A solid financial foundation is critical for the success of any business venture. Capital is required to start a business, buy equipment, set up operations, and cover various expenses. As a business grows, external funding becomes crucial for survival and expansion. A business loan often serves as a lifeline that helps businesses during such critical times.
Several banks and Non-Banking Financial Companies (NBFCs) now offer business loans to small and medium-sized enterprises. The process for applying is simple and can usually be completed online. However, before offering a loan, lenders evaluate specific criteria to determine eligibility. Let’s explore the key factors lenders consider when assessing a small business loan application.
1. Business Age
Lenders prefer businesses that have been in operation for at least two to three years. While the minimum required age could be one year, the older the business, the better the chances of getting a loan. A business with a proven track record of steady cash flow and profitability is seen as a lower risk. This makes it easier for such businesses to secure loans on favourable terms, including lower interest rates.
2. Nature of Business
The nature of the business plays a significant role in the approval process. Lenders are cautious when lending to businesses in industries that they deem weak or risky. This classification can vary between lenders and even change over time. A business that is considered risky in one geographical location might be viewed as safer in another. Therefore, it is essential to understand how your industry is perceived by potential lenders.
3. Existing Debt
Lenders carefully examine the existing debt load of a business. If a business is already having a substantial debt, It is considered a higher risk for lenders, which can lead to higher interest rates. A heavy debt-to-income ratio signals potential cash flow management problems. Businesses with high debt may be asked to provide collateral to secure the loan. Furthermore, existing debt levels will also impact the interest rate, often making loans more expensive. Seeking credit from multiple sources also signals to lenders that the business might have difficulty managing its financial obligations.
4. Credit Score
A business owner’s credit score plays a crucial role in the loan approval process. Most lenders prefer a credit score of 750 and above for unsecured business loans. A high credit score indicates financial responsibility and lowers the perceived risk for the lender. If the credit score is lower than this threshold, lenders may refuse the loan or offer it at a higher interest rate. It’s vital to maintain a good credit score to increase the chances of securing a loan with favourable terms.
5. Cash Flow History
Cash flow is one of the most critical factors lenders consider when approving a business loan. Consistent and steady cash flows indicate that a business is well-managed and capable of meeting its financial obligations. In contrast, unpaid invoices, prolonged debts, and unpaid taxes signal poor cash flow management. These red flags increase the risk for lenders and can lead to loan rejection or higher interest rates. Additionally, a strong cash flow history will influence the loan amount and the EMI that the business can afford.
6. Business Strategy
While submitting a business plan is not mandatory for every small business loan, a sound strategy can significantly improve your chances of approval. Lenders assess the business plan to understand how the loan will be utilised and whether it will improve the company’s profitability. A strong business plan projects future cash flows and outlines how the business will repay the loan, including the EMIs. Lenders prefer businesses that have clear strategies for using the loan to achieve long-term success.
7. Collateral
In some cases, lenders may require businesses to pledge assets as collateral, especially if the loan is considered high-risk. Collateral provides a safety net for lenders, as they can seize the asset if the borrower defaults on the loan. Offering collateral can also help secure a loan with lower interest rates and better terms. However, not all business loans require collateral, particularly if the business has strong financials and a high credit score.
Conclusion
Small business loans are becoming more reachable, but lenders still have to access particular criteria before the loan approval. Factors which include business age, operations, debt, credit score, and cash flow history can affect the loan amount, tenure, and interest rate. Businesses with a powerful performance in these areas are more likely to get settled at appropriate loan terms. A business loan can be an important tool for development and long-term success.
