What are the Factors Banks Consider Before Granting a Loan to a Business?

Small, medium or large businesses must put their best foot forward when applying for a business loan from banks or NBFCs. The available funds will determine their success and provide them with the capital required for growing their business or starting a new project. In addition, proper funding can consolidate their debt, ensure good capital flow to the company and help the business overcome financial crunches.

Here are factors banks consider before Granting a Loan to a business

Credit History
Cashflow
Collateral
Repayment capacity
Documents

Below you can find in detail about each of them.

Broadly, there are six types of business loans in India:

Working capital loan – Organisations use working capital loans to meet their day-to-day expenses and other expansion services. These are primarily short-term loans with a tenure of up to twelve months. The funds can be used to purchase raw materials, improve business cash flow, pay salaries, hire staff, add to the existing stock or inventory, etc.
Term loan – Term loans are repaid in regular payments over an agreed period. These loans can be categorised as short or long-term loans, and the repayment tenure is typically between twelve months to five years.
Letter of credit – Used mainly by those in the trading business, the letter of credit is a credit limit where banks provide funding guarantees to companies dealing in international trade. It can be used for export and import purposes by businesses and is the reasonable assurance required by enterprises dealing with unknown suppliers.
Bill discounting – Invoice of bill discounting is a funding facility where sellers get an amount in advance at discounted rates. Buyers must contribute in the form of an interest rate, which is to be paid as a monthly fee.
Overdraft facility – It is a type of funding where banks allow their account holders to withdraw cash from their accounts if their balance is zero. In an overdraft facility, the interest is charged on the utilised amount from the sanctioned limit.
Equipment finance or machinery loan – This funding option enables business owners to get the money required to purchase a piece of new equipment or machinery or upgrade the existing ones. Large companies or enterprises in the manufacturing industry typically use equipment finance or machinery loan. Business owners even enjoy tax benefits after availing of this loan.

So, these are the different business loan types in India that businesses can apply for to expand and grow their business or meet their daily expenses. You can learn about all these loans, interact with more than 700 lenders and get competitive interest rates by registering on the Yubi Loans platform.

Business loans in India can be secured or unsecured. However, before approving the loan application, banks must ensure certain business-related things.

The factors banks consider before granting a business loan are given below.

1. Credit History

Having a good credit history is a priority for banks when granting a business loan application. If your business or you need a better credit score, the chances of getting your loan approved for your business may seem challenging.

Lenders, especially banks, are always concerned about the loan repayment capacity of the borrower, which is why they need to keep track of the borrower’s business and personal credit score.

On average, banks prefer to lend money to businesses whose credit score lies between seven hundred and seven hundred and fifty. A business with a good credit score has a good credit history, indicating strong money management skills. Conversely, if the company has a CIBIL score of below 680, it is a sign of bad credit history, and banks consider such businesses a potential risk in terms of repayment.

2. Cash Flow

If a business has low cash flow, the business is considered a potential risk by banks. A low cash flow means the borrower will take more care of their business costs and expenses than their credits.

To learn about the business’s income and cash flow, banks check the business accounts’ bank statements and the business owner’s bank statements.

However, business owners can enhance their cash flow by setting goals, doing a cash flow analysis of their business and putting a well-defined payment cycle in place.

3. Collateral

Banks offer secured and unsecured loans to businesses. If the bank has requested a guarantee for secured lending, they wish to limit the risks involved. Therefore, banks need to know beforehand the kind of security or collateral the business will offer in exchange for the loan. The security or collateral can be a commercial real estate property, machinery or costly equipment of your business, vehicles, accounts receivable and other business assets.

Collateral is an asset that banks want to secure the business loan or the line of credit. The bank may also accept a second or third lien on a primary residence as security. Before granting the loan, banks will consider the asset’s appraised value and ease of liquidation. Most banks lend only up to a certain percentage of the asset’s appraised value.

Besides collateral, banks might even want to see a personal guarantee from their borrowers. This puts banks in a safe position, and business owners are encouraged to work with the bank to ensure the business’ success.

4. Repayment Capacity

Banks want to ensure the complete repayment of the business loan, and the borrower’s ability to ensure this is defined as their capacity.

When a business owner applies for a loan, they authorise the lender to check their bank statement, credit history and last year’s ITR to know their repayment capacity. This allows the bank to evaluate the business’ repayment history of their previous or existing loans. Furthermore, the transactions made by the business indicate credits and debits that the company currently carries.

After studying these, banks calculate the borrower’s debt-to-credit ratio to reject or approve a specific business loan application.

5. Documents

Businesses cannot exist without documents. Every business needs documents to start, operate and expand. Whilst different lenders may have different eligibility criteria for approving business loans, they all ask for relevant documents. Some of the documents required by banks before grinding a loan to a business are as follows:

Identity proof – Aadhaar card, driving licence, passport, PAN card, voter’s ID, etc.
Address proof – electricity bill, telephone bill, ration card, trade licence, passport, sales tax certificate, lease agreement, etc.
Income proof – bank statement of the last six months.
Financial documents – last two years ITR, along with computation of balance sheet, income & profit loss account for the last two years, etc.
Proof of business continuation.
Business ownership proof – certified true copy of Memorandum & Articles of Association, sole proprietorship declaration, business licence, etc.
Last three years audited financials.

By submitting these documents, businesses can show it is legal and does not pose a massive risk to the bank. If all the documents are approved, it will take banks only a short time to sanction the loan amount requested by the business owner.

Wrapping Up

Every financial institution has unique parameters for analysing the borrower’s creditworthiness, but the above mentioned factors are standard evaluation methods. Overall, the business and bank must form a strong relationship that meets the requirements of both parties.

You can sign up on the Yubi Loans platform to connect with different public and private banks in the country offering business loans. Talk to them, discuss your requirements and seek interest rates. Then, compare them to make an informed decision.

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