Additional cash is needed to take the small business to the next level. The only problem is that the loan application was rejected. It wasn’t because the applicant failed to fill out the paperwork properly. Other issues led the lender to decide the risk associated with approving the application was too great. By knowing why business loan applications are rejected, it’s possible to resolve those issues before seeking any type of loan.
This article will explore a few of the more common reasons small business loans are rejected and what can be done to correct the problems:
- Debt to Income Ratio
- Insufficient Collateral or Security
- Lack of a Realistic Business Plan
- Cash Flow Issues
- Unacceptable Credit Score
Debt to Income Ratio
This is nothing more than the relationship between how much collected revenue the company experiences each month and the amount of monthly financial obligations. That includes fixed and variable obligations. The goal is for the lender to determine that there is enough money coming in to cover all those current debts and still have enough money to make timely payments on the small business loan. Typically, lenders prefer to do business with applicants when they are spending less than half of their collected revenue on current debts. Anything over that amount puts the approval of the application in jeopardy.
If you are spending more than half of your monthly revenue on current debts, consider trying to pay off some of those obligations before applying for a loan. Couple what with seeking to secure new clients who generate more revenue, and the odds of being approved will increase.
Insufficient Collateral or Security
While there are unsecured small business loans, they are usually reserved for clients with higher credit scores. When the business credit score is lower, being approved is still possible. The most likely outcome is that the offer will be for a secured loan.
Lenders will expect that the fair market value of a pledged asset will be sufficient to retire the loan balance if necessary. If that is not the case, the lender may consider the risk of doing business with the applicant too great.
Adjusting the amount requested on the application is one possibility. Pledging more than one asset as collateral may also be acceptable to some lenders. The only way to know for sure is to ask.
Lack of a Realistic Business Plan
Business plans are not wish lists. They are logical and realistic ideas about where the business is today, where the business owner wants to be a year from now, and detailed steps about how to get there. Plans that are long on optimism and short on factual information will not impress any lender. What this type of plan will do is lead to a swift rejection.
Keep the business plan practical and factual. Never overestimate the results of using specific strategies. If anything, be slightly pessimistic about the potential results. This more realistic presentation is likely to win favor with a lender and increase the odds of being approved.
Cash Flow Issues
When the cash flow is consistent and enough to ensure the debtor can make the loan payments on time, the odds for approval are higher. If the lender notes that the Receivables aging has quite a bit of money past sixty days, that’s a red flag. When the cash flow varies greatly from one month to the next, that is another major concern.
Improve the odds for approval by stabilizing the monthly cash flow. Work to get the aging more in the 30-45 day range and improve the collection effort in general. Doing so will normalize the cash flow and make lenders feel easier about approving the loan.
Unacceptable Credit Score
Higher credit scores do lead to faster approvals and more competitive terms. Know the business credit score and be prepared to focus on lenders who are likely to seriously consider the application. There are lenders who will work with applicants with scores as low as 600. There are even some who will extend bad credit business loans for companies with scores in the 550-600 range.
Do what can be done to increase the credit score. Little things like making payments on time and reducing debt will help.
Remember there is no one business loan arrangement that is right for every business. Know what lenders expect and position the company accordingly before submitting an application. Doing so increases the chances of being approved the first time.