Inside the Mind of a Credit Underwriter: Three Best Practices
When looking for financing to fuel the growth of their businesses, an estimated 99.95% of small business owners and entrepreneurs opt for debt financing. And for good reason: there are several advantages of debt financing, including retaining full ownership of their companies, lowering their tax liability, and building up their business credit score.
To help you understand more about the process of obtaining a term loan, we sat down with Jamie Shulman, a senior credit analyst at Bond Street. Let’s take a closer look at three best practices that will help prepare you for the application process.
Be Realistic: How Much Can Your Business Afford?
Virtually all entrepreneurs are innate positivists. While you do want to let the enthusiasm about your business permeate throughout your application and presentation, you have to be able to back up your claims with solid data. Shulman explains, “Oftentimes we speak to applicants who believe our loan will give them the power to grow X%, however without real data, we must temper their expectations given the concrete historical financials we have. If a business has only grown 10% or 20% for the past three years, we will need verification to agree with an owner’s assumptions of 50% growth going forward.”
Keeping detailed financial statements, including a balance sheet, income statement, and cash flow statement for your operation is essential to make a strong case about future growth. An underwriter will use items from those statements to calculate a series of financial ratios—indicators used to evaluate your business. For example, Bond Street uses the debt service coverage ratio (net operating income/total debt service) to measure your business’s ability to pay its current debt obligations with cash from operations. You’ll want to make sure that your financial ratios are aligned with the narrative that you’re presenting to your lender.
Be ready to field questions from your credit underwriter about a less rosy business situation. For example, if you were planning on using a loan to hire several new employees, what would happen if it were to take you longer than expected to train that new staff and begin seeing their work impact the bottom line? In this example, you could include two financial projections: one that assumes that new staff are trained on time and one that assumes that it takes longer to train that new staff. By including a more conservative scenario, you’ll demonstrate that you have planned for contingencies in case your bottom line were to shrink a bit.
Be Specific: What’s Your Use-Case?
Every business has a secret sauce that they guard, but, when it comes to business lending, you have to provide as many details as possible. “The more specific the better when detailing your use case, especially for larger dollar loans. We want to see that you put thought into the requested amount and that it is reasonable given your business’s financial state and its goals,” explains Shulman.
A credit underwriter is going to match financial products to the type of opportunity that you’re presenting. It’s helpful to have a general sense of what different types of debt financing are typically used for. Term loans for example are typically used for larger growth investments. A few common examples include:
- Investment in property, plant, or equipment for an expansion
- Hire of additional employees to meet higher customer volume that can be proved with historical data
- Development of a new ecommerce site or upgrade of an existing one for streamlined processing of online orders
- Refinance of existing high-interest financing
Take the time to flesh out your business plan and be specific about how you plan to implement that plan. Prepare your application catering to your lender and investigate the characteristics of businesses that they’re looking to finance.
Be Transparent: What Are Your Financial Obligations?
“The more that the underwriter has to uncover on their own, the less confident they are in lending to you,” advises Shulman. During the application process, your underwriter will take a look at additional documentation, such as bank statements or business credit reports. It’s possible that you misunderstand what would be considered debt or that you have debts you’ve forgotten to include, which is why we recommend reviewing your bank statements and bureau reports prior to applying. Note: certain monthly obligations, if included in your profit and loss statement, will not be considered debts, such as rent or utilities.
Also, don’t forget about your personal and business credit reports. Sometimes credit reports contain errors or aren’t up-to-date, but lenders have to trust those reports. For example, a bankruptcy in the past seven years on your report virtually always leads to an automatic denial at Bond Street.
Before submitting your application, order your personal and business credit reports, become familiar with them, and review them thoroughly. In case you find an error or need to update data, initiate the dispute processes right away and gather supporting documentation that you can present to the lender. Any lender wants to know what financial obligations you have other than your business expenses and how those obligations will change over time.
To help you get ready for your loan application, here’s a step-by-step guide to applying for a loan with Bond Street.