How to Prepare for a Business Loan
< View All PostsWhether you’re just starting out or have been in business for over ten years and looking to grow your business, it may be time to take out a business loan to give your business the influx of cash it needs to be successful. If you’re wondering how to prepare for a business loan, we’ve prepared a checklist to help walk you through the steps of applying for a loan.
1. Determining the Amount
Before you apply for a business loan, review your business goals and determine whether you really need a loan. Think about what you want to do with the funds and review your books and assets to determine if you can obtain the funds another way.
Some common uses for business loans include starting a business, expanding a business, purchasing equipment, increasing inventory, and improving cash flow. After determining the use of the funds, research to determine how much cash you’ll need to achieve your goal. For example, if you are purchasing equipment determine the price range of the piece from low-end to high-end.
2. Credit Report
As with any loan, the lender wants to understand the risk involved with lending you money. Your credit score—a score generated based on your past lending history—will be the first thing a lender checks. However, which credit score a lender uses to assess your ability to pay off the loan will depend on the type of business entity you have. For example, if you have a sole proprietorship, the lender will check your personal credit score, but if you have an LLC or other incorporated business entity, your business will have its own credit score.
Before applying for a business loan, you will want to check your credit score to know if you qualify for the loan. Generally, a personal score of 700 or more is good enough to obtain a loan, and a business credit score of 75 or above is good. If your score is lower than this, it may be a good idea to increase your score by making payments on time or paying down high credit cards to raise your score.
3. Gathering Necessary Documentation
The lender will likely also want to see the following documentation before extending a loan to you.
- Bank Statements: You will need bank statements from at least the past three months. Lenders will use these statements to review your income and expenses to determine how well you manage your finances. They may also use these statements to predict future cash flow and assess your ability to repay the loan.
- Financial Statements: Generally, lenders will ask for financial statements, or a profit/loss sheet, for the past three fiscal years. These statements will be compared with your bank statements for consistency. Although you don’t have to be profitable to obtain a loan, you will need to be prepared to explain how you plan to use the loan to get your business out of the red.
- Tax Returns: You will need both business and personal tax returns for the past three years. Tax returns should be the most accurate depiction of your business finances and can be compared with all of your other financial documentation.
- Balance Sheets: A balance sheet is a list of your company’s assets and liabilities. Assets include anything that has present or future cash value and could potentially be used as collateral to guarantee your loan. Whereas liabilities are any outstanding debts. Lenders use balance sheets to determine whether you have the resources to pay off all of your existing debts or if your debts outnumber your assets.
4. Reviewing Your Options
From traditional bank loans to SBA loans, there are a variety of loans to choose from depending on the type of your business or financial situation. A few types of business loans include:
- Traditional Bank Loan: You’re probably most familiar with a traditional bank loan, or term loan, that you obtain directly from a banking institution and repay through monthly payments throughout the term of the loan. One of the advantages of this type of loan is that you can generally find a low interest rate.
- SBA (Small Business Administration) loan: According to their website, SBA reduces risk to lenders by guaranteeing major portions–up to 85%–of loans made to small businesses. This enables lenders to provide financing to small businesses when funding is otherwise unavailable.
- Specialty Financing: If you need to lease or buy equipment, specialty financing allows you to purchase the equipment on credit, pay for the equipment in monthly installments, and use the equipment as collateral for the lifespan of the loan.
- Line of credit loan: If you are not sure how much cash you’ll need, a line of credit loan may be a good option for your small business. With these loans, you will be approved up to a certain amount and can withdraw cash as needed, up to the approved amount. Although interest rates are generally high with these types of loans, you will only pay interest on the cash actually withdrawn.
5. Submitting Your Loan Application
Once you have determined the amount of money you need, gathered your paperwork, and determined the type of loan you need, it’s time to apply for your business loan. Although some lenders permit you to apply online or over the phone, most lenders will want to meet with you, in-person or by phone, to discuss your application. Be prepared to discuss any “red flags” such as a low credit score or excessive business losses. After your application is accepted, it will go through an underwriting process and the lender will contact you with their decision.
If you have begun the process of researching business loans and feel overwhelmed by the process of gathering documentation and organizing your business’s financials, you’re not alone. With Eco-fyle’s bookkeeping and accounting services, we can help you compile financial reports, track expenses, and prepare tax documentation. Request a free consultation to get started.
