3 Tests To Qualify For A Small Business Loan

Banks and other lenders are really only concerned about one thing; getting repaid.

After all, that is how they still make the bulk of their revenue; making loans and getting repaid both interest and principal.

Thus, to qualify for a business loan, you simply have to demonstrate that your business can service the loan request – meaning being able to make the loan payments for the life of the loan.

Most lenders will perform the following 3 analysis calculations to determine if your business has the cash flow to service the proposed new loan.

1) Spread The Financials:

Banks / lenders will require three years of past financial statements at a minimum. The reason is to see if your business could have serviced the loan over the last three years. If it passes this test, then your business should be able to service the loan for the next three years.

Thus, they use your past business performance to determine what your future performance should be.

To spread your financial, most lenders will do the following for each past period that your business provided financial statements:

  • Take your net income (that is your net profits after all operating costs, taxes and interest payments).
  • Add back any non-cash accounting items like depreciation (deprecation is not an ongoing cash expenses but an accounting anomaly to reduce taxable income for tax reporting purposes only).
  • Add back any one-time charges or expenses – expenses that are not expected to reoccur in the future.
  • Then subtract out the interest charges for the proposed loan – only the interest portion at this stage as interest payments are considered regular business expenses.

This results in the true net positive (hopefully positive) cash flow of the business – cash flow that will be used to pay the principal portion of the business loan.

Now, if your business’s cash flow at this point can cover the principal portion of the loan, you have almost pasted this test.

Most lenders will not just want to see if your business’s cash flow meets the minimum principal portion of the proposed loan but would like it to cover 25% or even 50% more. The reason is that should your business have a slow period and revenues decline by say 25% or 50% – your business’s cash flow would still be sufficient to make the loan payment.

Example: Your business requests a $100,000 loan for three years with a monthly payment of $3,227 – broken down as interest of $449 and principal of $2,778.

Therefore, your monthly cash flow should not only cover the $2,778 in principal but say 1.25 times more or $3,473.

Also, keep in mind that this cash flow figure should not only cover the proposed loan’s principal but the principal payments of all the business loans the company has.

Principal payments are not income statement items and are not accounted for based on normal operating income and expenses but are balance sheet items and are paid out of net income (after all operating expenses).

Interest charges from loans are an operating expense and accounted for when the financials are spread.

Financials could be spread monthly, quarterly or even annually – depending on the types of financial statements requested or the policies of the lending institution.

If you can past this test via your past business performance, then it is highly expected that your business will do the same in the near future.

2) What If Scenarios:

Here, the lender will perform a series of “what if” scenarios on your financial statements.

For example, they may take your total revenue per period and reduce it by 10% or 20% – keeping all other items (your expenses) the same.

Then, spread those numbers again to see if your business could still service the proposed loan – e.g. still have the cash flow to make the payments.

Again, reassuring the bank or lender that your business would still be able to repay them should your business hit a slow period.

3) Debt-to-Equity Ratio:

Lastly, while your business may be able to service the proposed loan’s payments, banks also want to ensure that your business is not over leveraged – meaning that your business does not have too much debt in comparison to its equity.

Let’s say that the entire market declines or crashes and your revenues fall so low that you are forced to shut down the business. In this situation, would you still be able to repay all your lenders – including this proposed loan?

Thus, lenders look to a safety measure known as the debt-to-equity ratio.

Measuring your debt-to-equity is simply taking your Total Liabilities and dividing them by your company’s total equity.

The higher this ratio, the more risk the business has as it is relying on too much outside debt financing.

A ratio over 3 (meaning that the business has three times the debt as it does equity) is too much risk for most lenders to feel comfortable with.

Most businesses will have a debt-to-equity ratio between 1.5 to 2 and are considered safe to their prospective lender.

Now, if your business does not pass all these tests with flying colors and you still need a small business loan to grow, then it is up to you (the business owner) to manage your company in such a way to bring your business in line with these tests.

It all starts with your understanding of your business and the measures it has to pass to qualify.

