5 Steps to Qualify
Qualifying for a business line or loan is easier when you’re prepared. While there are several key areas lenders will be focusing on, it is important that you as the business owner is ready to present the perfect, complete package for review if you hope to get approved.
Here are the five steps to being prepared ;
- Organize your finances
- Understand your options
- Know your limitations
- Create a checklist
- Have the right expectations
How can you determine what your business line of credit should be?
Take your total estimated annual gross revenue (sales) and divide by 365. That gives you your daily cash need. Next, determine your total number of accounts receivable, plus inventory days on hand (Use of Funds) and subtract your accounts payable days on hand (Source of Funds), and this is your usage. Multiply your daily cash need times the usage (accounts receivable days less accounts payable days) and you will get the estimated line of credit needed for your business.
For example:
Sales …………… $5,475,000/365 = $15,000 (daily cash need)
Accounts Receivable days on hand …………. 68 days (usage of cash)
Add Inventory days on hand ……………….. + 30 days (usage of cash)
_________________________________________________
………………………………………………………………98 days (usage)
Less Accounts Payable days on hand …….. – 52 days (source of cash)
_________________________________________________
………………………………………………………………………..46 days
Multiply by usage ………………………….. x $15,000 (daily cash need)
_________________________________________________
………………………………………………….$690,000 (estimated need)
Your company estimated line of credit need is now known ($690,000 in the example) and that number sets the tone for discussion in terms of the amount of money you need in working capital to operate your business.
How can you determine what your business loan should be?
You should start with creating a detailed costs projections for the use of borrowed funds. Secondly, prepare financial projections, including profit & loss and cash flow statements to estimate the revenue that you will generate by taking out a loan, and your costs. Often, banks will not make a loan greater than 8 to 12 percent of your annual revenue. So if you have $100,000 a year in revenue, you’re doing yourself a disservice by asking for a $500,000 loan. Furthermore, there is interest to pay and typically banks borrow at about a 20 factor meaning, if you borrow $1 you have to pay back $1.20.
How can your choice of bank affect how creditworthiness is determined?
A very large bank may use systems to determine credit. In short, the commercial lender feeds information into an often-automated system, and it comes back with an answer.
At community banks, generally speaking, there is individual involvement. They don’t use those types of systems and instead give more attention to the numbers and to understanding the individual business’ situation.
Regional banks are compartmentalized by market size and often have multiple officers handling each market. Once a business jumps into another category, it has to get a new loan officer. Today’s market is not just about being a lender, it’s value added. If your banker can’t bring value to the table, the bank is just a commodity, and the lowest price wins. Community banks provide a higher value because they are selling the value that can be brought to the relationship going forward.
Jegan Vengada is an experienced lending officer with 15 years in the financial industry. Reach him at 240-230-7055.