Most businesses don’t have bottomless pockets they can dip into whenever they want. At one time or another, every company finds itself temporarily short of funds. To address capital shortfalls, firms need access to external sources of capital, such as business loans.

You may need a business loan to purchase or upgrade equipment, procure inventory, expand your existing team, or onboard new vendors or suppliers. A business loan can also help your company expand into a new market, meet its working capital requirements, and strengthen its financial position during a lean period.

In India, many financial organisations provide favourable business loans. These include commercial banks, government-owned banks, non-banking financial companies (NBFCs), and microfinance institutions. Some lenders provide financing as an ongoing credit line while others make lump sum payments in one or more installments. All lenders perform credit evaluations of businesses before sanctioning loans. Such “credit assessments” give lenders a good idea of the borrower’s future ability to repay the loan (repayment capacity) so that the lender is not left with a bad loan or “non-performing asset” (NPA) on their books.

What is Credit History, and Why Does It Matter?

For any business, its credit history refers to a record of how it handled and repaid the debt in the past. The credit history is always recorded in the company credit report (CCR) prepared by an RBI-approved credit bureau like CIBIL, Equifax, CRIF HighMark, or Experian.

The CCR demonstrates a company’s credit history by detailing its number and type of credit accounts, period for which each account has been open, amounts owed, whether bills were paid on time, amount of available credit utilised, and the number of recent credit inquiries. In addition, the CCR may contain information about the borrower’s bankruptcies, liens, foreclosures, repossessions, or charge-offs.

All of this information creates a picture of the borrower’s credit history. Lenders like banks and NBFCs rely on this picture to understand the borrower’s repayment ability, assess their own risk, and decide if they should extend credit to the borrower. Simply put, lenders will never make lending decisions without first assessing a borrower’s credit history. When making such assessments, they always look at the 5Cs of credit history: capacity, collateral, capital, character, and conditions

By understanding these factors, you will be able to understand exactly how credit institutions assess your creditworthiness and take appropriate steps to enhance it. You can also prepare appropriate documents to strengthen your loan application and increase your chances of getting the loan approved.

The 5Cs of Credit History that Matter In Your Business Loan Application

The 5Cs of credit history are the 5 fundamental factors that lenders assess when analysing a company’s loan application. Together, these factors – which are both qualitative and quantitative – enable them to gauge your creditworthiness and predict your risk of defaulting on a loan. These factors are:

1. Capacity

Capacity refers to your current ability to repay a loan. Lenders assess this ability by:

  • Reviewing how your business generates revenue
  • Predicting how much revenue it is expected to generate
  • Comparing current income against recurring debts
  • Investigating if you have any outstanding debts
  • Assessing your debt-to-income (DTI) ratio

Lenders may look at your balance sheet, P&L statement, cashflow statement, and other financial documents to find all this information. If yours is a new business and you don’t yet have a proven track record of positive cashflows, banks may ask you to provide company projections, backed by data, to assess your repayment capacity and guide their lending decisions.

2. Collateral

Collateral assures lenders that even if you default on their loan, they can repossess the collateral to recover some of their funds. You don’t have to provide collateral if you apply for an unsecured business loan. But if you can, your chances of loan approval will go up. Providing collateral can also give you some negotiating power with the bank regarding lower interest rates and more affordable tenures.

Lenders usually assess the collateral to determine its current and future value. Ideally, the collateral should have a similar value to the loan. It should also be able to maintain (or appreciate) its value throughout the loan tenure.

3. Capital

Capital includes all your assets and liabilities, including machinery, equipment, inventory, products, buildings, and land. When applying for a business loan, a lender wants to know your asset capital. They will also assess which assets can be sold off or liquidated in case you are unable to repay the loan, and to what extent such sales or liquidations will allow them to recoup their losses.

4. Character

Character refers to a firm’s ability and willingness to repay its debts, which will reflect in its reputation and repayment track record.

