Should you need a loan for the growth of your small business, potential loan providers consider various factors when evaluating your business. Depending on their findings they’re likely to approve your loan and also determine the applicable interest rate. Among the different criteria, the business revenue you generate is a major factor. Lenders need to assure themselves that your company can pay back the loan. Even though you offer the necessary collateral, lenders typically find that the recovery procedures take too much time and expense. They would instead prefer to make sure that financial figures you present to them are reliable enough. Here’s how business revenue affects your loan sourcing potential.
Traditional vs. Innovative Business Loan Products
The cash flow that your company generates in a month dictates whether you can avail of traditional or innovative business loan products. Traditional loans are the products that you can source from conventional lenders like banks, lines of credit, real estate loans and those backed by the SBA or Small Business Administration. Unconventional or innovative loan products are lent to you by other providers. They may be peer-to-peer loans, credit cards, short-term loans, merchant cash advances, peer-to-business loans, and friends and family. You could also take loans for your business against any personal assets you own.
Business Revenue vs. Kinds of Small Business Loan Products
Firms that have been in operation for at least two years with higher business revenues can get traditional small business loan products more easily as compared to newer enterprises. For instance, companies that generate a monthly income of $20,000 or more. You’ll pay a lower rate of interest, but do expect to deal with elaborate qualifying procedures, lengthy paperwork. You may also need to provide collateral. On the other hand, if your business shows cash flows ranging from say, $8,000 to $15,000 a month, you could opt for innovative loans. Although you’ll pay higher rates of interest, you can access the loan products without detailed procedures and a large stack of paperwork.
Debt Service Coverage Ratio or DSCR
Aside from the time in operation and business revenue, potential lenders take into consideration the debts you owe. They need to ensure whether your earnings are enough to meet your monthly obligations along with the repayment installments against any new loan products they give you. To evaluate this factor, they calculate the Debt Service Coverage Ratio or the DSCR. The higher this ratio is such as 1.25 and above, the higher are your chances of loan approval. Lower ratios can make lenders wary of providing the loan products you need. To arrive at this ratio, you divide your operating income by the total debt service costs.
Operating Income and Total Debt Service Costs
Operating Income: This is the income you’re left with when you have paid off all your operating expenses such as salaries and wages, utilities, conveyance and so on. However, do not deduct any interest that you need to pay and the applicable taxes.
Total Debt Service Costs: These are the costs you owe such as interest payments on any current loans you have, payments towards the principal, pensions, and sinking fund and any other obligations. The sinking fund is the amount of cash you regularly set aside to meet future expenses such as replacing an old piece of machinery and payments towards a long-term loan.
Debt Servicing Cost Ratio vs. Loan Potential
If you have a higher DSCR, it indicates that your business can meet all its obligations and have enough cash left over to pay back the loan installments. But, a DSCR of 1 shows that the income you generate entirely goes towards paying off its current obligations. In this case, it might not have enough cash remaining to honor the loan. Further, if your DSCR is less than 1, it means that you’re probably dipping into your savings to keep the enterprise in operation. Thus, you may not be able to pay off any new loan products you take.
When lenders consider your business for a loan, they need to check for the cash flow and liquidity status of your company. They’ll also need to know about the debt you currently need to pay off and your capacity to honor any new debts you might take. Accordingly, they are likely to scrutinize your business revenues carefully. If you’re able to demonstrate that your enterprise is a viable investment, creditors will be happy to extend to you the loan products you need.