Starting or expanding a business necessitates extensive funds for fulfilling purposes such as maintaining daily operations, purchasing equipment, renting office space, paying staff salaries, etc. or more. However, around 36% of business organizations in India face loan rejection owing to low credit scores. Committing a few mistakes while taking a business loan could lead to loan application being rejected delaying business operational as well as expansion goals, or the worst missing on key growth opportunities.

Nevertheless, when the time comes to make sound finance decisions for their businesses, entrepreneurs need certain guidance.  For instance, a research report states that even while SME enterprises are increasingly applying for more business loans, the number of working capital loan defaults has been rising sharply. It goes without saying that entrepreneurs lack the expertise, financial discipline, and knowledge necessary to help them make the best choices for their business. 

Business Loans – Meaning, Purpose and Management

Hence, a business loan could be defined as the amount of capital borrowed by businesses from lending institutions to fulfil either short-term or long-term business objectives. Such a credit facility is specifically designed to meet urgent financing requirements of a business. 

Whenever businesses seek credit facilities from lenders, they should do so with a clear purpose in their minds. Once approved and disbursed, they should strive to stick to the same use of the loan for which it was taken throughout the loan cycle. For example, if a business loan has to fulfil working capital needs, borrowers shouldn’t divert funds to purchase new land or machines.  A credit arrangement is a financial agreement between a lender and a borrower thus businesses must ensure that any borrowing does not impede their organization’s growth. 

Moreover, applying for a business loan can be a time-consuming and complicated process. Therefore, by avoiding some frequent errors when filling out a loan application, the applicant may increase the likelihood of loan acceptance.  

Common Mistakes to Avoid While Taking a Business Loan

An effective business loan application necessitates meticulous attention to detail. When applying for a business loan, it is recommended to avoid these ten frequent mistakes to increase likelihood of business loan approval-

Neglecting Credit Score 

It’s a known fact that a credit score of the borrower is a key determinant for deciding debt repayment ability within a specific timeframe. While assessing business loan applications, financial institutions not only review the credit profile of the applicant business entity but personal credit profile of the business owner. 

While looking for a business loan, concerns such as missed payments, collections, and an enormous debt burden on the personal credit of the business owner could undermine the loan application’s success. Additionally, business owners should maintain their personal credit score around 700 and maintain overall credit use below 30%. 

Suggested Approach

Businesses can avoid loan rejections by maintaining a high consistent credit score. Promptly addressing any discrepancies can go a long way in maintaining a good credit score. Review business credit reports from various institutions that offer such services to check for errors that can reduce the business’s credit score. Optimizing both corporate and personal credit ratings through careful debt management can help to boost business loan applications.

Failing to Research and Compare Lenders 

Failure to compare loans and a lack of research can be expensive errors for businesses seeking funding. Lender-specific terms and conditions include borrowing costs, conditions, expenses, and repayment terms. Businesses can make well-informed decisions that align with their long-term goals and financial capabilities by conducting thorough research and comparing different lenders.

Suggested Approach

While local credit unions and banks are an excellent place to start, it is not necessary to restrict research to only conventional brick and mortar establishments. Presently, NBFCs and digital lending solutions offer swift access to funds through streamlined applications. Additionally, seek out lenders who offer the required company loan type or who specialize in the applicant’s industry.

Not Having Paperwork in Order

Applications for business loans must be submitted with correct and complete documentation to guarantee a seamless procedure. However, going into a company loan request ill-equipped is a definite way to get rejected. 

Suggested Approach

Prior to completing an application or visiting with a lender, gather these important documents

• Financial Statements- A minimum of three years’ worth of financial statements, including cash flow, income, balance sheet, and statements of profit and losses, should be submitted along with the application.
• Business Plan- Financial institutions prefer to see a well-written business plan that outlines the goals, target market, competitive environment, marketing strategy, and financial forecasts of the borrower organization. Preparing a realistic and up-to-date business plan outlining business’s goals, procedures, and projected revenues will help them to secure credit.
• Personal records of business owners- It comprises personal record of the entrepreneurs’ comprising data regarding personal assets and liabilities, credit histories, bank account, investment account statements, and personal tax filing records.
• Business Licenses and Compliances- It entails all of the licenses and authorizations required for operating the business.

Choosing the wrong loan product. 

