Tips For Establishing Business Credit Fast

Borrowing from the SBA

Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn’t always easy. Before you approach your banker for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider your loan. This discussion outlines some of the key factors a bank uses to analyze a potential borrower. Also included is a self-assessment checklist at the end of this section for you to complete.

Key Points to Consider

Some of the key points your banker will review:

1. Ability/Capacity to Repay

The ability to repay must be justified in your loan package. Banks want to see two sources of repayment – cash flow from the business, plus a secondary source such as collateral. In order to analyze the cash flow of the business, the lender will review the business past financial statements. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years, as they have a financial track record. If the business has consistently made a profit and that profit can cover the payment of additional debt, then it is likely the loan will be approved. If, however, the business has been operating marginally and now has a new opportunity to grow, or if that business is a startup, then it is necessary to prepare a thorough loan package with a detailed explanation addressing how the business will be able to repay the loan.

2. Credit History

One of the first things a bank will determine when a person/business requests a loan is whether their personal and business credit is good. Therefore, before you go to the bank or even start the process of preparing a loan request, make sure your credit is good

3. Equity

Financial institutions want to see a certain amount of equity in a business. Equity can be built up through retained earnings or the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than 4 times the amount of equity. (Or, stated differently, when you divide total liabilities by equity, your answer should not be more than 4.) Therefore, if you want a loan, you must ensure that there is enough equity in the company to leverage that loan.

Don’t be misled into thinking that startup businesses can obtain 100% financing through conventional or special loan programs. A business owner usually must put some of his/her own money into it. The amount an individual must put into the business in order to obtain a loan is dependent on the type of loan, purpose, and terms. For example, most banks want the owner to put in at least 20 – 40% of the total request.

Example: A new business needs a $100,000 to start. The business owner must put $20,000 of his/her own money into the new business as equity. His/Her loan will be $80,000. The debt to equity ratio is 4:1. Note that this is only one of many factors used to evaluate the business – simply having the right debt to equity ratio does not guarantee you’ll get the loan.

The balance sheet indicates the amount of equity or net worth of a business. The net worth of the business is often a combination of retained earnings and the owner’s equity. In many cases, an owner’s equity will be shown as a loan from shareholders, and is therefore a liability. If a business owner wishes to obtain a loan, he/she will be obligated to pay the bank back first, not his/herself. Consequently, it may be necessary to restructure the liability so that it becomes the owner’s equity, or subordinate the loan. If the current debt to net worth is 4 or over, it is unlikely that the business will be able to obtain additional debt/loan. Understand your financial statements.

Understanding Financial Statements:

The primary financial statements are represented in the balance sheet and income statement. Learn more about these statements

BALANCE SHEET

The balance sheet is a snapshot of the company’s financial standing at an instant in time. The balance sheet shows the company’s financial position, what it owns (assets) and what it owes (liabilities and net worth). The “bottom line” of a balance sheet must always balance (i.e. assets = liabilities + net worth). The individual elements of a balance sheet change from day to day and reflect the activities of the company. Analyzing how the balance sheet changes over time will reveal important information about the company’s business trends.

INCOME STATEMENT

Known also as the profit and loss statement, the income statement shows all income and expense accounts over a period of time. That is, it shows how profitable the business is. This financial statement shows what how much money the company will make after all expenses are accounted for. Remember that an income statement does not reveal hidden problems like insufficient cash flow problems. Income statements are read from top to bottom and represent earnings and expenses over a period of time.

4. Collateral

Financial institutions are looking for a second source of repayment, which is often collateral. Collateral are those personal and business assets that can be sold to pay back the loan. Every loan program, even many microloan programs, requires at least some collateral to secure a loan. If a potential borrower has no collateral, he/she will need a co-signer that has collateral to pledge. Otherwise, it may be difficult to obtain a loan.

The value of collateral is not based on market value; that is discounted to take into account the value that would be lost if the assets had to be liquidated.

5. Experience

A client who wants to open a business and has no experience in that business should not seek financing, let alone start the business unless they intend to hire people who know the business or take on a partner that has the appropriate experience. Regardless, the client should be advised to take some time to work in the business first and take some entrepreneurial training classes.
Sample Collateral Chart [http://www.corporatefasttrack.com/SBA_Collateral_Ratio.htm]

Questions Your Banker Will Ask

The key questions the banker will be seeking to answer are as follows:

  1. Can the business repay the loan? (Is cash flow greater than debt service?)
  2. Can you repay the loan if the business fails? (Is collateral sufficient to repay the loan?)
  3. Does the business collect its bills?
  4. Does the business control its inventory?
  5. Does the business pay its bills?
  6. Are the officers committed to the business?
  7. Does the business have a profitable operating history?
  8. Does the business match its sources and uses of funds?
  9. Are sales growing?
  10. Does the business control expenses?
  11. Are profits increasing as a percentage of sales?
  12. Is there any discretionary cash flow?
  13. What is the future of the industry?
  14. Who is your competition and what are their strengths and weaknesses ?