How lenders assess a small business loan application

The five Cs: an organising idea

Credit assessment is traditionally summarised in five words.

• Character — the track record and integrity of the owners: how past loans were repaid, how the bank account is conducted.
• Capacity — whether the cash the business generates can service the debt.
• Capital — how much of the owners’ own money is in the business.
• Collateral — what security supports the loan if cash flow fails.
• Conditions — the state of the industry, the purpose of the loan and the wider economy.

Each document you submit speaks to one or more of these.

What the underwriter reads

Vintage and constitution

How long the business has operated, and whether it is a proprietorship, partnership, LLP or company. Most lenders set a minimum period of operation. A longer history in the same line, at the same premises, with the same owners counts in your favour.

Bank statements

Usually the last twelve months, and often the most closely read document of all. The underwriter looks at average balances, the pattern of credits, cheque and mandate bounces, and whether the credits in the account are consistent with the turnover you have declared. Large unexplained cash deposits, circular transfers between related accounts and a balance that touches zero before every instalment date are all noticed.

GST returns

Returns show whether filing is regular, how turnover is trending, and how concentrated your sales are among a few customers. Turnover in GST returns is compared with bank credits and with the income-tax return. Gaps in filing suggest either stress or indiscipline.

Income-tax returns and financials

Profit, net worth, borrowings and the movement in stock and receivables from year to year. A business that shows very low profit to save tax will also show low repayment capacity to a lender. The two cannot be separated.

Credit reports

The owners’ personal credit reports and the firm’s commercial credit report show every loan and card, how each was repaid, and how many lenders you have approached. For a small firm the owner’s personal record carries great weight. See what affects a business owner’s credit score.

Industry, buyers and security

Some sectors are treated cautiously by particular lenders. Who your customers are matters too, especially for receivable-backed finance. Finally, the security: property, stock and receivables, a credit guarantee cover, or personal guarantees.

The ratio that matters most

The debt service coverage ratio (DSCR) compares the cash the business generates with what it must pay lenders in the same period.

DSCR = cash available for debt service ÷ total debt obligations (principal + interest)

A ratio of 1 means every rupee earned goes to lenders, with nothing spare for a bad month. Lenders therefore want a cushion comfortably above 1, and each sets its own minimum. If your ratio is thin, a smaller loan or a longer tenure may be approved where the original request would not be.

Red flags that cause rejection

• Bounced cheques or failed auto-debit mandates in recent months.
• Overdue or written-off accounts, or loans marked “settled”, on a credit report.
• Many loan enquiries in a short time, suggesting urgent need.
• Turnover that differs sharply between bank statements, GST returns and the income-tax return.
• Missed or late GST filings.
• Existing instalments already consuming most of the monthly surplus.
• Sales depending on one or two customers.
• Mismatched names, addresses or signatories across documents.

What you can fix before applying

1. Route all business receipts through the business bank account, so that turnover is visible.
2. Clear small overdues and get closed accounts reported as closed before you apply.
3. File pending GST and income-tax returns and keep them consistent with each other.
4. Keep enough balance for instalments and statutory payments a few days ahead of their due dates.
5. Apply for an amount and tenure your cash flow can demonstrably service.
6. Assemble a complete, consistent file. The list is in documents you need for a business loan.

Some of these take months to show in the records, so start before the need is urgent. On Vaanij Capital the first step is a soft eligibility check that does not affect your credit score; the lending decision itself is made by the regulated bank or NBFC whose offer you choose.

This article is general information for business owners. It is not financial advice — loan terms are set by the lender, so read the lender’s own documents before you commit.