How to Start and Grow Your Own Auto Tow Truck Business

Owning your own auto tow truck business can be an extremely lucrative business. Entrepreneurs that operate auto towing businesses typically enjoy stable profits. Auto tow truck business owners can begin their operation with one truck, a business plan, a business license and insurance. There is always a need for vehicles to be towed. This results in a stable, practically recession proof business for many business owners. On any day of the week there are a number of vehicles that need to be towed for a variety of reasons. Reasons may include the following:

Vehicles are repossessed.
Vehicles may be abandoned.
Vehicles are parked in no parking areas.
Vehicles are immobilized due to accidents.
Vehicles regularly break down due to mechanical problems.
Vehicles may illegally parked due to violating street cleaning regulations.
Vehicles may have been driven by motorists arrested for various reasons.
Vehicles may be illegally parked with major parking violations such as fire hydrant blocking, etc.

If you start your auto tow truck business with one truck you won’t get in over your head too soon. With one truck you can manage your costs and determine if your actually net income matches your projected income based on your business plan. This also gives you an opportunity to examine weaknesses in your business if any. It also allows you to determine your strengths. This self-assessment is important because if you are aware of your strengths and weaknesses, you can make adjustments where necessary.

When starting an auto tow service business you will need to establish hours of service. You may need to offer 24 hour service if you plan to secure contracts with local and state government agencies. Government agencies as well as many businesses request 24 hour towing service capability as cars need to be towed 24 hours each day.

You can successfully operate a 24 hour operation with one truck. However, you will need two drivers. This way the hours can be divided into two 12 hour shifts for each. Therefore, each person can be on call for twelve hours each day.

You must promote your business so you should have promotional material. This should include at the very least business cards. You should call on companies that need towing services. This should include auto repair companies and other companies that need towing services including government agencies.

As your business becomes more profitable you should look for ways to increase your income. This can be accomplished by hiring more drivers and purchasing additional vehicles. The safest way to do this is to add one additional truck and one or two drivers at a time. This is what many small business owners with limited capital choose to do.

Prior to purchasing another truck you should have determined that the business income is sufficient to accommodate the purchase of an additional truck and the additional equipment required to do the job successfully. Also, there are the increased insurance costs. All additional expenses should be taken into consideration. Taking the time to build your business slowly is often the best road to success.

Business Letters – The Different Types of Business Letters

All business letters are written to make something happen. They either inform or seek information or action. A business letter that doesn’t seek action is a non-letter and should never have been written.

This article discusses the main types of business letters and their purposes:

Letters of Transmission

These letters, also called “cover” letters accompany something that is being sent to someone and explain why and from whom the item is being sent. For example, when a company’s annual report is distributed, it is usually accompanied by a letter of transmission highlighting several key points in the report and informing recipients that the report is enclosed or attached.

Letters that Inform

As the title suggests, these letters are intended to inform recipients about something. If you have a mortgage, you may have received a letter from your financial institution advising you that your interest rate has increased. This is a common example of a letter that informs.

Requests and Responses to Requests

Businesses write to individuals or businesses requesting a variety of things or events. These letters of request are usually responded to with letters of response.

Letters of Offer and Acceptance

When a person applies for a job and is successful, he or she usually receives a letter of offer outlining the terms and conditions of the job. Letters of Offer are also used for contracts. When a person accepts an offer, a letter of acceptance is used.

Sales Letters

Everyone knows what a sales letter is, they need no explanation. If you are like me, you receive far too many of them.

Condolence Letters

These aren’t common, but occasionally businesses send letters of condolence to spouses of employees who die, whose family members die, or who otherwise run into a sad or difficult time in their lives.

Conclusion

The interesting thing about letters is that each has a different way of being written depending on it’s purpose. All should have the three common elements; an opening paragraph explaining what the letter is about, the body with full details, and an action ending asking for something to happen.

When I receive a letter written by someone who has completed a business communication course, I can tell within seconds. Most of the other letters I receive are mediocre at best or poor at worst.

If you are in the business of writing business letters, reports or other documents and haven’t studied business communication, I strongly suggest you enrol at the earliest or at least read some of the other articles I have written about business communication.