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Jun 2015

Knowing Your Limits: Assessing Your Business Loan Capabilities

June 20, 2015
Capify Australia

Statistics on the survival rate of new businesses vary. The general claim is that around 80-90% fail during the first five years of operation, while a more recent study shows that around half of them actually survive over the same period. It is crucial that businesses have enough cash to fund the enterprise for the first few years or so of operations.

Although there are a lot of options, the most common are either to add more capital or take out business loans. The problem with the latter is the stringent rules that are applied in securing loans. Hence, in order to get a loan approval, business owners should be able to assess themselves and their readiness to take out a loan.

Review your business performance

An accurate assessment of a business begins with a review of business performance. A business owner must be able to keep accurate, updated and detailed records and financial statements, calculate the necessary financial ratios, and compare them not only with projections but also with industry standards, if possible.

Take the position of the lender

Business loans involve the assumption of risk both from the perspective of the creditor and the debtor. In assessing whether one’s business is ready for a loan, it is important to assume the position of the lender and ask oneself the same questions the lender will be springing. Some of these queries are:

  1. Can the business repay the loan? – Cash flow management is key. It is not enough that the business makes money. It must be shown that the business will retain enough cash to pay its obligations regularly and maintain operations, not neglecting the interest premium payments in the calculations.

  2. Can you repay the loan if the business fails? –  Collateral, collateral, collateral. Some small businesses do not have credit histories to back them up. Most of the time, banks and financing companies look at collateral to lessen the risk.

  3. Does the business collect its bills? – One of the most underrated problems that businesses face is their inability to collect receivables. A business may be operating profitably but is unable to survive because the revenues reflected in income statements do not actually translate to cash; banks also look at the business’ ability to collect as an indicator of future performance.

  4. Does the business have a profitable operating history?– A business’ capacity to grow is borne by its performance history.

  5. How does the business manage its cash flow? – Does the business match its sources and uses of funds? Are sales growing? Does the business control expenses? Is there any discretionary cash flow? These are typical questions asked in order to gauge how a business owner makes decisions to use cash efficiently.

  6. What is the future of the industry? – Some industries are more risk-averse than others. Banks and financing companies are more inclined to fund “traditional” business models than experimental ones simply because they can rely on the industry’s tested trend and history to predict the future of an enterprise. On the other hand, if a business does not offer something new, it is also unlikely that a financing company will take interest in extending a loan. The key is to show both a history of profitability through industry examples and a unique business proposition that will differentiate it from the growing competition.

  7. Who are your competitors and what are their strengths? – Businesses do not operate in isolation. A gauge of how well-prepared a business owner is and how reliable his predictions are is his knowledge of his competitors.

Revise the business plan

After doing the above-mentioned steps and evaluating the business, the business owner must then devise a good business plan, with specific strategies to improve operations and profitability. It must clearly set out goals, outline the steps to be taken in achieving these, and project the profitability of the business in terms of income and cash flow. The business has to be detailed and realistic, with assumptions and projections clearly set out, and everything summarised clearly in just a few minutes of reading.

Barriers and Due Diligence

The most common barriers to securing business loans are poor credit ratings or lack of a credit history and collateral, improper reporting or the presentation of an incomplete and vague business plan. Again, lenders look at the viability of the business and the likeliness that the owner is able to pay back its loan. By following the steps above, the business is able to convincingly present its capacity to succeed.

There are alternatives to business loans. One such option is a merchant cash advance which is easier to secure than a traditional business loans. While there are marked differences between the options, the principle in getting the approval in either is the same: it begins with due diligence.

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