One challenge for the modern business owner is figuring out how best to approach their bank for a loan.
Just like your business needs to make a profit, so does the bank. That means that when you approach a bank for a loan, you are asking the bank to enter into business with you. More importantly you are asking the bank to consider your business plan, your strategy, your expenditure and accept some of the risk if your business does not succeed in your future plans.
In some ways that makes your bank similar to a venture capitalist or potential investment partner; they will want to know about the downside as well as the upside and see as much of the detail as they can before they decide whether they’re supporting a sound and viable financial decision or not.
From the bank’s perspective their one big question is – how much risk do we take on with this loan? And each bank will have its own guidelines that are used to assist them in assessing each application that it’s presented with.
Many loan applications a bank receives are not approved, simply because the risk the bank is being asked to bear is too high, or because the person assessing the loan application believes the applicant is unable to support the risk.
In Australia, banks are regulated by the Australian Prudential Regulation Authority (APRA). This governing authority requires that banks hold larger amounts of capital against riskier loans, something they prefer to avoid. As a consequence, a bank may decline your loan even if you’re a qualified, viable business simply because they are overexposed to risk in a particular sector.
Before you begin your loan application process make sure you have clear answers for these 4 key questions that will be front of mind for your Bank Manager –
- What are the funds going to be used for? How long do you need the funds for? – for example, to fund the purchase of inventory or to fund a building extension?
- What is the realistic amount of funds you need and can afford to repay?
- What level of security are you able to offer the bank? If you where the bank would you agree with the value of the security?
- How will the bank assess ‘risk’ for your business?
The 3 main things that the bank is looking for when reviewing your loan application are information, security and experience. That means your loan application needs to demonstrate to the bank that you can organise your thoughts and ideas in writing and support them with financial information. So the more quality information you’re able to give the bank about your business, your plans and your industry, the more likely you are to have your application approved.
Because risk is such an important factor in the loan application, having preliminary discussions with your bank to find out the kinds of security they would be looking for, and the dollar value of such a security will make your application process smoother.
Be prepared to talk through all aspects of your loan, including answering questions that may feel very personal, so that the Bank Manager has a complete account of your situation. You may need to prepare yourself in the event of your loan only being granted with a covenant (a covenant is an agreement between two or more parties that binds them to specific actions or conditions).
Loan Application Checklist
Your bank will be very interested in how you run your business, generate profit and manage cash flow so as well as providing lots of financial information they’ll want to understand your strategies and plans.
- Concise written detail on the following must be included:
a. What does your business do
b. A brief business history – include information about past successes and the depth of experience you and your team have or if you’re a start-up – any relevant successes or experience the people behind your business have
c. Snapshot industry information
d. Ownership details and business structures
- Personal financial information – it’s likely that your bank will do a credit check on you and any other business owners as well as the business itself. The types of financial information your bank may be looking for includes:
- A list of your personal assets
- Your previous years tax returns
- Personal banking details, including loans and deposits
- Historical business financial information – if your business has been in operation for a while, your bank will want to see any historical financial information (usually balance sheets, profit and loss statements and cash flow statements) for the past three years. Ideally, you’d get this information prepared or at least reviewed by your accountant, as tour bank is likely to want other data including BASs, current receivable and accounts payable schedules, bank statements and other financial reports.
- Forecast business financial information – your bank will also want to view forecasts: cash flow projections, profit and loss forecasts and balance sheet forecasts. The forecasts should:
- Cover the full term of the loan you are after
- They need to clearly state any assumptions you have made when producing the forecasts
- Be written as if your loan application has been accepted and successful
- You may also choose to include best and worst case scenarios in your forecasts
- Analysis of financial ratios – your Accountant should be able to help you by preparing an analysis of financial ratios and documenting any details on any sensitivity analysis.
- Details on the loan you require – a detailed explanation of why you need the loan should be included in your application. The purpose is critical in helping the bank determine the type of loan you require.
You need to give the exact amount of the loan that you’re after, why you need that amount and the term over which you are seeking the loan for.
For most types of business loans, banks require security. As part of your application, you must identify the security you are prepared to offer, making sure that the value of the security is greater than the value of the loan. Be aware that the value of the security needs to be seen to be stable so that it remains fixed for the duration of the loan.
- Business plan – even if your business is established and been around for many years, including a business plan as part of your loan application helps to demonstrate your knowledge of business. You can also include your marketing plan and references to your major clients and suppliers as part of this section of your loan application.
This checklist gives you the fundamentals of what you’ll need to provide to your bank, but as ever be prepared to provide any other reports or documentation that they request.
Common Business Loan Application Mistakes
- Asking for more money than you need
Banks have been in the business of loaning money a lot longer than you’ve been in a position to ask for it. That means they have lots of formulas and ways to calculate how much they think you can afford to borrow and how much they think you really need.
- Hurrying the bank to make a decision
The loan application and approval process the bank goes through can sometimes involve many different people, so the person you deal with may not be the one who makes the decision but they can certainly be ‘on your side’ if their role is to present to the decision makers inside the bank. Pushing the bank to work through their loan approval process faster could also be interpreted by the bank that something isn’t quite right and cause them to delay further while they do more deeper checks into your business and the potential risks you present to them.
- Being unclear about the meaning of particular financial terms
In particular recognising that business turnover (or cashflow) is not the same as net profit. Brushing up on your report reading skills and get a refresher on banking jargon will ensure you don’t embarrass yourself with a mix up over the meaning of different terms.
- Mistakingly inflating the value of business assets
The bank wants to know the value of your assets based on standard market value, especially where business assets are being offered as part of security over the loan. From the banks perspective if the loan goes bad they’ll want to sell your business assets as quickly as they can to cover their losses and that means standard market value.
Remember, when you’re approaching your bank for a loan you’re really asking them to invest in your business, so stand back and get an outsiders perspective of your business, so that you can present your application in the best possible light. And if you find that you’re too emotionally involved and need someone else to help you through the challenges of your first business loan application, talk to your Accountant and performance or business coach. Your Accountant will be able to help you with the numbers, whilst your business coach will help You prepare.