The process of applying for a business loan in India and finally getting it approved could be a challenge specially for MSME and SME businesses. The different types of challenges may include, lots of paperwork, multiple followups and compliances etc. Whether it is a newly established business entity or one that is expanding a pre-existing unit, these challenges in availing a business loan can delay their growth and expansion plans. In turn leading to unnecessary delays and losses. Irrespective of whether you are a new business owner or an experienced one, it is a good idea to have complete understanding about the loan eligibility requirements and the common challenges faced by businesses to avail business loans and the ways to avoid such challenges.
Common SME Loan Challenges and Solutions.
Common Challenges of Applying for a Business Loan in India
Apart from the basic compliance and paperwork requirements, we see that the struggle to avail a business loan at favorable terms in India is real. Especially so for the SME section of borrowers as they have lesser bargaining power compared to their corporate counterparts.
Insufficient Credit Score
The business credit score is a crucial factor to evaluate the repayment ability of the borrower entity. Whenever the borrower entity makes a business loan application, the lending institutions check the credit score as an indicator of their financial discipline and creditworthiness. Hence, a lower credit score may cause lenders to perceive applicants as high-risk borrowers and reject loan applications.
Some of the common reasons for low credit scores could be due to-
- Poor Credit History – Failure to make timely payments for the EMIs, outstanding dues on past business loans, or credit card bills, etc. may cause the credit scores of a business to go down significantly. If the business has been “Written Off”, it can lead to outright rejection of the application for business loan.
- High Credit Utilization- Business entities utilizing a large portion of their available limits, usually more than 40% of their total credit limit could indicate financial instability.
- Multiple Loan Applications- Submission of multiple loan applications within a short period may cause several hard inquiries from lenders that could temporarily lower business credit score, making business loans harder to obtain.
- Inadequate credit history- Newly established businesses or people with inadequate credit exposure may be unable to avail large credit sums due to lack of proper past records proving future repayments by the entity.
Steps to improve business credit score for Applying for a Business Loan in India
Lets look at how a business can overcome the challenge of maintaining a good credit score.
- Making timely payments- Make sure any financial commitments like credit cards and business loans are paid within the due period. If possible, implement an auto payment mechanism or implement payment notices to avoid payment delays.
- Credit score monitoring- Review and monitor credit score from credit record bureaus such as CIBIL regularly. If you notice any inconsistency, communicate the same to credit bureaus to rectify it.
- Lower and maintain debt to equity ratio- When the borrower pays off all current debt before requesting a new business loan, it will raise its creditworthiness.
- Taking smaller loans- In order to raise credit score, borrower entities might also think about availing smaller loans to make sure timely payments.
Incomplete or Inaccurate Documentation-
Lending institutions like banks and NBFCs need a variety of documentation to ascertain financial stability and reliability of borrowers. Incomplete or inadequate information may result in automatic rejection of the business loan application. Accuracy in documentation making and submitting itself can be a challenge to business owners in India.
Some of the typical documentation related mistakes include-
- Incomplete KYC related documents- Lack of documents such as PAN, Aadhar, business licenses to operate the business, etc. or more.
- Inaccurate financial statements- Mistakes in documents such as tax returns or financial documentation such as balance sheet and profit and loss statements.
- Lack of revenue proofs- Missing bank statements to back up claims of revenue or inconsistent sales records, etc. are two examples for lack of revenue proofs.
- Invalid business licenses- Trade licenses necessary to run the business which have expired or due for renewal might also be a major issue for loan approval.
Steps to Avoid Documentational Inaccuracy or Errors for Applying for a Business Loan in India
- Keep updated financial records- Ensure all financial documentation is up to date through undertaking periodical review of balance sheets, income statements, sales records, cash flow statements and other documents.
- Check and promptly renew expired licenses- Periodically review and renew all expired business licenses before application.
- Connect with a seasoned expert- An experienced professional could offer valuable advice and help to create necessary financial documentation and reports.
Insufficient Cash Flows
Whenever a business entity makes an application for a loan, the lenders also assess their business cash flows to ascertain whether it can fulfill its repayment commitments. Generally, businesses with inconsistent or insufficient cash flows are regarded as high risk by the lenders that could result in loan rejections. This can be a challenge for MSME and SME borrowers where they have to settle for stringent repayment tenures and unfavourable terms, like, higher interest rates for the applicant business in India.
Some of common cash flow challenges incurred by businesses include-
- Delayed client payments- Clients taking longer to repay loans might interrupt revenue streams making it difficult to repay business loans.
- Seasonal fluctuations- Businesses reliant on seasonal sales might find it challenging to maintain cash flows uniformly throughout the year.
- Lack of Inventory Management- Funds tied up in inventory without sale may reduce funds for other uses.
Steps to improve business cash flows for Applying for a Business Loan in India
- Use advanced cash flow management software- Employing cash flow management software could help to monitor earnings, outlays, and unpaid invoices. It also helps to track and stabilize cash inflows and outflows helping to improve loan eligibility criteria of the borrower entity.
- Encourage early payments-Provide incentives to the clients to ensure timely payments and steady cash flows for your business.
- Negotiate favorable payment terms-Extend better terms of credit with suppliers and partners to ensure better liquidity position for the business.
Lack of Collateral
Start-ups and small-scale businesses lack adequate collateral which can cause them to be viewed as high-risk borrowers by the lenders. Lack of these assets could make the loan seem risky for the lenders that could result in the rejection of loan application or being offered at higher interest rates.
