Why did Your Business Loan get rejected?

“Borrowing isn’t inherently bad; it depends a lot on what the debt is financing.” Stephen Moore

I have seen the happiness on the faces of many entrepreneurs when I placed?loan?sanction letters in their hands.? But loan rejection is not a happy state.

Availing of?a loan?is most businesses’ need for growth, especially for SMEs.? There is a limit up to which promoters can invest their capital in the business. Beyond this point, they need the support of external sources and lenders like banks or NBFCs.

Lenders usually support a healthy business. No one would like to risk their?money?for an unhealthy and risky business. They are answerable to their management and shareholders.

With the massive NPA problem, the Indian financial system is facing, lending has become more and more stringent. However, there is no dearth of money for good business.

Here we look at the aspects that usually affect the chances of your loan application getting approved. Knowing these will help you be better equipped to deal with the banking system and availing loans.

1.?? High Debt to Equity Ratio

This means you have already borrowed more than what can support your own fund. This makes the lending risky as the owners’ stake is quite low. The ideal ratio is 1 to 1. Lenders can go up to 1: 3. A ratio beyond this usually becomes unacceptable by the lenders.?

(Note: In the real estate business, I have seen the bank had financed Rs. 1000 Mn against the equity of Rs. 10 Mn. That means the ratio of 1: 100. This is mainly because the security value was sufficient enough to give lenders comfort.)

2.?? Low Current Ratio

A less than 1 current ratio indicates the company could face a liquidity crisis. Creditors are higher than debtors. Current liabilities are higher than the current which can support the repayment. ??Most of the time consistently lower current ratio is a sign of a liquidity crisis. Usually, lenders prefer a ratio of 1: 1.33.?

3.?? Low-Profit Margin

This makes the lending risky as the business may run into losses if the margins are thin. A healthy?profit?margin and speedy sales recovery are two important aspects of the business and banks consider both as a sign of a good borrower.

4.?? Inconsistent Turnover

There has to be consistent growth in the turnover. If the consistency in turnover is not there, the business is facing growth challenges.? The inability to grow could mean the business is facing a tough time.

Banks assess whether this is due to a lack of capital or capacity. In such a scenario, the bank may support the business. Alternatively, if the reason is competition and price pressure. Loan application becomes untenable.

5.?? High Debtors

This indicates the company is not able to recover sales money on time. This indicates an uncompetitive company position and a highly competitive industry. It also could be due to the casual approach to recovery of the owners. In all the scenarios, it is not good for the business.

Usually, 2 to 3 months are considered a sale recovery period. It varies from industry to industry. But higher recovery period is not good for the liquidity of the business. ??This increases the working capital investment.

The chance of long-term debtors turning bad is also high.

6.?? Frequent Cheque Bouncing

This is a serious issue. Cheque bouncing is considered a serious problem. This indicates promoters’ financial indiscipline and a cash crisis.

Frequent cheque bouncing reflected in the bank statement seriously hampers the chance of loan approval.

“The ability to sign a cheque is the least reliable guide to a company’s fitness.” David Plowright

7.?? Inadequate Collateral Security

Landers many times ask for additional security over and above the assets they are financing. This is known as collateral security.

When the bank is financing working capital stock and receivables or machinery, banks may ask the borrower to provide immovable or liquid security as a safety.

When the borrower is unable to provide or what he can offer is inadequate as per the bank’s norms, the bank may reject the loan proposal.

Though under the?Credit Guarantee Scheme (1)?loan up to Rs. 20 Mn. is possible without collateral, security with certain terms and conditions.

“There is a defined gulf Between credit and character If you doubt this, ask any banker; He will advise that character is nice but it is not collateral.” ?Evan Rhys,?Poems from the Ledge

8.?? Low Credit Rating

Banks have their internal rating process. If the company is not rated by an external credit rating agency, the bank’s internal rating scorecard decides whether the borrower is creditworthy.

This is mainly about financial performance; industry classification and promoters’ track record.

9.?? Bad Credit History

Indiscipline in loan servicing and repayment in the past hampers the chance of future loan availability.

Lending is a highly trusted and worthy activity. When the promoters are not serious about repayment or their business is unable to support timely repayment, lenders’ money is at risk.

Known credit risk most lenders would like to avoid. It could be compensated by additional collateral security and justifiable reasons for the delay or default.

Even for the NPA account promoters, getting a loan from the banking system is very difficult, even for their non-NPA accounts.

10.??Weak/Risky Industry

Some industry is classified as weak or risky based on the economic scenario. Like real estate or Chemical or such industries that are either over-borrowed or is uncompetitive due to economic and global factors, are on the caution list. Banks lend to companies in these industries very cautiously.

11.?Unrelated Diversification

Lenders would like to refrain from lending to promoters who are undertaking unrelated diversification. This could be risky. Promoters’ industry experience is an important factor when banks consider a loan proposal.

12.?Promoters on Caution List

If the promoters have defaulted on loan repayment, export credit recovery, criminal record, or any such records which doubt the integrity of the promoters, RBI has a caution list of such promoters. If the promoters are on the board or are anyway.

Remember, a loan is not for bad times. No one will lend you when your business is not doing well. Borrow when you are doing good and your finances are in good shape.

From my book: Indian Start-ups, SMEs & Financial Literacy