NFIB

Five Red Flags To Avoid When Applying for a Bank Loan
06/ 18/ 2002

Securing a bank loan may mean the difference between staying in business or closing shop. Because of this, preparing a loan application is critical. Work with experienced accountants or financial advisers while preparing your loan application and be aware of what banks consider "red flags"--negative features that could kill chances of a loan even though all other aspects of the application are in good order. In today's Workshop, Jeffrey Moses lists the five most serious red flags.

1. A business plan that doesn't fully describe the company's chance for success. Remember, banks are ultimately concerned only about your likelihood of paying back the loan. Because of this, every aspect of your business plan should focus on showing how the loan will help grow your business. The quality of your company's products doesn't matter (unless the quality is fundamental to making more money), and it doesn't matter how beneficial your company will be to the community. Show how the loan will enhance your chances for profitability.

2. Excessive debt in comparison to cash reserves. Banks don't like to loan money only to pay off a company's debts, so work with your accountant or business adviser to present acceptable debt-to-assets ratios. These include, among others, current assets to current liabilities ratio (current ratio), debt to net worth ratio (usually for individuals), short-term debt to cash reserves ratio and long-term debt to projected revenue ratio.

3. Spotty credit report. Before applying for a loan, examine your reports and do your best to clear up any negative aspects. If something cannot be cleared up immediately (such as persistent late payments), explain the situation to the lender. It's best to notify lenders of a negative credit report item, rather than having them discover it on their own and think that you were trying to hide it.

4. Inadequate or inappropriate collateral. Banks don't want to have to force liquidation for repayment. But they do want to know that in such a situation, collateral will be relatively liquid and cover the loan amount.

5. Lack of down payment. Banks rarely lend to companies or individuals who have no cash reserves to make a down payment. This is not always the case, but in general it's worth your while to wait until you have an adequate down payment when requesting financing for equipment, product, services or office space.

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