Module 1: Financial Management
The first step in applying for a business loan is to get your paperwork in order. A lender will want a lot of documentation from you. After all, you’re borrowing their money. They want to know if you are a reasonable risk. You may already have a good relationship with your bank and even the business loan officer. But there are others behind the scenes who make decisions about your loan who don’t know you. They only know you by what they see on the various documents you submit or fill out.
Don’t be discouraged. This behind-the-scenes stuff happens when you get any loan. In this case, however, it’s you and your business that are being scrutinized.
Here are some of the things you’ll want to have available.
- Business plan. A business pan and the profit plan contained in it will show how loan proceeds will be used to increase sales and profitability for your business while demonstrating that your plan will allow the loan to be repaid in full. Your plan should include any research you have done to establish your costs and your marketing or sales strategies to support projected increases in sales. A typical business plan for a loan will:
- Have a statement of purpose
- List the owners of the business
- Describe the business and how it will make a profit
- Provide financial statements like a P&L statement and a cash flow projection
- Provide other documents such as references and proof of insurance
- Know what you can afford. A loan is an opportunity to increase available cash, but it also increases your debt. Your plan should factor in the cost of repayment, including interest and fees. Make sure you’re not taking on more debt than you can repay within the allotted length of the loan.
- Study your financial statements. Your lender will want to see your financial statements. Make sure they are up to date and accurate. Include historical statements to provide a complete picture. Be prepared to discuss your statements in detail and be ready to explain any issues.
- Check your credit score. Request a copy of your personal credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion). Check it for any inaccuracies and ask them to be fixed. If there are any negatives, be ready to explain them to the lender.
- Have collateral options. If you’re seeking a loan for a fixed asset (machinery, equipment, etc.), the asset itself is usually the collateral for the loan. If you default, the asset is sold or repossessed. If you are seeking a line of credit, you may not have to put up collateral if you have a strong history of profitability. But if you’re new to the lender, they may want you to put something of value up against the loan; just make sure it’s not your house.
- Cash can be required. If you are seeking a loan for a new business or an expansion project, the lender may ask you to put in some cash. The required contribution can range from 10% to 30% of the project’s total cost.
Putting together a loan package
Getting a loan is not something you do on a whim. Ultimately, you are taking on additional debt, debt with interest. Before you ever pursue this route, you need to make sure that you have all your documentation prepared and in a form that a lender can easily review, dissect and consider.
Here are the basic components of a loan package. Some of these will look familiar since they also appear above.
- Business plan: Lenders usually want to see an up-to-date business plan that describes your costs, your management team and your sales and profit strategies.
- Business financial statements. This includes your financial statements (balance sheet, cash flow projections and profit and loss statement) for the last three years plus the current year.
- Personal financial statements. Depending on the type of business you run, you may need to have a personal financial statement that shows your assets, liabilities and net worth. Have them ready, just in case.
- Personal and business tax returns. You should have three years of past tax returns available for you and your business.
- Equity contribution detail. A business loan may require the owner to contribute 10% to 30% in cash or equity. Include a summary that documents the amount and source of proposed equity contributions.
- Credit report. Lenders will order your personal credit report as part of the application process, but you should already know what’s in it so you can address any negative issues that may spring up.
- Lenders usually require collateral, so include options in your application; personal or business assets that you can use to guarantee the loan.
- Project cost documentation. Include purchase agreements, appraisals, contracts and official estimates that document the projected cost of your project.
Qualifying for a loan
Now that all your documentation is in order, it’s time to look for a loan. As noted, your current bank may not have the best deal or terms. Moreover, their lending practices may be more strict than other, smaller institutions.
Before you start knocking on doors or filling out loan applications, here are some of the things a lender will look for in a viable loan candidate.
Good credit score. Your credit history tells a lot about you and how you manage your debt. Typically, the last seven years are reviewed, and your lender will look at the amount of credit you have and how well you paid it back, especially loans.
Equity contribution. You need to put money in, either in the form of cash or equity, which can be in the form of equipment, machinery, real estate and other fixed assets. The amount and type tell the lender how committed you are to the project and the risk you are willing to take using your own assets.
Ability to repay. Your financial statements for the past three years will provide the lender with a good understanding of your ability to repay debts and maintain a positive cash flow at the same time. Criteria varies by lender, but you need to demonstrate historically strong profits, good management skills and growth potential.
Loan-to-value ratio. If you’re purchasing building, land, equipment or machinery with the loan, your lender tends to loan between 70% and 90% of its market value. An appraisal will determine the maximum amount of the loan, and the business will need to make up the difference.
Looking for a loan
If you need to borrow money, you want to shop around. Some government-guaranteed loans may be offered by one bank and not another in your community. If you need a smaller loan, you may want to look at an SBA microloan which combines business coaching and technical assistance with a loan of up to $50,000. Some specific segments of the business community, such as veterans or those in designated disaster areas, may be eligible for special loans.
Here are some other places to consider:
- Many banks offer loans, lines of credit, equipment leasing loans and SBA-based loans that are specifically designed for small businesses. If you already have a relationship with a bank, start there. They may be more generous with terms and interest rates since they know you already have accounts there. If your bank doesn’t offer small business loans, ask if they can provide a referral to another lending instruction in town.
- Regional lending organizations. Banks aren’t the only game in town. Many community organizations offer business loans.
- Washington State Department of Commerce
- Community Development Financing Institutions (CDFI)
- Small Business Administration (SBA) Resource Partners such as Small Business Development Centers (SBDC), SCORE, Women’s Business Centers, Veterans Business Outreach Centers, and US Export Assistance Centers
- Certified Development Corporations (CDCs), part of the National Association of Development Companies (NADCO)
- Microenterprise development organizations
- USDA Rural Development office
- Regional SBA office
- Your city, county, state, or community economic development department