The Five Cs
- Character
- Collateral
- Capacity
- Capital
- Conditions
Business loan requirements – how banks assess your application
Let's get down to business... loan applications.
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.
Am I eligible for a business loan?
Like with any loan, business loans have eligibility requirements. The applicant will have standard eligibility requirements such as residency status, age and income. But on top of that the business itself must meet certain requirements.
Each lender will have its own criteria so be sure to compare and check your eligibility closely.
- Reason for applying: Depending on the loan, you might need to show you're borrowing to buy equipment, needing to pay invoices or intending to grow.
- Trading history: You'll need to have been operating for a certain period of time to be approved for a business loan. This can vary from a few months to more than 1 year. You will generally need to prove you have been generating an income for a period of months.
- Turnover: Each lender will have its own requirements for how much the business needs to be making. 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: Your business will need to have an Australian Business Number (ABN) or Australian Company Number (ACN) to be eligible.
What do I need to provide to apply for a business loan?
Unlike regular personal loans, banks will often be quite strict with the documentation they require as part of a business loan application.
- Identification verification: Personal identification such as a driver's licence or passport.
- Personal income statements: Bank statements to detail your personal income, savings, expenses and other loans.
- Business verification: Evidence the business exists through an ABN as well as evidence that the applicant owns the business. If there are multiple owners you may need to get each of them to verify.
- Financial statements: This will likely include a balance sheet and income statement, to prove your business is making enough money to repay the loan.
- Business projections: Particularly if your business is in the early days you may need to provide a business plan, cash-flow projections and other business information.
This is not an exhaustive list and the lender may ask you for further information or documentation at any time, but it does give a good overview.
Why was my business loan application rejected?
There are several reasons a business loan application may be rejected. Some reasons are more easily corrected than others. For example, if you were rejected for having a poor credit score, you can take steps to improve it.
It may also be that if you applied again with a lower loan amount or with security, you would be approved. If you are thinking of applying again with different loan details you should be careful, even if you're applying with a different lender. Having multiple credit applications too close together can negatively impact your credit score.
Questions to ask yourself before you apply for a business loan
When a lender decides to give you a business loan they are essentially deciding they have faith in your business succeeding. To make that decision, they'll need some specific information from you and may ask further questions.
In preparation, you should ask yourself the following:
- What is the purpose of the loan? The bank will want to know the specifics of what the loan is for: it's not enough to say that you need money to grow the business. The loan can be for refurbishment, staff costs, training new employees, handling litigation, new equipment or cashflow management.
- How much do you want to borrow and when do you need it? Working out how much you need and a timeframe for the money will show the lender you have a specific plan. It will also ensure you don't borrow too much or too little.
- What is your preferred repayment plan? When you apply for a business loan you can usually choose whether you want to repay weekly, fortnightly or monthly. If you can put forward a proposal detailing when and how much your repayments will be, it proves that you're on top of your business expenses and taking the loan seriously.
- What are your projections for the business? Putting forward how you think the business will progress over the next 12 months will help give the lender an idea of what they're lending money for and reassurance about the loan being repaid.
- Do you want to secure the loan? You can usually choose between secured and unsecured loans. Secured loans have lower interest rates but you'll need to put forward an asset as collateral. Typically that would be a car, property or piece of equipment.
What do banks look for in a business loan application?
"The five Cs method" refers to 5 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, you can better tailor your business loan application.
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:
- Credit scores. They'll look at the credit health of not just the business but you personally as well.
- Financial history. Examining your financial history with an eye to prudent spending, general savings and organised financial management.
- Existing engagements. Checking your relationships with other lenders, banks and credit agencies to see if you pay off any other business loans on time.
- Stability. 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.
Collateral
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'll need detailed information on anything you intend to use as collateral.
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 approval. 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.
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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