Understand How You Will Be Evaluated
Raising money is difficult. Be it venture capital, private equity or loans from bankers. It is always easy for a large corporation - with an established business track record - to raise money. The experience of a Small or Medium Enterprise (SME) is quite another story. While each lenders' approval criteria may differ marginally, they are largely the same. Read on to get an overview of lenders' requirements:
CAPACITY
Capacity refers to the ability of the firm to repay the loan.
Lenders use CIBIL credit reports - the Company Credit Report (CCR) for businesses and the Credit Information Report (CIR) and Credit Score for individuals - to evaluate a loan application. Capacity is evaluated by determining whether a company's income - current and future - will be adequate to cover additional debt obligations that the company is seeking to incur. Lenders also review the repayment history of the company to determine if it has not been able to meet its obligations in the past. This is possibly one of the most important factors that a lender considers while making the lending decision. Late payments, defaults or suits filed by lenders against the company will likely lead to an outright rejection of a loan application.
COLLATERAL
Collateral refers to forms of security that can be provided to the lender while applying for a loan. Collateral can be in form of business inventory, accounts receivable, equipment, commercial vehicles, property or any other tangible asset.
The chances of a loan approval become more favourable when the loan application is supported by multiple forms of collateral.
CAPITAL
Capital, in this context, represents the owner's investment in the business. Before applying for a loan, the owner has to have a significant investment in the business before the lender will even consider making a business loan. The loan officer will look carefully at the amount and quality of capital the owner has to offer.
KEY FINANCIAL RATIOS
Lenders look for a variety of financial ratios to judge the financial health of a business before sanctioning a loan.
Some key financial ratios are listed below:
- Liquidity: The amount of cash and working capital a company has.
- Leverage: The amount of debt on a company's balance sheet.
- Inventory: The raw materials, work-in-progress goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale.
- Turnover: The annual sales volume net of all discounts and sales taxes
- Receivables Turnover: The amount of accounts receivable in relation to sales.
- Gross Profit Margin: Net sales (minus returned goods, discounts and price reductions) minus cost of goods sold.
- Return on Sales: The percentage of profits remaining after direct expenses, overhead, unusual items and taxes.
Overall a company should be able to generate enough cash to cover the incremental burden of its debt obligation while adequately servicing its working capital requirements in order to be eligible for a loan approval. The CCR and the CIR play a critical role in determining a loan approval because they provide an objective description of a company's financial strength to a lender.
