Does My Small Business Qualify for a Business Loan?
Every small business owner dreams of expanding his ambit to compete with the big giants of the industry. But only a handful of them succeed because they raise funds for their business at the right time. While the failure of a business depends on several other factors, the shortage of the fund is one of the most important factors in the loss of business. At some point down the line, every business needs external funding; without external funding for a long time, your business may not leverage market opportunities.
Raising money from investors can be a challenging proposition for small businesses. However, small businesses have other options, such as business loans and P2P loans, to raise funds. But there are certain prerequisites that must be fulfilled prior to getting a business loan. Generally, small business owners are sceptical about their eligibility for a business loan. If you’re also in a state of confusion about whether your small business will qualify for a business loan or not, this article is definitely for you.
So, let’s look at the factors considered for a business loan approval
For a small business owner, thinking about a business loan that too at a high rate of interest can be a risky choice. However, if you have an excellent credit score, the chances are that you will get a business loan at a lower rate of interest. As a business loan seeker, you must keep in mind that a lender sees your credit history while evaluating your business loan application. In India, the minimum CIBIL score to secure a business loan is 750+.
Cash flow and income
Positive cash flow is crucial for every business. Steady and healthy cash flow shows that a business has the potential to repay the loan. In other words, cash flow is a representation of your business’s health. Apart from the positive cash flow, lenders also look for income to determine how profitable your business is. However, if your business is relatively new and not attracting a good amount of cash flow, then you can take a personal loan to expand your business.
Age of business
Many businesses shut down in the very first year. So that’s the obvious reason banks and other lenders typically require a business to be operational for a minimum of two years to qualify for a business loan. As a borrower, keep in mind that the lender doesn’t look for the registration date of the business, instead, it looks how long an enterprise has a business account. Normally in India, a minimum of 3 years of business history is required to get approval from traditional lenders. However, businesses that have been operating for less than 2 years can also get a business loan from multiple lenders, especially NBFCs.
Current amount of debt
Lenders use FOIR (fixed obligation to income ratio) AKA debt-to-income ratio to measure the percentage of your debt payments against your monthly gross income. As a result, most lenders expect a borrower to have a debt-to-income ratio below 50%. The lender makes sure that your monthly loan obligations/ liabilities are within 50% of your monthly income, considering that 50% of your monthly income is being used for other business activities.
Apart from a debt-to-income-ratio, lenders also see the balance sheet of the business to measure the financial health of the business. The balance sheet is a basic document that summarizes your business’s financial health, which includes assets, liabilities, and equity. Ideally, your total assets should be equal to the sum of your liabilities and equity accounts.
Credit utilization ratio
The lender also sees your credit utilization ratio. By looking at this ratio, the lender measures the credit hungriness of a borrower. The credit utilization ratio is the used portion of the credit available on your credit card. If you have a credit utilization below 30%, the lenders may offer you a business loan. On the other hand, if your credit utilization ratio is above 30%, you should try to lower it down and then apply for a business loan. Otherwise, the lender will reject your business loan.
Lenders provide two kinds of business loans secured and unsecured business loans. To get a secured loan, a borrower needs to provide any asset like a shop, gold, residential or commercial property to the lender. The best part of a secured business loan is, it comes at a lower rate of interest. However, some small business owners either don’t have property or they don’t want to risk their collateral for a business loan. Therefore, such borrowers can take the benefits of collateral-free business loans as lots of leading banks and NBFCs provide an unsecured business loan to small business owners.
Supporting a small business with a business loan is easy these days. But if you are taking a business loan for the first time, then you should be careful to look at a combination of factors considered by lenders before they lend a business loan. Before applying for a loan, make sure you have adequate CIBIL score, FOIR, and credit utilization ratio. However, these factors only matter when you look for an unsecured business loan. For a secured business loan, you need to provide any asset to the bank as collateral. Though, a secured loan involves a risk of losing assets but gets you a cheaper business loan. Apart from these factors, traditional lenders also look for the turnover, age, and profit of the business. Thus, by providing an audited financial report of your business, every small business can qualify for a business loan easily.