Commercial loan applications: a navigable process Featured

9:01pm EDT April 30, 2011
Commercial loan applications: a navigable process

We've all heard the adage, “Banks only want to lend to those who don't need the money.”

“Not so!” says Lloyd Bell Jr., senior vice president of Western Reserve Bank. “Banks can only flourish by making loans. Interest is their main revenue source, without which they can't survive. Simply put, all a bank wants for a commercial loan is a borrower who has a successful business, a logical reason for borrowing and the demonstrated capacity to repay the loan.”

How then can one best navigate the process of getting a commercial loan?

“The best approach is through effective communication accompanied by relevant and accurate information,” he says.

Smart Business learned more from Bell about how businesses can successfully obtain a loan from their bank.

How should a business prepare before approaching its bank?

The starting point is to think the need through, as you would for a personal car loan or mortgage. How much do you think you need to borrow? And, based on what you know about your cash flow generating capability, can you pay it back?

Then, approach a community banker and tell your story. How long have you been in business? What is your product or service? Who are your competitors? Who makes up your management team? What are the positives and negatives in your business? And where do you think your business is headed?

Are you looking for a loan for a bona fide business purpose, such as buying a plant or equipment, or for more working capital to support a growing volume of business? Speculation is considered an inappropriate reason for a loan. For example, say you use copper as a raw material in your business, and you believe the price will be going up soon. You want to buy now and make a buck when the price rises. You may end up being correct about the price, but speculation is not something the bank is going to want to finance.

Another point to keep in mind is that banks are not venture capitalists; they are not positioned to fund visions or start-ups. They are providers of debt capital, focused on providing funds to existing enterprises. You may have a great idea for a prospective business, but a bank is not the place to go for seed money. Your need some track record of successful operation, usually at least a couple of years.

What else does the bank look for?

The next step is to think carefully about when can you pay the loan back, bearing in mind that the bank is going to want to see a demonstrated capacity to generate the wherewithal to repay the debt, i.e. adequate cash flow. Saying ‘I think I can crank volume up substantially next year.’ with the thought that you can only pay the loan back if something extraordinary occurs is not a realistic way to look at your capacity to repay.

The bank lender will look at the cash flow your business seems capable of producing and match that with all of your debt payments, existing and proposed. Typically, the bank likes to see a cash flow to required payments ratio of 1.2 to 1, meaning that the cash flow — defined as net income plus non-cash charges such as depreciation, plus interest — covers all of your debt payments with an extra 20 percent cushion.

If the servicing requirement on the prospective borrowing is just way beyond your demonstrated capacity to repay, the bank, naturally, is going to decline the request.

What kind of information does a business need to provide to its bank?

Make sure your accounting records are in order, meaning that they are maintained in a timely fashion, are accurate, and give you the capability to produce statements, like balance sheets and operating statements, quickly. This is important not just for the loan application process, but, looking ahead, for the provision of statements to the bank on an ongoing basis.

In assessing your capacity to repay a loan, the bank will want to see several years of financial statements and tax returns, plus a personal financial statement and several years of personal tax returns.

Finally, think about what sort of collateral you have to secure your loan. Is it the plant or equipment you're acquiring or working capital assets such as accounts receivable or inventories? Bear in mind that the bank will want a margin of protection, meaning that they will loan less than 100 percent of the value of the assets serving as collateral — for example, 80 percent advance on real estate, 75 percent to 80 percent on receivables, 50 percent on inventory.

And don't forget your personal credit score. Check it, and if it is below 650 — 700 for some lenders — make sure there are good reasons for it not being higher. The score is not so much a measure of capacity as it is a gauge of reliability and whether you honor your obligations.

What should a business do after it is granted a loan?

Once get the loan you need to maintain ongoing communication with the bank, letting them know how the business is doing.  Keep the bank supplied with interim and annual financial statements, produced in a timely manner and communicate significant developments.

This should seem intuitive, but, surprisingly, a lot of owner operators are so focused on the selling or production end of their business that they are not always tuned in to the need for good financial reporting and communications. For those who are, life can be easier: a smooth relationship ensues, and when you need additional credit, the bank is in a better position to deal with your needs routinely and quickly.

Lloyd Bell Jr. is senior vice president of Western Reserve Bank. Reach him at (440) 746-6100 or