Some of the common collateral challenges happen due to-
- Lack of physical assets- Small -scale businesses engaged in service-based businesses may not have adequate tangible assets to pledge with the lender.
- Assets pledged already- It may be possible that available assets have been used for collateral for previous loans.
- Insufficient asset valuation- Again it might be possible that the value of the assets is inadequate to secure the loan sum.
Steps for successfully Applying for a Business Loan in India without collaterals –
- Seek collateral-free loans offered under Government schemes- Credit schemes for small scale businesses have been offered through government programs like CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises).
- Build a strong credit profile for your business- Securing unsecured loans can be facilitated by a consistent revenue stream and a well-documented financial history. If your business lacks tangible assets for security purposes look for government backed subsidized loans or unsecured business loans.
Unimpressive Business Plan-
The value of a good business plan for a borrower business cannot be undermined in any way. A solid business plan not only imparts confidence, but also displays qualities such as viability, profitability, and the ability to repay the loan. However, it is a challenge for smaller business owners to create a model business plan for the lenders. A business plan that lacks clarity or seems unfeasible may result in immediate rejection of the loan application.
Some Common challenges in making a business plan –
- Insufficient market research- Insufficient knowledge about the market, rivals and intended audience.
- Unrealistic financial projections- Exaggerating revenue or underestimating expenses can cast doubt on repayment ability of the borrower business.
- Lack of clear plan for loan utilization- Lender needs to have a clear understanding regarding the goals and objectives for the efficient utilization of loan sum.
Steps to Create a Persuasive Business plan for Applying for a Business Loan in India-
- Add credible market research report- Create a thorough business plan which is supported by facts and give clear understanding about the manner funds will be utilized to expand business operations. Show growing demand for the goods/services offered by borrowers in the market.
- Clearly define market projections- Make reasonable revenue projections using previous data. Specifying the loan will support accomplishment of company objectives.
High Interest Rates
Lender’s interest rates particularly in the informal credit market are another common challenge for businesses. Lenders may charge exorbitant interest rates especially for SMEs since they appear riskier to banks. Excessive interest may make it difficult to repay the loan balance and in certain situations may drive a company past its breaking point.
Some common causes of higher interest rates are:
High interest rate charges can be a big challenge for business borrowers in India. Let us look at what causes interest rate escalations.
- Unsecured loans – 12-24% annual rates for unsecured loans can make borrowing a costly affair.
- Informal Borrowing – borrowing from an unorganised sector, may lead to higher interest costs. But the businesses who are rejected bank loans have no other options but to go the unorganized route for capital.
- Penalties and hidden charges – Many times the borrower has missed out on important clauses in the sanction letter that are detrimental to the borrowing business. This may lead to heavy penalties and charges increasing the overall cost of borrowing.
- Early Stage Startups – with no credit track record and a strong credit score these businesses are vulnerable to being charged high interest rates by the banks.
Steps to bring down high interest rates for Applying for a Business Loan in India
- Compare loans – Offers from several lending institutions might help MSME to lessen the effect of high interest rates.
- Go for Government Schemes – Examining government programs and initiatives that offer subsidized loans may potentially be a viable substitute for increased borrowing costs.
- Use Collateral – The use of collateral may significantly bring down the cost of capital and hence reduce interest rates for the borrowing business. It is advisable to use collateral but with a caution that the banks are evaluating the property as per its value. The collateral can also be used to negotiate better terms while applying for a business loan in India.
Lengthy Procedures
The process for applying for and availing a business loan could be time-consuming and include many futile processes. In-depth analysis of the creditworthiness of the borrower business including its financial accounts, business strategies and credit assessment is typically part of this complicated and time-consuming process which may take months to be completed.
Some common delay points are:
- Time consuming paperwork and formalities – many a time the amount of paperwork required for applying for a business loan can take a long time to compile as per the directions of the lender.
- Multiple verification – The lenders may undertake various verifications in the form of KYC compliance, site visits, legal checks, etc. All this adds to the waiting time for the applicant business.
- Slow Processing – a bank may take anywhere from 2-4 weeks to complete the background work for loan approvals. Smaller businesses in need to immediate cash may find this discouraging
Steps Taken to Reduce Processing Time
Lets look at what steps can be taken to overcome the challenge of lengthy procedures and long time gaps while for applying for business loan in India
- Seek Professional Help – Small businesses can seek help with experienced professionals like consultants, financial experts, or BankKeeping with their loan applications. These experts may assist companies in navigating the complexities of loan acceptance criteria preparing the required paperwork and navigating the procedures.
- Rely on Fintechs – Additionally, the process obtaining a small business loan can also be streamlined by researching online lending platforms that provide streamlined application procedures and rapid approval turnaround.
Conclusion
Therefore, business loans could become a key growth driver for businesses enabling them to manage their expenditures, improve their products, seize growth opportunities and accelerate growth. At the same time the challenges faced during loan application can be a deterrent to growth of the businesses in India. Traditional lending sources follow a conservative approach towards lending business loans and facing loan rejection might be discouraging for businesses. However, having adequate knowledge regarding the loan application processes and requirements could save time and efforts on the part of the borrower.
Moreover, you could increase chances of business loan approval by avoiding four common pitfalls- maintaining a favorable credit score, keeping cash flow consistently and putting together a strong business plan. Further, maintaining financial discipline could help businesses to overcome common challenges against loan approval. Need help preparing your business loan application? Contact us today at BankKeeping