What Factors Are Considered When You Apply For A Business Loan?

What does it cost to operate a small business? Expenses vary widely, but suffice it to say that running a business is costly, especially during the initial period of establishment and, later, whenever the business expands. This is why small business loans are so important – they’re what enables small businesses to get started and offer new, valuable services. Still, it’s not always easy to qualify for a small business loan.

If you’re considering applying for a small business loan to support your operations, here’s what you’ll want to know before you head to the bank – and how you can best make your case to lenders. By educating yourself on the types of loans available to your company and what’s expected from applicants, you can increase your odds of qualifying.

Focus On Function

The most important thing that the bank will want to know when you apply for a small business loan is why you need the funds – what is their purpose? Among the most common reasons that people apply for small business loans are because they’re starting or purchasing a business, because an existing business is undergoing an expansion, or because the business has a lack of working capital. Your first task, then, is to identify what circumstances apply to your business and how borrowing money will allow you to meet your goals and grow your income so that you’ll be able to pay the loan back.

Run The Numbers

When you apply for a loan, the bank will tell you how much they’re willing to lend you, but before they offer up their numbers, it’s important that you do some calculations yourself. While banks typically won’t loan you more than you can afford, you don’t want to borrow more than you need, either. In order to determine how much can afford, you’ll want to consider your credit history and personal finances, as well as your collateral and any existing cash flow from your business. Then, switch tracks and evaluate how much you need to accomplish your goals.

Banks will consider similar factors when determining how much to offer your business as a loan, but they’ll also run some additional calculations. One of the most important of these is your business’s cash coverage ratio, or the ratio of cash to other liabilities. Ideally, you want at least a 1.0 ratio, meaning you have enough cash to cover current bills, but more is always better and can help you get preferable loan terms. Businesses that have a ratio of less than 1.0 will have a hard time getting a loan.

Know Your Loan Types

Just as you should be clear about how you intend to use your loan, it’s also important to understand what types of loans are available to you. Each will have slightly different terms and limits and, depending on your financial situation, you may qualify for certain loan types and not others. For example, SBA loans include everything from microloans of a few thousand dollars to disaster loans and large 7(a) loans. Businesses can only get an SBA loan if they’ve been denied reasonable terms from other lenders.

If your business is having financial difficulties – specifically if you have a poor cash coverage ratio or negative working capital – you may qualify for a working capital loan. Much like cash coverage ratio, working capital is a way of measuring financial stability, with working capital defined as current assets minus current liabilities. Working capital loans can help make up for a gap between assets and liabilities and support businesses that need to upgrade or expand in order to boost their cash flow.

Many small businesses need access to additional funding, and there’s no shame in applying for a loan as long as you’re an informed borrower. Prepare yourself with all the data you need to make the best case for your business – because only your advocacy can ensure your business gets the terms it deserves.

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