I have seen the happiness on the faces of many entrepreneurs when I placed loan sanction letter in their hand. But loan rejection is not a happy state.
Availing of loan is most business’s need for growth, especially for SMEs. There is a limit up to which promoters can invest own capital in the business. Beyond a point, they need the support of external sources lenders like banks or NBFCs.
Lenders usually support a healthy business. No one would like to risk their money for an unhealthy and risky business. They are answerable to their management and shareholders.
With a massive NPA problem, the Indian financial system is facing, lending has become more and more stringent. However, there is no dearth of money for good business.
“Borrowing isn’t inherently bad; it depends a lot on what the debt is financing.” Stephen Moore
Here we look at the aspects which usually affect the chances of your loan application getting approved. Knowing these will help you better equipped to deal with the banking system and availing loan.
High Debt to Equity Ratio
This means you have already borrowed more than what can support your own fund. This makes the lending risky as owners’ stake is quite low.
Low Current Ratio
Less than 1 current ratio indicates the company could face a liquidity crisis. Creditors are higher than the debtors. Current liabilities are higher than the current which can support the repayment. Usually, the consistent lower current ratio is a sign of liquidity crisis.
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This makes the lending risky as the business may run into losses if the margins are thin. Healthy profit margin and speedy sales recovery are two important aspects of the business and banks consider both as a sign of good borrower.
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There has to be consistent growth in the turnover. If the consistency in turnover is not there, the business is facing growth challenges. Inability to grow could mean business is facing a tough time.
Banks asses whether this is due to lack of capital or capacity. In such a scenario, the bank may support the business. Alternatively, if the reason is competition and price pressure. Loan application becomes untenable.
This indicates the company is not able to recover sales money on time. This indicates uncompetitive company position and highly competitive industry. It also could be due to the casual approach to recovery of the owners. In all the scenario, it is not good for the business.
Usually, 2 to 3 months are considered sale recover period. It varies industry to industry. But higher the recovery period is not good for the liquidity of the business. This increases the working capital investment.
Chance of long-term debtors turning bad is also high.
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Frequent Cheque Bouncing
This is a serious issue. Cheque bouncing is considered a serious problem. This indicates promoters’ financial indiscipline and a cash crisis.
Frequent cheque bouncing reflected in the bank statement seriously hampers the chance of loan approval.
“The ability to sign a cheque is the least reliable guide to a company’s fitness.” David Plowright
Inadequate Collateral Security
Landers many times ask for additional security over and above the assets they are financing. This is known as collateral security.
When the bank is financing for working capital stock and receivables or machinery, banks may ask the borrower to provide immovable or liquid security as a safety.
When the borrower is unable to provide or what he can offer is inadequate as per the bank’s norms, the bank may reject the loan proposal.
Though under the Credit Guarantee Scheme loan up to Rs. 2 crs. (Rs. 20 mn) is possible without collateral, security with certain terms and conditions.
“There is a defined gulf
Between credit and character
If you doubt this, ask any banker;
He will advise that character is nice
But it is not collateral.”
Evan Rhys, Poems from the Ledge
Low Credit Rating
Banks have their own internal rating process. If the company is not rated by an external credit rating agency, bank’s internal rating scorecard decide whether the borrower is creditworthy.
This is mainly about financial performance; industry classification and promoters track record.
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Bad Credit History
Indiscipline in loan servicing and repayment in the past hampers the chance of future loan availability.
Lending is a highly trusted worthy activity. When the promoters are not serious about repayment or their business is unable to support timely repayment, lenders money is at risk.
Known credit risk most lenders would like to avoid. It could be compensated by additional collateral security and justifiable reasons for the delay or default.
Even for the NPA account promoters, getting a loan from the banking system is very difficult to even for their non- NPA accounts.
Some industry is classified as weak or risky based on the economic scenario. Like Real Estate or Chemical or such industry which is either over borrowed or is uncompetitive due to economic and global factors, are on caution list. Banks lend companies in these industries very cautiously.
Lenders would like to refrain from lending to the promoters who are undertaking unrelated diversification. This could be risky. Promoters industry experience is an important factor while banks consider a loan proposal.
Promoters On Caution List
If the promoters have defaulted on loan repayment, export credit recovery, criminal record, or any such records which doubts the integrity of the promoters, RBI has caution list of such promoters. If the promoters are on the board or are anyway
“It’s easy to get a loan unless you need it.” Norman Ralph Augustine
Remember, a loan is not for bad times. No one will lend you when your business is not doing well. Borrow when you are doing good and your finances in good shape.