How banks assess a business loan application

Find out what lenders are looking for and what you'll need to do to get approved for a loan.

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Many businesses rely on loans to get off the ground, and financing is considered a normal part of the business process. To be eligible for a loan, you'll need to convince the lender that your business is a viable investment and that you'll be able to repay your loan on time.

Every bank has its own system for assessing a loan application and will have certain eligibility criteria that you will need to meet to be approved for a loan. Find out what they look for and how to get approved, and compare your loan options below.

Will I be eligible for a business loan?

Different banks have different requirements that you will need to meet to be eligible for a loan, but there are some general criteria that apply. However, the specific requirements will vary with each lender, so make sure to check with a specific bank to see if you will be eligible.

  • Trading history. You'll need to have been operating for a certain period of time (generally at least 3 to 6 months) to be approved for an unsecured business loan. Some lenders do offer loans for new businesses, and you may also have the option of alternative financing, such as invoice factoring and equipment loans. These loans will often not require your business to be a certain age.
  • Turnover. Many banks will also require that your business has a certain level of turnover to be eligible for a loan. The revenue required may be as little as $5,000 per month, or up to $200,000 per year, depending on the bank.
  • ABN/ACN. You'll need to have an Australian Business Number (ABN) or Australian Company Number (ACN) to be eligible for most business loans in Australia.

When should I apply for a business loan?

There are a number of reasons to apply for a business loan, including debt consolidation, improving cash flow, or funding new equipment or stock.

However, the most important thing is that your business meets the eligibility criteria of the lender, and that your business is in a position to repay the loan without harming your business operations or cash flow.

What documentation do I need to provide?

Unlike regular personal loans, banks will often be quite strict with the documentation they require as part of a business loan application. You will need to provide extensive documentation on behalf of both you and your business, especially if you're applying for a large loan amount or represent a risk to the lender.

You should have all of the following items ready before commencing an application:

  • Personal identification such as a driver's licence. You will always be required to provide this.
  • Business verification. You will need to prove the existence of, and your ownership of, the business.
  • Financial history. Lenders will almost always want to get an idea of how strong your personal and business finances are. They may ask to see bank statements, sales records, expenditure reports and other documentation to help them ascertain how risky it is to give your business money.

As well the documentation above, you should ensure that your business's financial information and details are up-to-date, and be willing to provide any further documentation requested by the bank at short notice.

For example, if you're running a new business and have been trading for less than 12 months, you may need to provide the following additional documents:

  • Cash flow projections
  • A business plan
  • A lease agreement

Preparing all your essential documentation before you apply for a business loan will ensure that you're ready to meet any requests for further information.

What questions will I be asked when applying for a business loan application?

To start with, many lenders will want to know more about your business and how you plan to spend the money. This will be determined by asking you certain questions. Make sure you have answers for all the following:

  • What is the purpose of the loan? It's not enough to say that it's for starting or running a business. The bank will want to know the specific need for the funds, whether it's for vendors, refurbishment, staff costs, training new employees, expanding your business, handling litigation or anything else. The more specific you are the better. You should know how you plan to spend the money before asking for a loan.
  • How much do you want to borrow and when do you need it by? Banks look for borrowers that have a specific amount of money and time frame in mind. This demonstrates that you have a clear spending plan.
  • What is your preferred repayment plan? You might not get exactly the terms you would like, but you do often have some control over the repayment period and size of repayments. If you can present a proposal, it shows the lender that you're on top of your business's profits and expenses. It also proves you have given thought to how you will pay back the loan with interest, which is what the bank mostly cares about.

If you can't answer these questions your business loan application might not make it past the initial enquiry.

