Applying for small business loans and financing is a stressful and demanding process. This lengthy exercise that features hours of paperwork can lead to frustration with sometimes higher interest rates that can cost your business, and oftentimes, rejection.
We have previously discussed what factors to consider when choosing the right lender for your small business. The next step is getting your application approved. Any small-business- friendly lender will need to underwrite your loan application and assess your business and financial risk.
There are steps you can take before and during your loan application to increase your success, reduce headaches, mitigate risk, and get approved with lower rates.
Lenders analyze a variety of factors to determine your eligibility and “lendability”.
Revenue Trends & Growth
Revenue is always important to lenders. It is one of the more universal measures for underwriting as it can reveal a lot about a business such as overall health, customer reach, business activity, business continuity, and income consistency.
Your business is a better candidate when it makes more money. Revenue trends can also help you and the lender determine what your maximum loan amount can be. It’s not unusual for the maximum loan amount to be higher than you need – it’s important to make sure you also understand how much you can realistically afford to borrow without the monthly repayment amount harming your revolving cash flow.
Expense Levels & Cost Benchmarks
Cost analysis is another factor in business loan underwriting. No matter how much revenue your business generates; if your margins are thin, you may be considered a risky candidate. To further support your application it’s beneficial to create, and stick to, a realistic annual budget. Be sure to optimize cost and spending in general, especially as you get close to applying for a small business loan.
One of the metrics underwriters use and you should be aware of is your “efficiency ratio” (expense as a percentage of revenue, which is your total expense divided by total revenue). In layman’s terms, your efficiency ratio indicates what percentage of your revenue goes to expenses and what percentage can be used for loan repayments and other obligations.
We’ve already discussed the financial performance and it depends on whether your bookkeeping is done on a cash basis or accrual basis. Lenders, however, will also need to know if you have cash in hand to pay their loan back in a timely manner. Having cash or cash equivalent can help your business in times of need and also show lenders you have enough cash to stay afloat in case there is a decrease in your revenue.
It is also important for your business bank account to have an acceptable balance with at least 20% more than your monthly payments. This is a good reminder to choose lenders who won’t force you to service a fixed monthly payment and allow you the flexibility to repay according to your business needs.
Another important factor to consider is your credit profile. Not only lenders will analyze your personal credit history as a guarantor, but they will also look at your business’ credit profile as well.
This report will also reveal if you have other open loans or outstanding balances influencing lenders’ decisions as well.
Business Strategy & Longevity
Lenders might ask about your business plans and assess if you will continue to operate and generate revenue during the repayment timeline. It is advisable to think through a 5 year plan and develop some ideas on your business’s future in the event lenders ask about it.
- Are you looking to expand your business?
- Mitigate risks?
- Open new locations?
- Hire more staff?
- Reinvest into another venture or even pay yourself more?
Think about all of these options and even though they might not be fully developed, you can still have them as future goals.
Your Corporate Status
It is important for you to ensure your company’s status is active according to your state’s Division of Corporation. If not, lenders can’t approve your loan and may have a hard time finding your company for credit reviews.
It also raises your risk profile significantly if the lender has to remind you to pay for your annual filings and maintain your status – If you’re forgetting about keeping your company’s status active, will you remember to pay back your loans? Avoid the headache, pay the state, and keep your company active.
There are other factors like economic landscape, your industry’s overall risk, and even your tenure in the business but if you’d like a better chance of getting approved for a lower rate and lower your risk profile, you can follow some of the advice above and make things easier for yourself and your business through Financial education.
As a reminder, you always want to make sure that your business is able to handle the loan repayment and your financial health is up to par to lending standards.
We hope these tips will make the small business loan process a breeze! If you’re looking for faster funding, explore our merchant financing options at Gravity Capital.
Gravity Capital, an alternative to traditional small business loans, enables Gravity Payments merchants to apply for up to 80% of their monthly credit card processing revenue in funding with flexible repayment timelines and no compounding interest. Learn more here.