The financial crisis of 2008 continues to have repercussions on the economy and small business owners. According to the Federal Deposit Insurance Corporation (FDIC) lending plunged 7.5 percent in 2009, the largest decline since 1942. The mortgage backed security crisis caused banks to tighten their lending policies making it more difficult for small businesses across the U.S. to secure a loan. Many small businesses have turned to friends and family or worse, credit cards, to finance their small business.
The bank is still a good place to get a loan. You will also get the benefits of establishing a relationship with a trusted financial institution, which can make it easier to finance needs throughout the life cycle of your business.
So how does a small business secure a bank loan in this tightened market? To get a loan in today's market, small business owners need to not only demonstrate creditworthiness, but be savvy about the loan process. This means understanding the standard process that banks use to assess risk and approve loans. Listed below are the 5 C's that are routinely used by banks in the loan approval process.
Capacity: This is the business' ability to pay back the loan. To assess this, a bank will look at the all-important cash-flow as well as other alternatives available that can be used to repay the loan. Keep up-to-date records so that you always know your cash flow balance. Know what you expect your cash balance to be in six months so that you can make the right decisions for your business today.
Collateral: Banks will consider usable assets as security for your loan. Things like equipment, real estate, accounts receivables and inventory on-hand are considered collateral. These can act as another form of repayment.
Character: Banks will assess the trustworthiness of a business by checking references and reviewing personal and business credit history, education and business experience.
Conditions: The bank will consider business conditions as part of the loan determination process. This means that they will evaluate external environmental conditions with respect to the business, including things like customers, competitors, changing cost of supplies and other economic indicators.
Capital: Net worth and equity of the business owner are two key financial metrics. As a business owner, one way to show that you are "loan-worthy" is with your own checkbook. A business owner unwilling to invest their own funds sends a bad signal to the bank.
The 5 C's are a good guide on how a bank determines financing. To prepare the loan process, know not only your business but have a firm understanding of your market. Do your own SWOT analysis to assess your market position. Understand external factors such as new market entrants and regulations that would impact your business. If you are refused a loan, ask for an explanation and whether the bank needs more information. Bottom line is that you'll need your finances in order before initiating the process; so getting your data into some form of accounting software is a good starting point.
Follow Jamie Sutherland on Twitter: www.twitter.com/sutherlandjamie