Finance for your business operations
Introduction to Business Loans
There are a wide variety of business (commercial) loans available in the finance market. These loans are typically used to finance a business’s major capital expenditures (for example, buildings or equipment), or its daily operating costs (often called working capital). This financing can help you to start or grow your business.
Types of Business Loans
Different types of business loans are available to suit different purposes. The most common include:
Secured & Unsecured Business Loans
A secured loan requires you to put up an asset as collateral (security) against the loan. If you default on your repayments, the lender is entitled to take ownership of your secured asset and sell it, if necessary, to recoup your outstanding loan debt. Property is the preferred form of security for most lenders, and depending on their lending policy, they’ll be prepared to lend up to a maximum percentage of the property’s value. This is known as the maximum loan-to-value (LVR) ratio.
An unsecured loan on the other hand requires no underlying asset to be provided as security. Unsecured loans therefore have potentially greater risk for the lender, and a higher interest rate is generally charged on them.
Overdrafts and lines of credit
Both these commercial financing options allow you to access additional funds for your business if you need them. An overdraft facility can be attached to your business bank account, enabling you to withdraw funds up to a pre-set limit, even if you have no money in your account.
A line of credit is a similar facility, but it’s a standalone account. Overdrafts and lines of credit can be useful for managing a business’s short-term cash flow, but interest is usually charged as soon as any funds are used.
There are three basic ways to finance the equipment you need to run your business:
- By taking a secured loan using the equipment itself as your collateral
- Via hire purchase. Under this form of financing, the lender retains ownership of the equipment and allows you to use it. When you make your last repayment, ownership of the equipment transfers to you.
- Leasing. Leasing is like hire purchase, except that there is no transfer of ownership at the end of the lease (and repayments are therefore generally lower).
If you provide short-term credit to your customers (for example, if you supply products to them on 30-day accounts), you can use debtor finance to allow your business to receive the funds owing to you straight away. A lender will provide finance based on the value of your business’s debtors.
Your business can be provided with a cash advance based on your regular monthly, quarterly or yearly sales. The repayments are also based on a percentage of sales, rather than being a fixed amount like the repayments on a standard business loan. This form of business financing may be comparatively easier to obtain, but the interest rate charged is usually higher.
Business Credit Cards
These are like personal credit cards. They provide your business with a pre-set credit limit that you can use for everyday business expenses. They may provide an interest-free repayment period, but typically charge high rates of interest if repayments are not made in full during this period.
To choose the best business loan, consider the purpose of your finance, whether your needs are short or long-term, and the pros and cons for the various options available.
Frequently Asked Questions
We go through a number of frequently asked questions about business loans below. If you have any further queries or would like assistance in organising business finance, please get in touch for an obligation-free conversation about your needs.
How do banks assess business loan applications?
Lenders will evaluate the risk profile of your business when you make a business loan application. The lower your risk profile, the better. Factors that they will consider when making their risk assessment include an analysis of what are commonly referred to as “the five C’s”: character, collateral, capacity, capital and conditions.
- Character: lenders can evaluate this by checking the credit history of both you and your business through credit reporting agencies. These agencies record any repayment defaults that have been made in the last five years.
- Collateral: this includes the current market value of any assets you can provide to the lender as security against the loan. The lender will be entitled to sell any collateral security assets if you default on your business loan repayments.
- Capacity: this refers to your ability to repay the business loan. Lenders will consider both your personal and business financial commitments as part of this evaluation, as well as the stability of your current and future income.
Another important consideration for lenders in assessing your capacity will be how long you have been successfully operating your business (or how much experience you have managing other businesses if it is a new start-up venture).
It is also likely to include an analysis of the industry your business operates in. Some industries are considered by lenders to be riskier than others. For example, some may be more significantly affected by downturns in the economy.
- Capital: this includes an analysis of the current assets and liabilities of both you and your business. The more saleable assets that you have in relation to your liabilities, the stronger your financial position and the lower your risk profile.
- Conditions: your risk profile determines the terms and conditions under which a lender may be prepared to offer you a business loan. The higher your risk profile, the less favourable terms and conditions will be offered to you (or you may have your application outright rejected). Examples of less favourable terms and conditions for business loan borrowers assessed as being ‘higher risk’ include higher interest rates and additional fees to compensate the lender for the increased risk.
What can I do to help my business loan application get approved?
