Business loan

How to qualify for a business loan – Forbes Advisor

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Taking out a business loan, whether to cover payroll or purchase inventory, can provide financing to help you through difficult times, improve your cash flow or expand your business. While each lender has their own rules, there are common business loan requirements you should be aware of when preparing to apply.

1. Professional and personal credit ratings

When you apply for a business loan, a lender typically reviews your personal and business credit scores to assess the risk you pose. While a bad personal credit score can hurt your chances of approval, a good personal credit score can improve your chances of loan approval and help you get a lower interest rate.

What is considered good or bad personal credit varies depending on the credit score model used by a lender and their own guidelines. One of the most widely used credit scoring models, FICO, ranges from 300 to 850. While scores below 580 are considered bad, a score of at least 670 is considered good.

Although minimum credit score requirements vary, some online lenders may approve you for a business loan with a personal credit score as low as 500. A traditional lender such as a bank, however, may require you to have a minimum score. as high as 680.

Similar to personal credit scores, what is considered good or bad credit also varies depending on the credit score model used by a lender. One of the most popular credit scoring models for businesses, Dun & Bradstreet (D&B) PAYDEX, ranges from 0 to 100. A good score ranges from 80 to 100; a bad business credit score ranges from 0 to 49.

Related: How to check your credit score

2. Annual business revenue and profit

Lenders often have minimum annual income requirements, and some also have minimum monthly income requirements. To confirm your business income, a lender will request bank statements and tax returns from your business. You can download your bank statements manually or authorize a lender to connect to your bank and analyze your statements, if necessary.

Additionally, some lenders may ask to see your profit and loss statements to determine if you have enough positive cash to borrow.

Related: How to get a cashless business loan

3. Time spent in business

Businesses that have been in business longer are more likely to be approved for a loan. Although minimum terms vary, it’s common for traditional lenders to require you to be in business for at least two years. Online lenders often require applicants to have been in business for at least six months to a year.

However, this requirement may vary depending on the specific type of business financing. For example, with invoice factoring, which involves selling unpaid invoices to a factoring company, a lender may require that you have only been in business for three months.

4. Debt to income ratio

Some lenders will look at your debt-to-income ratio (DTI) to determine if you can afford to take on additional debt. Your DTI ratio compares your monthly debt to your gross income.

You can calculate the DTI ratio by dividing your monthly debt by your gross income. For example, if your monthly debt is $10,000 and gross income is $20,000, your DTI ratio is 50% ($10,000/$20,000).

The higher your DTI ratio, the greater your risk as a potential borrower. Although minimum DTI requirements vary by lender, it’s a good idea to keep your DTI ratio at 43% or less.

5. Debt service coverage ratio

Another ratio considered by some lenders is the debt service coverage ratio (DSCR), which measures your company’s annual net operating income relative to its total annual debt. Remember that annual net operating income is another way of saying earnings before interest, taxes, deductions, and amortization (EBITDA).

To calculate your DSCR, divide your company’s EBITDA by its total annual debt. For example, if the EBITDA is $100,000 and its total annual debt (including the business loan you request) is $80,000, the DSCR is 1.25 ($100,000/$80,000) . A ratio greater than 1 indicates that a lender to your business will likely have sufficient income after expenses.

Although DSCR requirements vary by lender, U.S. Small Business Administration (SBA) loans require a minimum DSCR of 1.15.

6. Collateral for secured loans

Lenders offer unsecured and secured business loans. If you apply for a secured loan, lenders ask you to pledge something of value, such as accounts receivable or real estate, which they can seize if you don’t repay the loan.

Collateral requirements may vary depending on your specific loan. For example, you could take out a loan to purchase a business asset, such as equipment, a commercial vehicle, or a commercial building. The collateral in this scenario would be the purchased asset. This means that if you purchase equipment such as a commercial printer, the printer will serve as collateral.

Additionally, some lenders will require you to provide a personal guarantee, which means you accept responsibility to repay the loan with your personal assets if the company does not.

7. Your industry matters

The industry in which you operate also plays a role in your eligibility for a loan. This is because every industry has a different risk factor and some lenders cannot work with certain industries, such as adult entertainment businesses, gambling businesses, and non-profit businesses. Before applying, contact the lender to verify eligibility for your industry.

8. Business plan

Some lenders may ask you to share your business plan, particularly if you are a startup, which may include the following:

  • Financial projections
  • Purpose of using funds
  • Industry Outlook
  • Competitive analysis

Your plan should provide the lender with a detailed outline of how you intend to use the loan funds and include a five-year forecast of cash flow, income, and expenses. If you don’t know how to write a business plan, you can find sample business plans on the SBA website.

Documents Commonly Required for Business Loans

Before applying for a small business loan, gather the required documents. A lender will likely ask for some or all of these items:

  • Bank statements
  • Personal and business tax returns
  • Business licenses and permits
  • Employee Identification Number (EIN)
  • Warranty proof
  • Balance sheet
  • Copy of your commercial lease
  • Disclosure of other debts
  • Aging of Accounts Payable and Accounts Receivable
  • Ownership and Affiliations
  • Legal contracts and agreements
  • Your driver’s license
  • Business Insurance Plans
  • Payroll records
  • Incorporation documents
  • Business plan

For a list of all required documents, check your lender’s website and/or contact them before applying.

Next steps: Decide what kind of financing you need

The next step after learning how to qualify for a line of credit or business loan is to find the right type of business loan for your unique needs. Some common types of small business loans include term loans, SBA loans, business lines of credit, invoice factoring, working capital loans, and equipment financing.

Related: Best Small Business Loans