25 February 2020

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The ABCs of Applying Business Loans

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The first thing that will come to anyone’s mind when  planning to start a new business or thinking of expanding the  current business, is applying for a business loan to meet the initial capital. Unlike the previous decade, a number of banks are welcoming open handedly the SME’s with attractive schemes and door step services.

Many banks have expanded their credit options by regularly updating their product lines and services and had even opened special counters for SME’s.

How to approach a bank

Leveraging on credit is one of the best tools for expanding business.. So the question now is, how do you know if you’re eligible to apply for a business loan? In the world of banks and Financial Institutions, there are some components that they usually use to evaluate credit worthiness and trust worthiness of the clients approaching them. Your capacity to re-pay the loan and your reliability is considered as most important and critical to your credit worthiness.

Banks will analyze the financial statements and records of your business to see how the business is doing. In general, owners of businesses that have been operating with consistent and high profits for the past 3 years or more are easily approved by financiers.

The capital money you have personally invested into the business can be seen from your financial records. This is important from the bank’s perspective because it shows the level of confidence you have for your own business.

For novices in business, it will be a bit tough to convince the bank that you are a trust worthy client. The bank will look into your income status, personal credit history, current assets and liabilities, educational background and business experience or background to evaluate your eligibility.

Create a more accurate, polished and professional business profile with the help of a professional to present to the banks. Banks might even ask and talk to your references. They will look into your credit history and check if you have mishandled accounts, delinquent credit cards and whether you have past due loans from others. Finally, they’ll also check if there’s any legal cases filed against you, your partners or your business.A clearly prepared and well-researched business plan shows how much dedication and passion you have for your business.

If the banks assess you in terms of your assets, this method often calls for a collateral security and the loans sanctioned so are called a secured loan. A secured loan will usually have lower interest rates. So, you should seriously consider if you can offer a collateral for your business loan. Your collateral can be a property, business premise, machinery, or any other business assets.

If you have no collateral to present, then you’ll most likely get a higher interest rate in comparison or be approved only with a small amount for your business loan. All these depend on how much you need and the purpose for which you need it.

The banks may consider your purpose of applying for a business loan, and also the local economic conditions, i.e. the financial climate in your industry; if it is bad, you’re less likely to be approved for a loan.

Having an insurance to your property / equipments is a cushion for credit managers to sanction the loan easily. Some banks even insist on having insurance.

Credit worthiness calculations in general

Business loans are provided under two major categories: Term Loans (both secured and unsecured) and Over Drafts. Loans can be applied for a variety of business requirements such as starting new business ventures, expansions / new purchases, working capital requirement, vendor and dealer financing, bill discounting etc. There are different types of term loans today like short term loans, long term loans and intermediate loans.

Credit worthiness is calculated on the basis of your annual turn over as per account statements. For account statements banks usually rely as per Income Tax Returns (ITRs). It is a practice to show business as a loss in ITR’s to save tax. But such practices would affect the credit worthiness of the client.

The most common documents banks would ask for loan approvals are : KYC documents ( ID and Address proofs ), ITR’s ( last 2-3 years ) which should be clubbed along with Balance Sheets, P & L Accounts of the respective years ( audited and certified ). Statements of all bank accounts and loan accounts and a business profile along with an ownership proof of the business premise also would be asked. These are the basic documents asked and it may vary for start ups.

Old generation banks and cooperative banks, to a certain extend rely upon existing customer relationship, or the previous / existing experience with the client as an evaluation of this trust worthiness.

But new generation banks strictly follow their set calculation patterns. A common calculation pattern of banks and Financial Institutions’ is sanctioning a loan amount which could be a set multiple of the monthly income.

Some other banks calculate on the basis of Fixed Obligations to Income Ratio (FOIR). Most banks restrict FOIR to a maximum 50% of the monthly income. That means, taking into consideration that he needs 50% of his income for his other expenses, all the repayments of fixed obligations including the new application would be restricted to 50% of the gross monthly income. The calculation will be like this:

Loan Eligibility = Gross monthly income * 50% - all other obligations / per lakh EMI ( EMI calculated on the basis of tenure and rate of interest.

For collaterals usually the loan eligibility is calculated on the basis of LTV ( Loan to Value ) of the pledged property, restricting the loan amount up to 70-85% of the property value based on the current market value evaluated by the bank’s evaluator.

For new entrepreneurs, banks are even working out schemes of sanctioning loans on the basis of the good track record of their existing or extinguished loans. But at the same time, taking too much loans would restrict your credit worthiness.

A consumer loan repayment history is maintained by every bank in their respective branches. Every time when there is default in credit history of borrower it is reported by individual banks from which he has taken loan to the CIBIL (Credit Information Bureau of India Limited). On the basis of the reports sent by its member banks, CIBIL maintains its CIR. It is circulated by CIBIL in its original form on demand of lending institutions when an individual approaches a bank seeking new loan. If a person who has taken loans from different banks and has defaulted on them, its default report can be generated by any banks through CIBIL with accuracy that how many loan A/Cs does the individual maintains & on which loan A/Cs his EMIs are overdue.

You can access your CIBIL score (CIR) directly from CIBIL by clicking the following link  http://www.cibil.com/accesscredit.htm and follow the instruction mentioned in the link

Banks and FI’s today have many scientific methods to check and access your credit scores and the process of credit appraisal is getting more scientific, especially with the adherence to CIBIL reports.

So, keep in mind, a good and steady repayment of loans and related transactions can get you out of a debt trap and also it will restore and enhance your credit worthiness in future.



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