Businesses have access to a variety of business loan choices, including working capital loans, equipment purchase loans, start-up loans, business loans for women, and more. Business organizations should look for available options suiting their requirements which will help further their loan objectives.  

Suggested Approach

Researching different loan products offered by lenders will help borrowers to determine the right category of loan products. At this point, several factors must be considered, including business loan eligibility requirements, loan amount, tenure, interest rate, conditions of the loan, and so on. Choosing the correct loan product is critical for businesses seeking to stay committed and on schedule to meet their objectives. 

On the other side, selecting the wrong loan product may cause the borrower’s business to endure higher interest rates with loan terms misaligned to their business objectives. As a result, it is vital to conduct organic research for lenders and the right loan category rather than blindly going for any loan available.

Inadequate Details 

Although with the advent of technologies, there has been drastic improvement in the processing and disbursal time for business loans. Financial organizations examine credit risk through carefully reviewing the information provided in the application. Lenders typically require information such as the business name, age, official address, and financial figures, as well as the entrepreneur’s personal and financial information.

Even if originally authorized, if false information is uncovered during subsequent audits it might result in legal ramifications, making subsequent loan applications more difficult. 

Suggested Approach

Preparedness is the key to success. It is absolutely necessary for businesses to provide true information to the banks/lenders. Take a checklist from the lending institution and keep everything ready. Some common requirements may include, but are not limited to, tax filings, registration documents, financial statements and projects etc. SMEs may employ digital tools to cross check data consistency across all documents and financial statements. Borrowers may take help of experts like BankKeeping for complicated submissions like CMA data reports etc. 

Though, it is imperative for applicants to submit complete details for enabling quick loan processing and avoid loan application rejection. It is to be noted that the information required to be submitted for loan application processing might vary slightly depending upon the lender policies.

Lack of Collateral

It is often believed that businesses do not need to pledge assets as collateral to secure a business loan. Thus, small business loans are typically granted without collateral post submission of necessary business-related documents. However, some lenders also offer the option of collateral submission for business loans.

Other than this, the lender seeks several kinds of collateral from loan applicants. Assets like inventory, real estate, or equipment are generally pledged as security for a secured business loan.

Suggested Approach

Offer Collateral where possible. If the loan is secured i.e. backed by collateral, it would help businesses to get the loan at a lower rate of interest. However, if the loan is not backed by collateral, the cost of borrowing would be higher. With secured loans, the lender has lower risk of losing money that can be recovered in case of loan default. This enables borrowers to avail credit facility at lower interest costs.

With collateral in place, businesses could avail higher amounts compared to an unsecured loan. Businesses should make the decision whether to pledge collateral for security on the basis of their requirement and applicable interest rate – this is termed as collateral management and can bring down borrowing cost effectively. Failure to comprehend or get ready for collateral requirements may result in unfavorable lending conditions and impede loan approval.

Neglecting Loan Terms and Conditions

Certain businesses undervalue the importance of carefully reading contracts before signing them. It is undeniably essential to develop a deeper understanding of all the loan terms before signing the loan agreement. The financial health of an organization can be significantly affected by key financing terms, such as interest rates, fines, repayment plans, etc.

Eagerness to obtain capital may entice businesses to accept terms that may not correspond with their company’s objectives or repayment ability. While they may offer temporary respite, variations like extended repayment terms, only interest payments, and balloon payments have higher long-term costs. Ignorance of the lending conditions could give rise to future complications apart from higher borrowing costs. 

Suggested Approach

Hence, it is essential to read the aspects of the loan agreement carefully to avoid such significant pitfalls. All hidden costs of borrowing can be deciphered if the borrower reads the sanction letter thoroughly and negotiates as per their capabilities. This can be done with the supervision of experts like BankKeeping who may help you understand the Loan Sanction Letter in a detailed manner. Also, align the repayment schedule with businesses’ projected ability to meet its payment obligations.

Frequent Applications or multiple applications simultaneously

Although, applying to several lenders at once might come up as a way to gain faster loan approval, but this strategy can backfire, especially on the business credit score. Each application creates a hard inquiry on the business credit history, which lets lenders know that you may be in dire need of money or have unstable finances. 

Submitting business loan applications frequently or applying for several loans at once could give a sense that the company is heavily dependent on business loans. 

