This article outlines 10 things you should know and have prepared before applying for a business loan.
Finding ways to finance your business is one of the most important steps in building that business and your future, so it makes sense that this would be a detail-oriented, fully involved process. After you’ve decided on an idea and developed a business plan (more on that later), it’s time to secure the financing you need to ensure your business can be a success. So, what do you need to know beforehand? When it comes to getting a business loan, the devil is in the details! As you move forward with your business plan, make sure you have as much information as possible – there is no such thing as having too many answers.
Be sure to check out our series on Financing Solutions for Startups, where we go through a variety of financing options, including getting a loan.
10 Things to Know:
1. Business Plan
Your business plan is an in-depth analysis of your company’s products, market, team, financials, and more. This document needs to be as detailed as you can make it, including multiple sources for your information and in-depth analyses of your business’s growth, development, and success. For more information on creating a business plan, check out our series on Business Planning 101 and Building Your Business Plan, where we go through detailed steps in helping you create a strong business plan.
In order to reassure banks that your business is worth lending money to, you will need to pledge hard assets against a business loan as collateral. This means that, if for any reason you are unable to hold up your end of the loan and default, this collateral will be forfeited to the bank to recoup some of their losses. These hard assets will be closely scrutinized by the bank to reduce the bank’s risk.
For example, if you pledge receivables to support a commercial loan, the bank will go through major receivables accounts to make sure the companies in question are all financially sound and creditworthy, and will only accept a portion of receivables to back a loan.
In the cases of smaller or startup businesses, it is not uncommon for entrepreneurs to need to pledge personal assets like house equity against the business loan. This then makes you personally responsible for the loan’s payment.
3. Business’s Financial Details
To confirm that your business and personal finances are sound, banks will require an understanding and documentation of all current and past loans and debts, all bank accounts, investment accounts, credit card amounts, supporting information from tax ID numbers, addresses, and complete contact information. Bank lenders are often looking for at least 3 years of financial data to approve a loan, meaning that if your business is much newer than that, personal guarantee will likely be required.
4. Details on Accounts Receivable
When providing details on your business’s accounts receivable, be sure to include information on account aging, account-by-account information (for checking the accounts’ credit), and sales and payment history.
For more information on the essentials of your business’s cash flow, check out our article here.
5. Details on Accounts Payable
This will include much of the same information as accounts receivable, except now regarding what you owe suppliers on the goods and services you have purchased. It is also prudent to include credit references when discussing your accounts payable, as companies who sell to your business on account can vouch for your payment behaviour and reliability.
6. Complete Financial Statements (Audited or Reviewed)
When applying for a bank loan, you will need to include a balance sheet which lists all of your business assets, liabilities, and capital. While it is best to include several years of history, the most recent balance sheet is the most important one. Additionally, your Profit and Loss statements should go back 3 years. Exceptions can be made if your business does not have that much history, but you have good credit and assets to pledge as collateral. Include as much profit and loss history as you have, as mentioned before, it is always better to have more answers than few.
When it comes to auditing and reviewing your statements, choosing which route to take (if either) depends on your business’s size and history. Having audited statements means paying up to a few thousand dollars to have a CPA go over them and take formal responsibility for their accuracy. The price for an audited statement is high because the CPAs are fully liable and can be sued over bad audits. Alternatively, having statements reviewed will be less expensive, because the CPAs who review the statements have less liability if something is incorrect or faulty.
Banks will not always require an audited or reviewed statement. It is important to always have a complete financial statement prepared, whether it is audited, reviewed, or not, but the bank will likely care more about the collateral, assets at risk, and assets you pledge. For more information, check out our article on Creating Financial Statements.
7. Personal Financial Details
This is where some people may be surprised! While you are applying for a business loan, as an individual who is likely trying to grow a business, there may need to be some personal guarantee as part of the loan process. This will include information such as social security numbers, net worth, details on assets, and liabilities (home, vehicles, investment accounts, credit card accounts, auto loans, mortgages, etc.). Additionally, if there are multiple business owners involved in the loan application, the bank will want financial statements from each owner with significant shares to fully comprehend the financial situation going into the business.
8. Insurance Information
With new businesses, it is not uncommon for banks to require business owners to take out insurance against the death or disability of one or more founders. Often the fine print will direct the insurance payout to the bank first, in order to pay off the loan. This is done to ensure the loan gets paid in event of death or loss of ability to finance it, and allows the bereaved or caretakers to focus on other matters at hand.
9. Copies of Past Returns
Most bank loans will require applicants to submit both personal and business income tax returns for the last 3 years. This will include returns for the principles in your business.
10. Agreement on Future Ratios
Many loans will include loan covenants or agreements, in which the company agrees to keep some key ratios. These ratios can include current ratios, which measure the company’s ability to meet financial obligations by representing the number of times current assets exceed current liabilities; quick ratios, which measure a company’s ability to meet its current obligations using its most liquid assets; or debt to equity, which measures the percentage of total assets financed with debt.
If your financials fall below covenant-determined levels, you are technically in default of the loan and subsequent necessary action will occur.
As you prepare to apply for a business loan, remember to prepare details, details, details! When you have all the information that the bank needs and more, you will be able to present a strong case for your loan and get the funding you seek. With this list of 10 items to collect and know before going for a bank loan, you will be as prepared as possible and will have your best chance at creating a funding plan that best suits you, your business, and your goals. If you have a loan application to do, or are working on, keep these things in mind to create the strongest case for your business’s potential!
Download this resource 10 Things to Know Before Getting a Business Loan.