  • How much have you borrowed in the past?
  • Did you repay all loans on time?
  • Or did you consistently make late payments on one or more loan?
  • Do you (or did you) have any delinquent accounts, collection accounts, or bankruptcies?
  • Have you demonstrated an ability to organise and manage your finances?

All these aspects of your character will show up on your CCR and help lender to evaluate your credit risk and predict the likelihood that you will repay their loans on time.

5. Conditions

In addition to capacity, collateral, capital, and character, banks also look at the general conditions relating to the loan you are applying for. Conditions such as the interest rate and principal amount influence the lender’s willingness to extend the loan. Other conditions like repayment schedule and (your) industry performance could also play a part in influencing lending decisions.

Sometimes, lenders also look at conditions that may be outside your control, such as the state of India’s economy or pending legislative changes. Different lenders may also set their own conditions or requirements when assessing your creditworthiness and deciding whether to approve your loan application, so make sure you know these conditions when applying for a business loan.

Important Document to Strengthen Your Business Loan Application

When assessing your company’s creditworthiness, all lenders will ask you to provide certain documents. These include:

  • Applicant’s identity proof such as PAN card, Aadhaar card, or passport
  • Applicant’s/business’ address proof such as telephone bill, electricity bill, lease agreement, or sales tax certificate
  • Company’s income or revenue proof
  • Company’s financial documents, such as balance sheet, P&L statement, and cashflow statement
  • Business ownership proof, such as such as sole proprietorship declaration or Articles of Association (AOA)
  • Proof of business continuation
  • Company tax returns

Some lenders also ask for a business plan detailing the company’s business model, market analyses, and income projections. Others ask for a detailed description of how the business intends to use the loan. By submitting these documents, you can prove that your company is a legal entity and involved in a legal business (e.g., it is not involved in the drug trade), increasing the likelihood that a lender will sanction your loan.

Banks may ask for different documentation depending on whether you are applying for a secured or unsecured business loan. Let’s explore these next.

Documentation Requirements for Secured vs. Unsecured Loans

You can apply for secured and unsecured business loans as a business borrower. Both come with their pros, cons, and documentation requirements.

Documentation requirements for unsecured loans

With unsecured loans, there’s no need to pledge any asset to guarantee the loan. These loans are supported only by the borrower’s creditworthiness and credit history, which is why most lenders require that the business be in operation for at least a certain number of years in the same line of business.

Typically, Indian lenders ask for these documents to process and sanction unsecured loans:

  • Company profile
  • Company product range
  • Borrower’s proof of identity
  • Borrower’s proof of residence
  • Audited balance sheets for the previous 3 years
  • Bank statements (in the applicant’s or company’s name)

Unsecured loans are typically disbursed very quickly and lenders ask for fewer documents. In general, it is easier to get an unsecured loan. However, the loan amount sanctioned may not be very high and the loan tenure will be short or medium-term.

Documentation requirements for secured loans

To avail a secured loan, you will have to provide some collateral to secure or support the loan, such as property, accounts receivable, or inventory. Secured loans are often available for lower interest rates since the collateral protects the bank’s investment in you.

Also, since the bank’s liability and risk are substantially reduced due to the collateral, you can get a larger loan amount, better terms and conditions (e.g., low processing fee, faster approval, etc.), and flexible repayment terms. The downside is that the lender may repossess your asset if you default on the loan. Also, disbursement speed is slower since the lender will take time to assess your asset’s value.

You must submit all the above documents when applying for a secured loan. In addition, lenders may ask for additional documents to assess your creditworthiness and minimise their lending risk. These may include:

  • Description of how you intend to use the loan
  • KYC documents
  • Certificate of incorporation
  • Partnership deed
  • Certified copy of Memorandum of Association (MOA)
  • Certified copy of Articles of Association (AOA)
  • Tax audit forms
  • Sales tax certificate
  • Trade licence
  • IT returns for at least the last 2 years

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India’s business loan ecosystem has improved significantly over the past few decades. However, access to fast, low-cost credit remains a challenge for many Indian businesses. Yubi Loans can help you overcome this challenge and access the funds you need to take your business to the next growth stage.

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