Suggested Approach

Rather, go out in-depth research to find the right lenders from small finance banks, NBFCs, to digital lenders. Check their loan products and lending terms and compare them with each other. Also, focus on building a loan application which will be easily accepted by certain lenders offering suitable loan products.

Not Knowing Business’s Financial Health

One of the most common mistakes made by business owners that leads to loan rejection is a failure to grasp the financial state of the business. Lenders such as banks, NBFCs, digital lenders, etc. assess credit risk on the basis of factors such as applicant credit history, debt ratio, revenues, cash flow performance, etc. If the borrower business lacks financial stability, the loan application will be rejected.

When banks and lenders approve a business loan, lenders check the borrower’s repayment ability as per the lender terms. Provided below is a list of elements lenders use the following criteria when evaluating the viability of company loans:

• Lenders prioritize consistent revenue growth and good business margins when granting loans. Although there may be seasonal variations, unpredictable wages lower borrowing capacity.
• Stable cash flow is crucial for business loans’ financial sustainability. It should generate sufficient revenue or profits to meet operating costs and debt obligations.
• Lack of effective cash flow management is a key reason for failure for business organizations.
• Businesses having an adverse Debt to Income Ratio (More than 40 percent) indicates financial instability. It should ideally be maintained between 30-40% of the total business revenues.
• Lenders combine business creditworthiness as well as personal credit history of the entrepreneur to assess the loan acceptance and lending terms.
• Multiple credit rating agencies have stated the fact that loan applicants with a credit score (650 or less) might have to pay higher interest on loans. 

Suggested Approach

Analyze company financial statements to maintain precise and up-to-date revenue, income, and balance sheets. Cutting excessive spending, raising account receivable, and improving inventory control all help to maintain a healthy cash flow. Look for errors in credit reports and submit them for rectification. Next, employ available funds to reduce previous debts, that can help businesses to gain creditworthiness.

Further, assess the corporate entity’s Debt Service Coverage Ratio to figure out whether net income exceeds 1.25 times the size of loan installments. It will benefit the business borrower through boosting the likelihood of approval and securing favourable loan conditions.

Applying Without Sufficient Cash Flow

Strong cash flow enhances borrowing terms and gives lenders peace of mind when business loans are granted. While seeking a business loan, make certain that the business can readily repay it. Lenders take into consideration regular cash flows as it demonstrates business ability to repay the business debt within agreed period.

Seeking a credit facility lacking any consistent income or profit margins raises the likelihood of rejection, even though the user has an excellent credit score. Normally, lending institutions evaluate business cash flows through-

• Business bank statements reflect steady income and expenses. 
• The Debt-to-Income Ratio to analyse monthly debt repayment out of revenues.

Thus, lenders may prefer businesses showcasing proof of steady or increasing profits. 

Suggested Approach 

Businesses struggling with uneven cash flows could consider taking the following steps-

• Boosting revenue or adjusting product prices to generate more income.
• Reducing unnecessary expenses to boost profit margins
• Build up reserves by allocating funds for three to six months’ worth of payments.

Final Thoughts 

Business loans are extremely beneficial means for entrepreneurs in obtaining the funds required to establish or grow their enterprises. There are numerous sorts of loans available with several lenders ranging from operational capital loans to meet routine requirements and unsecured business loans for larger investments.

Businesses can improve their chances of obtaining capital to fuel expansion on favourable terms by avoiding common errors when seeking business loans and diligently marking all boxes. Avoiding such common mistakes could ensure loan approval and disbursal process for the borrowing business organization.

FAQs

Is cash flow important for getting business loans?

Yes it is highly important from the point of view of the lenders as it shows the repayment capability of the borrowers.

Is it necessary to read the loan sanction letter?

It is of utmost importance to read the sanction letter thoroughly. It will have all the details related to late submissions, pre-payment clause, and all other covenants that will impact your business and borrowing. 

Will applying to multiple lenders impact loan terms?

Yes, each application may lead to hard inquiries on your credit score and multiple applications may also signify distress borrowing. Both of which can negatively impact credit score leading to higher borrowing cost. 

What will happen if my documents are incomplete, inconsistent or missing? 

It can lead to delay and also a rejection of the loan application. Aim to submit correct and complete documents like financial statements, tax returns, business licenses, and KYC records to avoid rejections and speed up processing.