Example: Applying for a shop fit-out loan

For example, Blake runs a clothing store and wants to take out a shop fit-out loan to help him refurbish his retail space. He wants to borrow $60,000 to cover all his expenses, so to complete a loan application, he'll need to provide the following:

  • Details of the purpose of the loan. Rather than simply stating that he needs the loan to refurbish his shop, Blake needs to be as specific as possible. By providing a detailed breakdown of exactly how he will spend the money – design, building materials, labour, lighting, flooring, technology, signage, fixtures etc. – Blake can provide his bank with a complete picture of why he needs the loan.
  • Loan amount. The best way for Blake to decide on the desired loan amount is to compare quotes from shopfitting companies. By including the quote from the company he decides to use to complete the fit-out as well as by providing details of the timeline for work to be completed, Blake can demonstrate that he has a clear plan for exactly how the money will be spent
  • Repayments. Based on his projected business income and expenses once the fit-out is complete, Blake calculates that with fortnightly repayments, he should comfortably be able to pay back the amount he borrows over the next three years.

By providing all this information along with all his personal and business financial details, Blake will increase his chances of getting his loan approved.

fingers-in-keyboard

The five Cs: What banks look for in a loan application

The Five Cs

  • Character
  • Collateral
  • Capacity
  • Capital
  • Conditions

"The five Cs method" as it's known, refers to five key factors banks examine when deciding whether to accept or reject an application: character, collateral, capacity, capital and conditions.

By having a good understanding of each of these Cs, you can tailor your business loan application to ensure it addresses each of them.

Here's a breakdown of each of these factors to get you started:

Character

This covers your integrity, reputation and overall willingness to make good on your debts. Lenders examine your character by:

  • Looking at both your personal and business credit history.
  • Examining your financial history with an eye to prudent spending, general savings and organised financial management.
  • Checking your relations with other lenders, banks and credit agencies and seeing whether you pay off business loans on time.
  • Determining your personal and professional stability through factors such as how often you change jobs, whether you had past business ventures that failed, how well you save money and whether you've had any legal issues.

Your character should demonstrate stability, consistency and reliability in financial matters. Providing bank statements, a credit report and copies of compliance-related payments such as GST and taxes can help.

Example: Getting rejected for a business loan

There are many different reasons why a business loan application may be rejected, but some of the most common ones fall under the "Character" category. Let's take a look at a hypothetical

Jim wants a loan to expand his growing construction business but is dismayed when his application for financing is quickly rejected by his bank. After all, Jim believes that he's in a reasonable financial position, his business prospects look bright and he's provided all the info the bank requested in his application.

However, a closer inspection of his credit file reveals that it contains a couple of black marks, both of which would make him look like a high-risk borrower to his bank.

Four years ago, Jim experienced some financial difficulty and fell well behind on his car loan repayments. He eventually entered into a debt agreement to help get his finances back on track, but failed to realise that the agreement would then be listed in his credit report, and therefore negatively affect his ability to access credit, for the next five years.

More recently, Jim's credit file shows that he missed a payment to his utility company. However, Jim believes this is incorrect and has ended up in his credit file due to a clerical error by the utility company, so he disputes the listing and eventually has it removed from his file.

But there's still the problem of the debt agreement, which will make it very difficult for him to access a loan. Knowing he's unlikely to be approved for a loan from most lenders, Jim decides not to apply for any financing in the next 12 months.

Instead, in the remaining year until the agreement is no longer listed in his credit file, Jim commits himself to being as financially responsible as possible. He resolves to make all debt repayments on time – setting up automatic payments for regular bills will help with this – and to do whatever he can to improve his financial position.

Then, when his credit report is in better shape, he'll be ready to apply for another business loan.

Collateral

What happens if you can't pay back the loan? What kind of security can you offer the lender? If you take out a secured loan, it means you borrow against collateral, such as a house or car. This can get you a loan with better rates, but it means the lender can claim the collateral if your loan is not paid. If you take out an unsecured loan, then you are borrowing without collateral.

Lenders prefer secured loans as they are a safer bet. An applicant who is declined for an unsecured loan might still be able to get one that is secured.

These are the types of things that are considered in a secured business loan application:

  • The type of collateral provided. This could be your house or business property, a vehicle, land or any other asset. Different lenders might have different preferences based on their own business interests.
  • The current and future market value of the collateral. Lenders will want to determine that the collateral has an adequate market value across the lifespan of the loan, so they can sell it if you are unable to make your repayments.

