Banks and other creditors only fear one thing. Not getting their funds back!
So, to get a business loan, just show the proof that your company can apply for a loan – that is, it is possible to pay back the loan for the entire duration of the loan.
Most creditors perform the following 3 analysis calculations to see if your company has the cash flow to afford a new loan.
1) Net Profit:
Banks/creditors require prior financial statements for at least three years. The reason is to find out if your company has not been bankrupted in the past three years. When this test passes, your business should be able to get a loan. They use your performance in the past to see what your future performance should be.
To get financing, divide your majority of creditors for each prior period of your financial statements:
Take the net profit (this is the profit, after operating costs, taxes and interest).
Include all non-cash accounting items, such as depreciation (write-offs are not cash, but reduce tax deductibility for accounting purposes and for tax purposes only).
Add one-time charges or costs – costs that are unlikely to appear in the future.
Then you deduct the interest costs of the loan since interest payments are considered as normal operating costs.
The result will be the actual net positive (probably positive) cash flow of the company – This cash flow will be used to pay the bulk of the business loan. This also proves that your cash flow can currently cover the bulk of the loan.
Most creditors do not just want to see if your company’s cash flow meets the minimum requirement for a basic loan but would like to cover 25% or even 50% more. The reason is that if your company has a slow period and sales are reduced by 25% or 50%, then your company’s cash flow is sufficient to pay for the loan.
2) What if scenarios:
Here, the lender will provide a series “What if” in the financial situations.
For example, total income for the entire period may decrease and decrease by 10% or 20%, with all other items (your costs) being the same.
Then re-divide these numbers to see if your company can afford a loan, and still have cash flow to make payments.
This reaffirms the lender that your business will still be able to repay even if the slows.
3) Debt to equity ratio:
Finally, banks will want to ensure that your company does not have excessive debt. They will want to confirm that your company does not have too much debt compared to equity.
Suppose the entire market you are in is falling, and your income is so low that you are forced to close the business. In this situation, are you still able to repay all your creditors – including this loan?
So the borrowers are looking for a security measure, called the ratio of debt to equity.
Debt equity measurement simply takes your liabilities and divides them into the total equity of your company.
The higher this ratio, the greater the risk. A ratio of more than 3 (that is, the company has three times its own equity in debt) is too risky for most creditors.
Companies that have a ratio of debt to equity of 1.5 to 2 and are considered safe to creditors.
Financing your company all starts with your understanding it’s financial standing and the steps you need to take to be qualified for the loan.