If you’re worried about whether or not your business can afford to receive a line of credit, worry no more. Business is all about solving these types of problems. That said, figuring out whether you have the resources to make all of your loan payments is not always easy. This article is all about demystifying the analysis by bringing to light the key issues that need to be addressed.
Think like a lender – While there is no one size fits all solution for determining the credit viability of a business, all potential borrowers share the common hurdle of satisfying a potential lender. Thus, getting into the mind of the lender is key. When you answer the questions that a lender will be asking, you will be well on the way to determining whether a loan is best. This should be done before taking out the calculator.
These questions can be boiled down into a few basic categories: Are you capable of paying the loan back? Are you going to actually pay it back? What happens if you cannot pay the loan back?
If you can confidently address questions like these, you have a much better chance at finding success with a lender. The next step is to then actually answer these questions more specifically.
Capability – It is best to use the same tools that banks and other lenders use to assess the suitability of a business for loans. One of these tools is a “debt service coverage ratio“ or a DSCR. This ratio divides the cash that you as a business owner will have to payback a loan in one year’s time by the amount of money you are borrowing with interest added. After you determine your cash flow for the year, you’ll want to calculate the annual debt payments you face. This is where a business loan calculator comes in handy. Find one online with websites like “Bankrate.com” to quickly get a figure. Aim for a DSCR of around 1.25 or more.
Making it happen – While understanding your businesses cash flow is crucial, lenders also need to know whether you as the business owner are trustworthy. The debt-to-income ratio is another tool used to determine your suitability as an individual. To get this figure divide your monthly total debts by your gross monthly income. Then multiply by 100 to get yourself a percentage. Lenders tend to look for a DTI no greater than 36 percent.
If all else fails – If you’ve made it through the first questions with success, you are almost there. However, you must also answer for what will happen if your business fails and you cannot pay the loan back after all. The best solution may depend on what the lender prefers. Some lenders need collateral, assets, and others want excess cash flow on reserve that the bank can claim if you fail to pay up. Remember that if you sign a guarantee on a loan contract that you are responsible for paying out of your own pocket in the case that your business fails.
Remember, all three questions are equally important to lenders. If you cannot answer just one of the three, it may not be best to take a chance on a loan.
