Ravi Chandran
Not all banks are created equal, but many of them focus on the same areas throughout the credit review process.
By: Hitesh Khan/
So it makes sense to learn what documentation, projections and narratives you’ll need to prepare as well as tips to ensure you negotiate the best loan package available.
Whether you are applying to a bank for:
- A line of home equity credit
- A line of credit for business working capital
- A commercial short-term loan
- An equipment loan
- Real estate financing
- Some other type of commercial or consumer loan
the same credit review process principles apply before banks even think of giving you loans.
The most fundamental credit review process principle most prospective lenders will concentrate on include:
- Credit history
- Cash flow history and projections for the business
- Collateral available to secure the loan
- Character
- Myriad pieces of loan documentation that includes business and personal financial statements, income tax returns, a business plan and that essentially sums up and provides evidence for the first four items listed
The first three of these criteria are largely objective data (although interpretation of the numbers can be subjective).
The fourth item—your character—allows the lender to make a more subjective assessment of your business’s market appeal and the business savvy of you and any of your fellow operators.
In applying the credit review process principles to assess whether to finance a small business, lenders are often willing to consider individual factors that represent strengths or weaknesses for a loan.
Table of Contents
Credit History
Lenders will want to review both the credit history of your business in their credit review process (if the business is not a startup) and, because a personal guarantee is often required for a small business loan, your personal credit history.
You should obtain a credit report on yourself and your business before you apply for credit. If you discover any inaccuracies or problems, you can correct them before any damage to your loan application has occurred. If you can, find out which credit reporting company your prospective lender uses and request a report from that company.
Reviewing Your Commercial Credit History
Before you apply for commercial credit, you should review a credit report on your own business, if your business has been in existence for a while. You can obtain a Business Information Report on your own business from Dun & Bradstreet.
Most conventional lenders will expect a minimum of four or five trade experiences listed on a business report before they consider the business creditworthiness. If you have been operating your business without credit, or with personal assets, you should consider making some trade credit purchases in order to establish a credit history for your enterprise.
Reviewing Your Consumer Credit History
Consumer credit agencies are required to remove any information from the report that cannot be verified or has been shown to be inaccurate. However, before you submit a letter disputing any debt to the credit reporting company, it’s often a good idea to contact the relevant creditor directly. If an error was made, you can often clear up the dispute more quickly if you take the initiative.
If the dispute is not resolved and your credit report is not adjusted, you have the right to file a statement or explanation regarding the alleged debt with the credit report. If your credit report does have some tarnish on it, you might consider requesting that any creditors with whom you have had a good credit history, but who did not report the transactions, be added to the report.
Providing Collateral to Secure a Loan
When it comes to obtaining a secured loan, providing collateral is a must. To a bank, collateral is simply defined as property that secures a loan or other debt, so that the lender may be seize that property if the you fail to make proper payments on the loan.
Understanding Your Collateral Options
When lenders demand collateral for a secured loan, they are seeking to minimize the risks of extending credit. In order to ensure that the particular collateral provides appropriate security, the lender will want to match the type of collateral with the loan being made.
The useful life of the collateral will typically have to exceed, or at least meet, the term of the loan. Otherwise, the lender’s secured interest would be jeopardised. Consequently, short-term assets such as receivables and inventory will not be acceptable as security for a long-term loan, but they are appropriate for short-term financing such as a line of credit.
In addition, many lenders will require that their claim to the collateral be a first secured interest, meaning that no prior or superior liens exist, or may be subsequently created, against the collateral. By being a priority lien holder, the lender ensures its share of any foreclosure proceeds before any other claimant is entitled to any money.
In startup businesses, a commonly used source of collateral is the equity value in real estate. The borrower may simply take out a new, or second, mortgage on his or her residence. In some states, the lender can protect a security interest in real estate by retaining title to the property until the mortgage is fully paid.
Establishing Your Cash Flow from Operating Your Business
The cash flow from your business’s operations—the cycle of cash flow, from the purchase of inventory through the collection of accounts receivable—is the most important factor for obtaining short-term debt financing.
Assessing Your Character as a Potential Business Borrower
The weight given to a lender’s assessment of a borrower’s character can vary tremendously between lending institutions and between individual lending officers. Many small businesses have found more success “selling” their reputation and good character to smaller community banks who may be more directly affected by the economic health of the surrounding community.
Documentation for Existing Businesses
For an existing business, you can anticipate a request to produce:
- Income statements and business balance sheets for the past three years
- Projected balance sheets and income statements for two years
- Projected cash flow statements for at least the next 12 months
- Personal and business tax returns for the last three years
- A business plan, depending upon the credit history of your business and the purpose for the loan, may be unnecessary, and a brief narrative of your intentions may suffice
