and medium sized companies that are not listed on a stock exchange.
The process may be different depending on the business involved, the sector in which the business works, the money that is required and the bank itself.
The Need For Small Business Loans
The need to apply for a bank loan is usually the result of a loss a business is experiencing, replacement or planned investments in new machinery, construction or renovation of a building or the finance of business growth.
This growth resulting in for instance an increase in accounts receivable that need to be financed by a third party.
Normally the first reason, your business is running with a loss, is the most difficult one to get your loan rewarded by a bank.
They must be convinced the loss is only temporary and the risk for the bank, in case of a collapse, is minimal.
The other reasons give you a fair chance to apply for a (small) business loan successfully.
Presenting Your Business Plan & Investment Budget
Before you speak to your account manager or loan manager at the bank, it is advisable to have a balance and profit and loss statement from a recent date to your exposal.
Preferably you will be able to present a balance that shows the situation after the point of investment.
And a profit and loss projection for next year and years to come.
You must think beforehand what you are willing to provide as collateral for your loans and what extra demands you are willing to give in to.
Although they often state the opposite banks are not there for you.
They are there mainly for themselves.
They will first and foremost take their own interests into account and then the interests of their clients.
In the best scenario your interests and that of the banks align.
Have you ever had to apply for a business loan?
What Happens Next
You account manager or loan officer will write an advice to honor or not to honor the customers loan request to present to the credit team.
This team will take several factors into consideration before making a final decision.
The bank will consider the current exposure they have on this client and the proposed exposure. The total amount of the exposure determines who is allowed to OK the business loan.
The credit team will examine the past relationship (if it involves a current customer of the bank) with the client.
Has the customer always obliged to their demands.
Has the relationship between bank and customer been trouble free.
Does the business act according to desired business standards.
Often Used Expressions
The degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity
The ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time.
The movement of money into or out of a business
A firm's market liquidity and ability to meet creditor's demands.
The ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately
Earnings before interest and taxes
The borrower's pledge of specific property to a lender, to secure repayment of a loan
More Subjective Criteria
The credit team will try to evaluate the entrepreneur or management team.
They will try to figure out if they are under or overachievers in their market.
They will tray to analyze the strengths and weaknesses of the company.
And the opportunities and threats the market in which they operate poses.
They will look at worst case scenarios for instance what could happen if the owner or general manager is no longer capable of running the business.
Ans last but not least they will try to evaluate the morality of the loan applicant. Will he be willing to work with the bank when their relationship goes sour.
Some Objective Criteria
This is the part where the numbers are crushed.
First of all the bank will try to make sure they are not financing any losses.
Banks do not mind society bailing them out, but the thought that they would have to bail a business out is quite unnerving for the man and woman in suits.
Next they will try to analyze the need for the loan requested. Is the amount asked for plausible. Is it too high or too low.
Banks do not like businesses to use a salami tactic.
Feeding them slices and forcing them to buy the whole salami. If you want them to buy the whole salami better be upfront about it.
Profit And Loss
The profit and loss statement is often the most important part.
The question has to be answered if the business will be able to pay back the loan out of their cash flow.
Is their any margin for error.
How are the earnings before interest and taxes.
What is the projection for next year.
Is it feasible that the higher repayments expenses and interest costs can be coughed up.
Small Business Loans
Tha Balance Sheet
The bank will examine your balance sheet before investment and after investment.
They will examine certain ratios.
For instance how the solvency of the company is.
What their quick ratio ,and current ratio are.
How they compare with other businesses operating in similar markets.
Conditions & Collateral
Last but not least the bank will think long and hard about the conditions they want fulfilled.
Interest conditions and repayment conditions.
And then there is the elephant in the room.
What is are the assets the bank will want as collateral for this loan.
Will they want a sponsion by the director / shareholder.
Are there other conditions that have to be fulfilled.
For instance often the bank will want to receive an interim balance sheet and profit and loss account (often at high costs for the business involved in this loan process).
After the credit team goes along with the final proposal, the account manager / loan officer will discuss the bank's offer with his customer.
Tips for Getting a Small Business Loan
The Finishing Touches
The customer will have to decide if he will take the bank up on their offer. There is usually some room for negotiation.
It more or less depends on the position of the business. Is it strong enough to interest other banks in offering their services.
That usually makes their position at the negotiation table stronger.
Suffice to say the bank will not always go along with the request for a business loan.
Sometimes a business will get a second chance for an adjusted proposal.
Sometimes the bank will ask the business to look out for another lender.
And incidentally the bank may even decide to no longer uphold their line of credit.
And then .. the going gets tough.
Do you think banks are doing enough as far as loans to small businesses are concerned?
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