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A business loan is a legal agreement between a lender (Banks, NBFCs, Private lenders) and a borrower, i.e., a business entity, for a certain amount of money. The lender gives the fund to the business who agrees to repay it within a stipulated time with interest.
The purpose of a business loan is to increase the availability of liquidity to finance the everyday needs of business and for expansion. For example, a businessperson may want to get a loan to maintain business operations, invest in equipment, expand its operations, or any other purpose. A business loan is beneficial for burgeoning businesses, and there is a multitude of lenders who are willing to partner with business owners.
However, a prospective borrower must understand what can lead to a loan application rejection. This article contains the top 5 reasons why a business loan application gets rejected and how you can improve loan approval chances.
5 Reasons Why a Business Loan Application Gets Rejected
Insufficient Cash Flow
The Cash Flow report highlights how a company has spent its cash. Apart from the Profit and Loss and the Balance Sheet, the cash flow report is another vital component of a company’s financial statement.
Cash flow provides lenders with a picture of your business’s financial capacity to repay a loan. Lenders try to figure out how your business will bring in enough money to cover the costs of any current financial obligations, as well as the cost of a new loan. The business owner can verbally share an outlook, a history, but that would bring no good unless it matches with the financial information in hand.
Ideally, the cash flow should exceed the amount required to pay your debts and maintain a steady operation. The excess cash flow should be used to fund a part of your business growth and repay the new loan. In other words, if cash-flow calculations indicate that a business will not be able to pay back the loan, then it is subject to rejection.
An inadequate cash flow may lead to the business’s failure, and the lender would never want to lose the money by opting for the wrong deal.
Existing Heavy Debt
An ongoing business’s debt level should match with its daily operation, growth plans, and business strategies. Heavy debt can cripple the business.
If an existing business is already in high debt, then repaying a new loan with interest makes it more difficult. A high debt burden means your capacity to repay your loans has been severely weakened or will become weaker in future.
Since the primary concern of a potential creditor is to check the repayment capacity of the borrower, a heavy debt can make the lender reject your loan application.
Low Credit Score
In India, CIBIL maintains your credit score. Your credit score is a 3-digit number that determines your creditworthiness in the eyes of the lenders. This score ranges between 300 and 900.
Any score above 750 is considered as an honest score. A low credit score is a primary reason that your loan may be outright rejected. The credit score forms the first impression for the lender before getting the loan sanctioned.
Incomplete Documentation
A business loan is granted based on the documents you provide. The loan approval process is complete when the lending authority verifies all the required documents.
Documents create evidence for the existence of your business, its stability, financial health and so on to know your business better. Incomplete documentation constraints the lender to assess your loan application objectively, leading to rejection.
Not Matching Other Eligibility Criteria
A lender may have specific criteria for the business to fulfil to be eligible for a loan. The lender may also modify its loan eligibility criteria depending on the micro or macroeconomic factors, political & social developments etc.
For example, applying for a loan for expanding your business may require you to remain therein business for a minimum of three years. Submitting a business plan without an in-depth study of the market factors can be rejected. A lender can mark a business as a risky venture and deny sanction of the loan.
Also, applying for a lower loan amount may not be a profitable deal for the lender.Many lenders set a threshold on the loan amount.
The lenders find it profitable to underwrite a larger amount of loan compared to a smaller one. Hence, a prospective borrower must evaluate all the vital aspects of the business and place the application before the lender.
Are you worried?
You do not need to be. Now that you know the problem areas take preventive actions before applying for a loan to ease the process.
Things You Can Do to Increase the Chances of Business Loan Approval
Improve Your Cash Flow Story
There are three primary ways to improve your business’s cash-flow picture: increase net income, reduce expenses or, in most cases, come up with a combination of both.
For a business expansion loan, you will need to prepare a future (projected) cash flow financial statement to show the effect the new loan will have on future income and expenses. If required, consult a business advisor to ensure that your future story of growth is accurately represented in the financial projections that need to be prepared.
Plan a Healthy Debt
A logical and standard protocol is to stop making unnecessary expenses. Look at all the debt you have accrued and organise the debts considering interest rates and monthly payments. By having all this data organised, you will prioritise which debt to tackle first. Pay off the outstanding loan. It will improve your debt-to-income ratio as well as boost your borrowing capacity.
Build Your Credit Score
Try to create a balance between secured and unsecured loans in your existing portfolio. Timely payment of bills and credit repayments are essential. Avoid maxing out your credit if possible. Close the accounts that are no longer needed. Too much available credit can also weaken your business credit rating. Strictly avoid making multiple credit applications at once. If your application gets rejected, leave some time before applying to another lender, as frantically applying for various loans will make your business seem desperate for cash.
Complete the Documentation
Complete loan documentation includes identifying the borrower, verifying the financial health, evidencing the debt, and perfecting the security of the loan. If the documents of the borrower can convince the lender to “buy-in” to the fact that the purpose of the loan is reasonable and attainable, then it is deemed to be complete.
Consider the Lender’s Criteria
Knowing the current market conditions and their impact on the business is crucial. Taking the lender’s perspective into account is also essential to have all the relevant information at your disposal before applying for a loan.
Now instead of shying away from the fear of rejection, take a small step to know more about the offerings in NeoGrowth. NeoGrowth can partner with you to accelerate the loan disbursement process with hassle-free documentation and easy repayment terms.
