by Brock Blake
Regardless of industry, geography or financing needs, applying for a small business loan can be an intimidating process. Business owners often feel like they are opening the door for potential lenders to analyze and critique every aspect of the business. If a small business doesn’t have enough business credit to assess risk, lenders will turn their attention to the owner’s’ personal finance information. But it doesn’t have to be as daunting as it seems.
First, it’s important to know where lenders focus their attention when a business applies for a loan. There are three key areas lenders look at to determine lending risk – cash flow, credit score and collateral. In the past, banks required businesses to have all three Cs to be considered loan worthy, but now with alternative lending options, businesses can still get funding despite missing one or two.
The Three C’s
Cash Flow: When it comes to cash flow, lenders will look at a business’ bank accounts, in and out cash flows, accounts receivables, and credit card statements. Of all the Cs, cash flow carries the most weight. While lenders will primarily evaluate your bank statements, using accounting software like Xero and QuickBooks to store historical records and ensure books are accurate and up-to-date helps give lenders information they can easily reference.
One of the most common types of underwriting lenders will go through is account receivables. Other key metrics lenders will look at are the average daily balance in your bank account, volume or number of deposits (each month), and total number of non-sufficient funds (NSF). The higher the average daily balance, the larger the number of deposits, and the lower (hopefully zero) number of NSFs, the better.
Credit Score: One of the misunderstood aspects of seeking capital is the difference between business credit and personal credit. The reality is that business credit is very rarely evaluated. Unless the owner has been in business for more than five years to establish business credit, (and, even then…) most lenders will look at the owner’s personal credit score. To lenders, a business owner’s personal record of financial management is just as important as their business’ record.
Lenders see creditworthiness as being indicative of overall management and attention to detail. This can spell trouble for business owners who didn’t manage their finances correctly when they were younger, or accumulated debt starting the business. To get back on track, there are several free credit services like Credit Karma to provide business owners with scores and advice on how to improve their score.
Determining Level of Risk to Lenders
The three Cs help lenders determine the level of risk a potential business owner carries when applying for a loan. How many Cs an owner can ‘check off’ can dictate their perceived risk in the eyes of the lender, and the quality and terms of the loan. A business can carry a low, medium or high risk based on the number of three Cs they can provide a lender.