What should I remember when seeking a small-business loan?
by Debi Enders
When you are seeking a loan, remember this: The criteria lenders consider when evaluating small-business loans are different from those they use to evaluate personal loans.
To determine whether you can repay a personal loan, a lender looks primarily at your debt-to-income ratio. That means adding up all your monthly debt payments and dividing them by your monthly gross income. For example, if your monthly debt payments total $1,500 and your monthly gross income is $5,000, your debt-to-income ratio is 30 percent, which could make you a good candidate for most personal loans.
Lenders want to understand your cash flow. To qualify, you’ll need to show that the cash coming into your business each month is higher than the cash going out. To assess your cash flow, lenders will ordinarily ask to see both your business’s profit-and-loss statements and its income tax returns. The tax returns are necessary because they provide proof of the income your business has earned.
Tax returns can also be a loan deal-breaker — especially if they show little or no earnings because you maximized your deductions to lower your tax burden. From a lender’s perspective, tax returns are the official last word. If they show your business has no earnings, your business has no earnings. And a business that has no earnings will likely find its loan application denied. In other words, accounting strategies that are great for lowering taxes can undermine your ability to obtain a loan.
With proper planning, however, you can have some deductions and get your loan too. A good accountant can devise a tax strategy that enables you to depreciate your assets while still positioning your business to finance new equipment, expand your operations or manage fluctuating cash flow.
Debi Enders (debi.enders@commercebank.com) is vice president, small business banking at Commerce Bank.