Businesses borrow money for a number of reasons. Additional capital may be needed to increase production capacity or to open a new office location. It might be necessary to borrow to expand into a new market or to upgrade the business IT facilities.
Whatever the reason, borrowing money involves the need to favorably impress the lenders you are approaching for finance. There’s never a guarantee that they will support your proposal, but there are some preliminary steps you can take to make a more convincing case to them.
Have all the necessary paperwork ready
Getting ready to apply for a loan is a lot like getting ready to sell a business. You’ll need to put together at least three years of financials including tax returns, financial statements, and lists of current payables and receivables. If the money is being borrowed to capitalize on an opportunity that will require the business to make significant investments, be prepared to present a comprehensive business plan that incorporates a model illustrating the projected results of making the investments.
How do your receivables and payables look?
Lenders like to see a business that gets its cash in quickly and doesn’t allow its accounts receivables to age beyond a reasonable period. Good businesses keep their cash flow under control by aggressively pursuing accounts receivable so they can pay their own creditors and take advantage of discount opportunities.
What is the value of your major assets?
Saleable assets are what a lender will look at to gain an idea of how much could be realized if the business has to be liquidated. Have an up-to-date list of all assets owned by the business and be able to show how they were paid for or how they have been financed.
Current and accurate valuations for all major capital equipment will need to be provided. These should be prepared by a third party that can give an independent estimate of their current value; what the business paid for something isn’t necessarily a guide to its present worth when depreciation is taken into account.
What is your current debt-to-equity ratio?
Lenders will loan different amounts to same-sized businesses in different industries. A high-tech business with $5 million worth of rapidly depreciating computer equipment will be viewed differently from a manufacturing business with $5 million worth of production machinery with many years of service life left in it.
You should have a pretty good idea of the amount you’re likely to be able to borrow before you approach a lender. If the amount is seen as ‘excessive’ because of the industry you’re in you may have to offer some of your personal assets as security for the loan.
What is your debt-to-income ratio?
Lenders know that loans must be paid back out of the profits of a business. Making loan repayments out of gross income can easily lead to cash flow shortages if the business isn’t suitably profitable. If the repayments are going to require too high a portion of the business’ profits it can also lead to problems.
A debt-to-income ratio of less than 50% is the norm, but less than 40% is preferable. This means that a business with monthly profits of $5000 should have no more than $2000 per month in repayments.
Both principal & interest repayments need to be covered
You’ll have to be able to show that the business can afford to make the loan repayments on top of covering all its regular expenses. This includes both the loan interest and a portion of the principal, depending on the duration of the loan.
When you prepare your case for any lender, keep all the above in mind. Get the business and your paperwork ready for the exercise; have a rough idea of how much your business is worth and of the amount you’ll realistically be able to borrow.
Information in this article is sourced from RAN ONE, Inc