What do lenders look at when extending you credit
If you are a small or mid sized business you may find it hard to get the types of financing you need in order to expand and grow your business. There are many reasons why lenders may not be willing to lend money to your business and it is important to understand what a lender is looking for before making a loan and how you are viewed by a potential lender so that you can get the most favorable loan possible given the circumstances that you are facing.
The major consideration before extending a loan to a borrower is how qualified that borrow is to repay that loan both given the economic climate that the business is currently in, as well as during a retraction of the economy in a recession or a depression scenario. To understand what is considered the lender will typically start by running certain ratios of your earnings to debt, your days of sales outstanding, and a few additional calculations that show your capacity to repay any loan that you take.
Then the potential lender will discount these factors in order to see how your business would stand up in a recession. If your sales decrease by 10% or 20% how would you be able to repay your debt. If your margins drop what does this do to your ability to repay your debt? If you lose a major customer what happens to your business model as well?
Beyond that the lender looks into the quality of data that they are provided. Audited financial statements are the best source of data for a lender so it benefits many small and mid sized businesses to get an audit by a certified public accounting firm performed even if they don’t currently have a loan that requires it, because they may need to obtain a loan in short order. Without an audited financial statement reviewed financial statements provide some but less assurance, and a tax return may be a possible substitution.
Many other soft non financial information is also considered by potential lenders. Your sales mix and the competitiveness of your underlying business is considered as part of the equation. Industries that are constantly changing like tech often find it harder to get loans even with superior profit margins as their business model may be cutting edge one day and behind the bar the next. Businesses with slow cash flow due to selling to hospitals or other slow payers may also have trouble bridging the gap. Lenders want positive cash flow that is predictable and reliable.
Overall, it can be hard to find a lender who is willing to lend money to a small or mid sized firm. To improve your chances, have audited or reviewed financial statements, a reliable business model that you can spin to a potential lender, and a conservative model when requesting a loan in which you are discounting the amount of money you are looking for so that you can more easily repay any loan you may take.