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FACTORS CONSIDERED BY BANKS WHEN DECIDING TO OFFER A LOAN

Your business is expanding, so you need to buy more equipment and fund increasing accounts receivable balances. How do you convince a bank to give you a loan for your business needs?

Purpose of the Loan

First, give the bank a business plan. Show them that your business is solid and you have a strong track record of performance. Convince the bank that you don't really need their money, but if you had it, here's what you could do with it. Banks get queasy about lending to desperate borrowers. Be specific about how much money you need, what you will do with it and how you will pay it back.

The business plan should include:


  • Summary of the business and its products and services
  • Experience of the management team
  • Competitive environment
  • Target market
  • Financial statements.

After the banker understands your business, the purpose of the loan and the method of repayment, he will evaluate the bank's risks by using the five Cs:

  • Character
  • Collateral
  • Capacity
  • Capital
  • Conditions.

The Importance of Character

Foremost on the list is character. If bank doesn't trust you or think you're an honest person, they will not approve your loan request. It doesn't matter how much collateral you have, it will not be enough to offset a lack of trust.

The lender needs the confidence that the borrower has the experience, education and industry knowledge to successfully manage the business. The borrower's reputation plays a significant part in getting a bank loan. Your credit history will show your track record for repaying debts.

The Need for Collateral

When a bank makes a loan, it determines a plan of how the borrower will repay the loan. If the borrower defaults on the loan, then the bank falls back on the collateral. A lender never wants to use the collateral to repay a loan, because the sale of the collateral may not be enough to pay off the loan.

Banks like to take property and assets as collateral as a way to recover their loan in the event the borrower fails to pay as planned.

Capacity to Repay the Loan

The borrower must show that he can repay the loan out of the company's cash flow. The bank will analyze a company's debt-to-income ratio and the amount of its free cash flow. Lenders like these ratios to provide a cushion in case the business takes a downturn.

The Need for Capital

Banks feel more comfortable when the owner has his own money invested in the business. Lenders like to know the owner will lose something if the business fails. If the owner is not investing in his own business, why should the bank?

Banks like lending to companies with a lot of capital because it means the owners have some "skin in the game." When owners have more personal capital in the business, they will fight harder and sacrifice more to save a business and repay their debts.

Overall Economic Conditions 

Beside analyzing the borrower, bankers will look at the overall economy, industry trends and even the direction of politics. They are thinking about factors beyond the control of the business owner that will affect the performance of the company.

It is almost impossible to start a new business and finance its growth solely with internally generated funds and owners' capital. At some point, small business owners will have to approach their banks for loans. Understand the process that bankers go through to evaluate their risks before you apply for a loan.

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