Four key factors banks check before giving business loans

Are you thinking of funding your business with a bank loan? It may be helpful to know what financial institutions are looking for when deciding whether to approve your business loan application.

How banks decide whether to give you a business loan

While there are a few different ways to fund your business, including through your own savings or equity, you may consider applying for a bank loan in order to fund your business.

Many business owners can assume that if they are successful in obtaining a business loan, their business idea has been given endorsement by the bank. Conversely, those who are unsuccessful may worry it’s because their idea seems unsound.

SBDC Business Adviser and former business banker Steve McLaren explains that in fact, your ideas for the business are not the key aspect banks consider when deciding whether to lend you money.

“The main concern for a financial institution will be your ability and propensity to pay back the debt,” says Steve.

“To make a judgement call on this, most banks and lenders will look at four key factors.”

1. Your track record

The first aspect a financial institution will consider is the history and reputation of the person or people applying for the loan.

They take into account your credit history, previous debts you have applied for (and your record of repaying these), your business experience and reputation. They may also want to review your tax returns and financial history, including previous loans you’ve paid off. The bank may also look into previous businesses or jobs you have held, or any legal issues you have been involved in.

“Some institutions refer to these aspects as ‘character’ – but in reality, it has nothing to do with your personality,” says Steve.

“It’s more about finding proof that you have the ability to pay back the loan.”

Lenders may also consider the primary activities of the business and its longevity, and aspects of the business environment including industry trends and business location.

Steve advises, “don’t get taken by surprise about what the bank may find out about you.”

“You can check your credit profile by using free resources such as the Office of the Australian Information Commissioner’s free credit reports or getting a copy of your credit score.”

Financial institutions may consider non-financial factors when assessing your business.

“Make sure that your website and social media accounts provide an accurate picture of your business, as the banks may look at these too,” says Steve.

It also pays to be aware that businesses with an outstanding tax debt or repayment arrangement with the ATO or another government agency may find it hard to get a loan.

2. Your ability to repay the loan

Your ability to repay the debt will be assessed by reviewing several items including previous bank statements, other loans and understanding the strategy of where you plan to take your business.

If the business is already established, previous financial information will be reviewed.

“To help provide evidence you are able to repay the loan, supply as much information as you can with your application,” says Steve.

Proof that could be useful include financial statements for the last two years, your balance sheet and profit and loss statements, and business bank account statements if you are not already a customer of the financial institution you are applying to. Cashflow projections and BAS statements may also be good additions.

“Most importantly, having a robust, up-to-date business plan is essential so that the bank can assess what you plan to do with the loan and how likely they are to be repaid,” says Steve.

Download our free business plan template to get started.

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Image of Steve from SBDC sitting in front of a computer looking at the camera
SBDC Business Adviser Steve McLaren

3. How the loan will be secured

Assets of value such as cash, property, inventory or accounts receivable (collateral) are usually used to secure a loan. You may need to document these assets, including their age, location and types, to help the lender determine their current and future value. Secured loans typically offer lower interest rates and higher borrowing amounts than unsecured loans.

Unsecured loans don’t require assets as security, but because they are higher risk, are usually for smaller amounts and are likely to attract a higher interest rate. Assets are not required for an unsecured loan, but it may improve your chances of being approved or help reduce the interest rate on the loan.

“To document the items and assets you have available to secure the loan, create a balance sheet,” Steve advises.

A balance sheet should document your assets and your liabilities and subtract the liabilities from the assets to arrive at your owner’s equity.

“Make sure that the valuations of assets you include are up to date and realistic. The valuation should be obtained from a professional valuer.”

See our example balance sheet.

4. Your overall financial position

A lender will look at all the capital you have available, in case this is needed to help make repayments on the loan. This can include:

  • Your net worth
  • Liquidity, such as cash savings and shares
  • Any deposit you are planning to make

Final words of advice

“As you can see, banks consider quite a few factors before deciding to loan money, and your business idea (outlined in your business plan) is only one,” says Steve.

“Most of it comes down to whether the bank thinks the risk of lending your money is outweighed by your likely ability to repay it.”

Steve recommends that new businesses don’t get disheartened if they are unsuccessful in getting a loan and reinforces that bank loans are only one way of funding a business. Bootstrapping (self-funding), family loans, selling equity and crowdfunding are also common ways of finding the money to advance or expand a small business.

You should also have a proactive discussion with your bank or a financial broker to get a picture of what you might be able to access, and what proof you might need.

“If your loan application is unsuccessful, check what the reasons for refusal were so you can use this information in the future,” he advises.

“At the end of the day, lenders want to know that you have a financial stake in the business when providing a loan. No matter how good your idea is, if you don’t have a financial stake in the business, it can be hard to obtain finance.”

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