You will need detailed information on any property you intend to use as collateral, including its purchase date, current valuation and photos of the item.

Example: Not enough collateral

Another common reason your loan application might be rejected is if you don't have sufficient collateral. If the collateral you offer won't be enough to help the lender recover any losses should you default on your secured loan, your application will most likely be rejected.

If this is the case, you have a couple of options:

  • Offer more collateral or a different type of collateral, such as an investment account, a business savings account or the value of your inventory.
  • Consider your unsecured loan options. Find out more in our guide to unsecured business loans.

Capacity

Capacity refers to you and your business's financial ability to repay the loan. A company where the income is less than the requested loan's interest rate, for example, would have a clear failure of capacity. A great character isn't enough without good capacity.

Lenders will consider:

  • Your business profits and personal income. Are these enough to pay back a loan?
  • Other debts, any dependants and your living expenses. These make a big difference to whether or not you have the capacity to repay a loan.
  • How stable your earnings are. If they're consistent, you have a better chance of obtaining the loan you desire. If they fluctuate, are seasonal or can otherwise be difficult to predict, banks will find these conditions less favourable.

Make sure you provide financial information which shows that you have the financial capacity to repay a loan.

Example: The importance of cash flow

Cash flow is one of the key factors banks consider when assessing business loan applications. They need to be sure that you will have enough cash flow to cover your ongoing business expenses but also to make on-time loan repayments. If your cash flow is irregular or seasonal, this can hurt your borrowing chances.

However, there are specific types of business loans designed to suit businesses that don't have steady cash flow all year round. Let's take a look at the hypothetical example of Sue, who runs a blueberry farm. During peak blueberry season, which runs from approximately October to February, Sue has plenty of cash coming in. She also has some cash flow for the couple of months either side of this peak period, but her business income dries up for the rest of the year.

So when she needs some extra funds to cover short-term production costs, she knows that a conventional business loan won't be suitable. Instead, Sue applies for a line of credit from a bank that specialises in agribusiness loans and allows her to make seasonal repayments during periods of peak cash flow.

Example: The impact of debt

Your level of existing business debt can also affect your chances of getting a loan. For example, Cath has a $50,000 line of credit to help cover day-to-day expenses and free up cash flow when required. However, because she's used some $43,000 of this amount already, this raises a warning flag to her bank when Cath applies for a separate loan to cover the costs of updating her business equipment.

By paying down this existing debt and getting her debt-to-income ratio to a more acceptable level, Cath will improve her chances of loan approval.

At the same time, it's worth pointing out that the under-use of credit can also have a negative effect. If you've never accessed business credit or you can't show a history of making on-time repayments, you might not have a large enough credit history to demonstrate your capacity to repay the loan.

Capital

This category takes into account your personal and business assets, and liabilities. Having capital reserves is favourably regarded by lenders. It means they can be sold off or liquidated in order to meet loan repayments, either as collateral or by you personally.

What lenders will be looking for:

  • Are your assets sellable? Can they be quickly and easily liquidated for a good return, or are they more difficult to unload?
  • What is your business's financial position? If publicly traded, what is its share value and equity distribution?

Take along historical balance sheets for past years, and budgeted balance sheets for upcoming years, to help lenders assess your capital.

Conditions

This refers to the terms and conditions under which the lender offered the loan. These can be more or less favourable for them or for you. When the lender has preferable conditions, it may be willing to give more leeway in a business loan application. Terms and conditions considered include:

  • Repayment schedule. How long it will take to pay back the loan and how frequently you make repayments.
  • Pricing. Higher interest rates and fees mean more money for the bank and make them more likely to accept your loan application, even if it's a bit riskier.
  • Other conditions. Some loan conditions may include certain requirements to be fulfilled, or contain conditions that impose additional responsibilities on you. A lender will consider the precise terms and conditions of a loan next to your application when deciding whether to accept or decline it.

Be sure to consider all the terms and conditions of a loan in detail. You may wish to contact a financial adviser to help you. If you're unsure of anything in the contract, your lender is obligated to answer any related questions honestly.

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