Financial Management 101: Tips on Receiving a Loan

Factors in Analyzing a Loan Application

There are five basic components that a potential lender will analyze with every loan application: character, capital, capacity, collateral, and conditions.

Character

This refers to the skills and background that you bring.

  • Your credit history: Run your credit report yourself before applying for a loan so you have a sense of how it will impact your chances. Some lenders have a set minimum credit score, but others are more flexible. If your credit score is low, look for a co-signer to guarantee the loan.
  • Industry experience
  • Business plan: This is a requirement for many lenders.
  • References
  • Management ability
  • Recordkeeping and transparency: Bring any financial statements you have, including tax records.

Capital

This includes your business and personal net worth, which is your total assets minus your total liabilities.

  • Liquidity (cash and near cash assets)
  • Working capital
  • Current ratio: Current assets divided by current liabilities
  • Quick ratio: Current assets minus inventory divided by current liabilities
  • The lower the financier determines your net worth to be, the higher the risk of lending to you. This can be offset by pulling in cosigners for your loan.

Capacity

This refers to your projected capacity to repay the loan. It’s based on a number of factors, including:

  • Business profitability and business cash flow: The profitability and cash flow of your business are determined by looking at your tax documents, projections, and budgets.
  • Personal capacity: If you have off-farm income, savings, or a solid co-signer, your personal capacity can make up for weak business potential.

Collateral

Collateral is security for the loan. You need to consider what you are willing to pledge in order to back the loan.

  • Real estate is the preferred collateral for most lenders. Most banks will lend 75-85% against the value of the land.
  • The useful life of the collateral should be at least as long as the term of the loan. This is something to consider if you intend to use something like equipment for collateral.
  • Machinery, equipment, and vehicles: Most banks will lend 50-80% against the value of the equipment, and all equipment must be insured.

Conditions

It’s important that you understand the terms of your loan.

  • Review loan approval terms, financial-reporting requirements, and collateral advance rates.
  • Loan covenants are requirements that are built into your agreement, such as the borrower agreeing to maintain a net worth above a certain amount.

Decision Making as a Borrower

Before applying for a loan, you must carefully consider whether a loan is appropriate for your needs.

Ask yourself the following questions:

  • What are my business goals?
  • How much money do I need?
  • Can my business afford a debt payment?
  • What type of financing should I consider?

Evaluate the financial health of your business against the following benchmarks:

  • Minimum debt-coverage ratio of 1.25
  • Minimum current ratio of 1.25
  • Minimum loan-to-appraised-value ratio of 0.80
  • Minimum credit score of 700
  • Maximum total monthly obligation of 36% (total monthly debt obligations / total gross monthly income) for consumer lending

Gather the materials you need in order to apply:

  • Loan application
  • Current financial statement (i.e. balance sheet)
  • Tax returns for the past three years
  • Projections or cash flow budget
  • Business plan, whether new or expanding
  • References or credit history
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This material is based upon work supported by USDA/NIFA under Award Number 2010-49200-06201.

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