Understand How You Will Be Evaluated
Understand How You Will Be Evaluated
Raising money is a tough job. Whether it is venture capital, private equity or taking loans from bankers. It is always easier for large corporations with established business records to raise money. The experience of a small or medium enterprise (SME) is a different story. Although the approval criteria may differ slightly from lender to lender, it is broadly the same. Read on for information on lender requirements:
Capacity
Capacity means the ability of a firm to repay the loan.
Lenders use CIBIL credit reports to evaluate loan applications – Company Credit Report (CCR) and Credit Information Report (CIR) for businesses and Credit Score for individuals. Capacity is assessed by determining whether the company's earnings—current and future—will be sufficient to cover the additional debt obligations the company is seeking to incur. Lenders also review the repayment history of the company and decide whether it has been able to meet its obligations in the past or not. This can be an important factor that the lenders consider while extending the loan. Late payments, defaults or lawsuits filed against the company by the lenders can also lead to rejection of the loan application.
Collateral
Collateral means the form of security that can be given to the lender while applying for the loan. Collateral can be in the form of business inventory, accounts receivable, equipment, commercial vehicles, property or any other physical asset. When the loan application is backed by multiple collaterals, the chances of loan approval are high.
Finance
Capital in this context means the owner's investment in the business. The owner has to invest significantly in the business before applying for the loan and only then the lenders consider business loans. The loan officer carefully examines the amount and quality of capital available with the owner.
Key financial ratios
Lenders look at a variety of financial ratios to assess the financial health of the business before sanctioning the loan
Some of the key financial ratios are listed below:
- Liquidity: The amount of cash and working capital held by the company.
- Leverage: The amount of debt on the company's balance sheet.
- Inventory: Raw materials, work in progress goods and fully finished goods that are considered part of the assets of the business, that are ready or will be ready for sale.
- Turnover: The amount of annual sales after deducting all discounts and sales taxes.
- Receivables Turnover: The amount of accounts receivable in relation to sales.
- Gross profit margin: Net sales (credit returned goods, discounts and value cuts) minus cost of goods sold.
- Return on Sales: The percentage of profit remaining after direct expenses, overhead, abnormal amounts, and taxes.
Overall, for loan approval, the company should be able to generate sufficient cash to meet its increasing debt liability burden and at the same time adequately meet its working capital requirements. CCR and CIR play a vital role in determining the loan sanction as they give a factual picture of the financial strength of the company to the lender.