There is no standard credit criteria that is applicable for all companies trying to get a business loan. Different lenders will have their own guidelines passed down to their analysts. Even different companies can go through different sets of guidelines when they are at the same lender. The differentiating factor that groups applicants to different categories, thus a different assessment criteria, is often the level of annual revenue.
Anyway, for organizations with millions in revenue, they usually have a relationship manager to handle everything from sending out check books and waiving miscellaneous fees. It is often the small and medium enterprises (SME) that will be subject to the harshest and stringent rules by an analyst.
While multinational corporations can often get a loan even when they are operating at a loss, the same courtesy is seldom applied to SMEs. And you cannot fault banks for doing so. A small company is after all, riskier than a big one with decades of history behind it. The good thing is, in view of the lack of history or profits at the financial year end, banks can actually work out the strength of cash flow in a company by using it’s bank statements. As cash is king, a borrower with strong cash flow can often get their requested loan even if they are operating at a loss. Here is how banks statements are often analysed for SMEs.
Recent bank statements
You will firstly be required to prepare your most recent 3 or 6 months worth of operating bank statements. These are the statements that your bank send out to you at the end of each month.
Revenue
Unless you are running a business that somehow radically gives debtors payments terms of more than 365 days, it is fair to say that the receipts in your statements show an overview of sales generated in the last 3 to 6 months. And using these deposits recorded, an annual turnover can be calculated by multiplying the total deposits by 4 or 2. 4 being 4 quarters, and 2 being 2 halves.
Profits
Now that we have obtained the annual revenue of a business, it is time to work out the profit margin. There is no way that an accurate calculation of profits and losses can be determined without a properly detailed income statement can be scrutinized. But there is no need for that. Because loans for SMEs tend to be smaller in size, lenders are more open to risks as long as the extra risks are compensated by better profits.
There are industry data that shows what kind of margin companies in particular industries generate each year. And lenders can use these data to work out the predicted profits of a company by multiplying these factors to the revenue worked out previously. Bear in mind that lenders can use their own numbers for varying industries. Businesses in the service sector tend to have the highest profit margins, while those in construction tend to have the lowest.
If you are wondering how that can be so when builders are often listed companies with huge profits, the answer lies in revenue. So even though a construction company might have a small margin, it makes up for it with huge volume. This means that if a service company has a profit factor 3 times that of a construction company, the builder will have to have 3 times the revenue of a service provider to achieve the same amount of profits.
With some examples, profit factors can run like this
Service – 14.54%
Manufacturing – 9.88%
Food and beverage – 9.22%
Construction – 5.78%
Retail – 4.24%
Retailers generally have a low margin
Type of business
Now that you can see the classification of your nature of business can determine how profitable your operations are, the next question is how your business is classified.
This is up to the judgement credit analysts. They will review the details an applicant had written on application forms and do a basic check with the registrar of companies. As information provided by applicants cannot be taken at face value, it is the job of analysts to make a judgement based on information they can gather. When there is doubt on whether a business belong to a category, they might even order a site visit for evaluation.
Classification problems can often arise. For example, a company providing an engineering service can be mistaken as a contractor. Or a Shop selling edible products be classified as a retailer. When there is doubt, preference is always given to the category with a lower profit factor. Banks avoid risk as much as possible. And their employees are trained to be safe rather than sorry.
Needless to say, you will want to achieve as high a profit as possible via these profit factors for the evaluation of a business loan application. A high bottom line inevitably means that a company has the required funds and cash flow to service a loan. A monthly average profit will then be generated.
Liabilities
Now that we have determined your business profits purely based on your recent bank statements, the next item that will be meticulously scrutinized is the company financial liabilities. These will deducted from the average monthly profit to derive a final number.
A liability in this instance will mean a recurring cost that has to be borne every month. These include office rental, hire purchase, vehicle loans, etc. And these items will show clearly in the bank statements if you are using that particular account in making payments. When there are liabilities which are not observed in these bank statements, you are required to declare them to the credit officer so that they can do their job properly.
If we take for example that your company has an average monthly profit of $10,000, with a vehicle loan of $800 repayment monthly, and a hire purchase for equipment at $2,600 monthly, the final number we arrive at will be $10,000 – $800 – $2,600 = $6,600.
With the final number now available, you might think it means that a lender can be comfortable in giving you a loan as much as a $6,600 monthly payment allows you. That is not so. Because lenders often impose a debt servicing ratio to that final profit. Depending from bank to bank, they can have different ratios that can be applied to the calculations. You can however, expect unsecured loans to have higher ratios while secured loans to have lower ratios.
Debt servicing ratio (DSR)
If a 70% DSR is applied to your $10,000, you will end up with $7,000. You will then have to deduct $800 and $2,600, leaving you with $3,600 to service your repayment. There can be many factors affecting the DSR to be used. For example, good credit scores can potentially bring up the ratio.
Using this $3,600, we can now work out your qualifying loan quantum. For simplicity sake, let’s not include the interest in this calculation. So if you are to take a 3 year loan, you will qualify for $129,600. If you go for a 5 year loan, you could end up with $216,000.
Bounced checks
For some reason, bounced checks are frowned upon by lenders. It is probably because this behavior demonstrates bad money management. Who would lend money to someone who is clearly unable to manage their own money? There is usually a tolerance level that analysts will accept before throwing out a case. Usually 1 or 2 bounced checks are within the range.
Now that you have a basic understanding of how banks statements are evaluated for business loan applications, you will know how to avoid pitfalls that can render an application as an outright rejection. The most important item seem to be the classification of business nature. Remember to make proper declaration and never lie about your details.