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For some entrepreneurs, bootstrapping your business is not an option. Here it is important to find an alternative method of raising capital. The business loan is the most well-known way for an entrepreneur to receive capital inflow.
Business credit is a company’s ability to borrow money to buy something now and pay back the money later. When a business applies for credit, there are five things (the five Cs) that a lender will consider before approving credit to the business. Here they are below:
Character refers to your company’s credit history. Depending on the history of your business, your personal credit history may also come into play. If the borrower’s personality test shows a history of responsibility for lender repayments and loan tenors via previous lending opportunities (e.g., credit cards, lines of credit, auto loans), the borrower will likely be approved for the loan. If the borrower’s character has an immature credit profile (e.g., no prior lending, arrears, collections), the lender will likely reject the borrower.
Similar to personal loans, there are ways you can check your business credit profile such as: B. Nav.com and DNB.com (Dun and Bradstreet). Business credit profiles are not as mature as personal credit, so you may see discrepancies in your various reporting source profiles.
Also see: 5 tips for securing the business credit you need to start and scale your business
A company’s ability is its ability to repay a loan. A lender will look at your debt-to-income ratio (DTI) to calculate capacity. The formula to calculate your debt to income ratio is (total debt/total income) x 100.
The lower your DTI, the better your ability to repay a loan in the eyes of a lender. As with personal loans, you want to keep your business DTI at 36% or lower to be considered for future lending opportunities.
Capital is your company’s assets that the borrower can use to repay a loan. Only liquid funds – such as bank balances, investments and assets that the lender can claim – are taken into account. In this case, receivables are not capital because it is not tangible.
Related: How to Qualify for a Business Start-up Loan
Collateral is an asset that can be offered as security to reduce the risk of loss of capital in the event of a default by the lender. Examples of collateral would be property, cash, inventory, accounts receivable or equipment.
Typically, lenders lend 80% of the value of the collateral. This means that the borrower would have to have 20% of the purchase amount or some other way of raising capital. This is known as the loan-to-value ratio.
Conditions include how the company plans to use the money and external factors, such as: B. the economic situation. For example, an equipment loan for a dropshipping business may be less risky than a working capital loan in a risky business environment, such as a home office. B. a credit company.
When applying for credit, some of the five Cs are more under the company’s control than others. Let’s discuss how you can increase your chances of getting a loan approval by improving character, capacity, capital, collateral and terms.
Related: These things can help you succeed in business borrowing
This increases your chances of getting a loan
Improve character: Character needs to be nurtured. Some ways to improve your character score include paying bills that are reported to credit bureaus (such as credit cards and lines of credit) early or on time, having an older credit age, diversifying your credit portfolio with a mix of revolving credit, installment loans, and unwanted ones Remove or close events (like late payments). By calling the number provided, you can verify that your lenders are reporting back to the credit bureaus. Some lenders, especially vendors with 30-90 net sales, may not get in touch until you request it.
Capacity Improvement: The company needs to make more money or spend less to improve capacity. Another option is to have a co-signer with a low DTI to improve your DTI.
Improve capital: Capital is harder for the company to control when the company is struggling to generate revenue. It is recommended that the company start saving as much as possible when preparing a loan application to ensure that the debt to income ratio is 36% or less. Some lenders lend at a higher interest rate of up to 50% DTI.
Improve collateral: Collateral is more difficult to control for businesses, especially digital businesses, as in most cases the collateral needs to be liquid and fully owned. One way to improve collateral strength is to enter into a secured loan agreement that uses additional assets equal to or greater than the loan amount.
Improve conditions: The terms are typically beyond the control of the lender and borrower. The borrower must have a good reason to apply for the loan and have a credit profile strong enough to meet the lender’s lending criteria. It helps the company to keep financial documents in order and have a strong outlook on generating revenue.
There are many considerations when applying for a business loan. Building relationships with lenders helps increase the chances of getting a loan approval. However, the most important attributes to consider are DTI, the reason for the loan, and business prospects. You should consult your financial advisor or accountant before taking out a loan.