For every successful business, there comes a point when personal
financing is no longer enough to sustain the growth of the company. Whether
they need to purchase larger, more advanced equipment to meet production
demand, buy more inventory or more property to expand operations, or hire more
staff, most businesses will be left with no choice but to reach out to a bank
for a business loan eventually. Unfortunately, many will get rejected,
especially if the request comes from SMBs (Small and Midsize Businesses), also
known as SMEs (Small and Medium sized Enterprises).
It is increasingly difficult for SMBs to get loans through
traditional methods such as banks (most banks in the US, for example, won’t
give out loans below $100,000), which raises the stakes even higher for
everyone competing to secure a bank loan. By understanding the main reasons why
banks reject loan requests, you can get a leg-up on the competition and ensure
that you take the appropriate measures to protect yourself before making an
application.
These are the top five reasons why banks will decline a loan
request:
What Is Your Credit Score/History?
When banks loan money to businesses, the number one thing
that concerns them is whether they will be able to get their money back. Your
credit score, which represents your company's financial history, is the most
useful indicator in verifying that you're a trustworthy business that can pay
back their debts. Banks want to ensure that you have a long-established record of
paying back your debts on time (most banks require a transaction history of a
minimum of two years) before they will approve a loan.
If your business has a bad credit history due to poor cash
management and not paying back debts, then the bank is not likely to trust your
ability to pay back your loan and will, therefore, reject your loan
application.
Bonus Tip: One of the best things you can do to build good credit is to always pay your bills on time, or even better, early. Please read our article to learn four more ways you can build good credit.
Inadequate Collateral
Another reason you might get rejected for a bank loan is if
you can't provide either sufficient collateral or the specific type that the
lender requires.
Collateral is an essential component to the approval of
loans because it protects lenders if the borrower cannot repay their debt by
giving them something of equal value to the amount borrowed. This typically
includes big-ticket assets, such as property and factory equipment. At the same
time, it acts as an incentive for the borrower to pay back their loan, so they
won’t risk losing their assets.
Bonus Tip: Small businesses which do not have anything to offer as collateral have the option of an unsecured loan. This is a loan without the requirement of collateral, which means that if you cannot pay off your debt, the lender can't take possession of your assets.
Evidence of Inconsistent Cash Flow
As we mentioned earlier, banks want to ensure that you have
a steady enough cash flow to pay back your loan before lending you money.
You must be able to comfortably cover both your business
expenses and loan payments and have some extra cushion in the case of any
unexpected expenses that could lead to you falling behind on your repayments.
Good cash flow does not only represent your ability to pay
back your loan; it also represents the strength of your business. Many
companies that declare bankruptcy do so because of cash flow issues. Therefore,
if you earn just enough profit to cover your daily operations and loan payments—without
a cushion for unexpected expenses—you are still considered to be a high-risk
client, and banks are not likely to approve your loan.
Reasons for poor cash flow include:
·
Being part of an industry with seasonal
fluctuations
·
Poor cash management that leads overall limited
cashflow
·
Major drops in finances
For lenders, only a steady and reliable cash flow shows that
you have longevity as a business, which makes them more willing to lend you
money.
Bonus Tip: If your business is seasonal,
make sure to offer another product or service that will supplement your cash
flow during the low-season months. Alternatively, change your payment policies
by adding late penalties or shortening the pay period to ensure more consistent
cash flow.
Concentrated Customers
In addition to irregular cash flow, banks will also consider
you as a high-risk debtor if most of your income comes from a concentrated
source. That means that banks aren’t likely to loan to businesses that are
reliant on one group of customers to keep them afloat, even if they have good
credit and cash flow. Because if that group of customers ever goes away, that
business's entire source of income is immediately gone—and
with it, their ability to pay back their loan!
Therefore, despite customer loyalty being highly valuable to
a business, it is just as important to have variety in your clientele.
Diversity will ensure that you are protected should you ever lose that business
relationship with your core group of customers. A broad consumer base will
guarantee that if this ever happens, you have a large enough income source to
keep your business running successfully.
Bonus Tip: Get the word out about your
business. Put active effort into your marketing and advertising strategies
which are crucial to expanding your brand awareness and therefore your base of
clientele, thus improving your chances for loan approval.
A Weak Management Team
A business, even a small one, needs a strong management
team. After all, they’re the ones with the education and experience required to
help your business grow. It is their job to come up with and execute the
strategies that will make your business grow successfully.
That is why the management team's strength is at the top of
the bank's list of requirements to get a loan approved. For them, the existence
of a strong leadership team that displays effective and efficient decision-making
is a guarantee that they will get their money back.
If you’ve had trouble securing a loan, try working on all the above to improve your prospects in the future, not only for obtaining loans but for the success of your company in the long term.