There is an old saying that “you don’t get a second chance to make a first impression”. It applies to any area of life, including a business loan application! Effectively preparing your application and the necessary supporting documentation is crucial.
It requires you to get organised before you meet with your lender and to “sell” both yourself and your business to them. Your business loan application preparation should include:
- Working out your financing needs and whether you need the funds upfront (for example, a loan) or on an ongoing basis (such as a line of credit).
- A realistic self-assessment of how much you can afford to repay.
- Evidence of your ownership of the business.
- Writing your business plan if you’re a start-up operation (or updating it if your business is already up and running). This plan needs to tell the lender about your business, its competitive advantages and how your loan funds will be used. It should also include realistic financial projections and budgets based on detailed market research if it is a new start-up venture (or the details of an existing business’s current and potential future performance).
- Ensuring that you can provide up-to-date and accurate information on your own personal finances. If you’re a full or part-owner of the business, lenders will want to know your current personal financial situation as part of their overall risk assessment.
- Ensuring you have all your business’s financial statements and tax returns up-to-date if you’re applying for a loan for an existing business. Ideally, these should be prepared by your accountant. You need to financially demonstrate that your business is low risk for the lender (for example, that your cash flow is regular and you’ll be able to make your loan repayments over your preferred loan term).
- Having your business's KPIs at your fingertips if you have an existing operation (for example, gross/net profit and sales figures for the most recent financial years).
- Identifying any assets that you may be able to use as security against your loan. Most lenders will require some form of security, particularly if you have no or limited business experience. This security will also usually enable you to get a lower interest rate on your loan.
- Checking both your business and personal credit ratings. Your chances of having your loan approved will be much higher if you have a good credit history. You have a legal right to access your credit rating through credit reporting agencies like Equifax or Dun & Bradstreet. You also have the right to have any incorrect credit history information promptly corrected, as it affects your chances of any loan approval.
- Researching the features of various business loan products on the market (for example, secured versus unsecured loans, overdraft versus line of credit facilities, fixed versus variable rate loans, and the interest rates available from different lenders).
What are common business loan application mistakes?
- Not taking the time necessary to prepare a strong case for approval.
- Providing insufficient documentation to support your case.
- Not understanding or being able to explain your business’s financial performance and forecasts.
- Inflating the value of your assets. Your lender will most likely have them independently valued, especially if they are being used as collateral security. It’s important that you provide realistic, up-to-date asset valuations.
- Asking for more funds than you can afford to repay.
- Asking for more funds than you need.
How much can I borrow for a business loan?
This will depend on the policies of the lender (for example, their maximum LVR in relation to any collateral security you can provide), the type of business loan product you need and your risk profile.
What features are usually available with a business loan?
Different business loan products have different features. Many of these features are the same as those that are available with different types of home loans. For example, depending on the type of business loan product you need, you may be able to have the following features:
- Fixed or variable interest rates. Fixed rates are usually made available for periods up to five years.
- Either a principal and interest business loan, or interest-only.
- The ability to make extra repayments on business loans (if they have a variable interest rate).
- A redraw facility (allowing you to withdraw any extra repayments you make later if necessary).
- An offset account to reduce the amount of interest you pay.
What proof of income is required for a business loan?
The more documentation that you can provide that demonstrates your ability to make your business loan repayments, the better. This should include:
- Financial documents (such as your business’s most recent profit and loss/cash flow statements, tax returns and your current balance sheet). Ideally these documents should be prepared by your accountant, who should also be able to assist you in providing realistic financial forecasts for your business.
- Your most recent business activity statements (BAS).
- Your most recent bank statements.
Some specialist lenders may be prepared to provide you with a low (or no) documentation business loan if you can’t provide all the proof of income information that they need. But be aware that you’ll generally be charged a higher interest rate (and potentially also increased fees) to cover these lenders for their increased risk of providing funds to you.
Can a guarantor be involved in a business loan?
Depending on your risk profile, some lenders may require you to provide a guarantor in order to have your business loan approved. This guarantor would be a person or entity that agrees to become legally liable for your outstanding business loan debt if you default on your repayments. Having a guarantor can lower your risk profile, but it is a serious commitment for the guarantor.
Where can I find the best business loan interest rate?
Most lenders will advertise their business loan interest rates, but it’s important to be aware that these rates can be negotiable. The lending market is highly competitive and your negotiating power will increase if you have a strong application (i.e. a low risk profile) for a large loan amount.
It’s also important to understand that most loan products have two interest rates: the nominal and the comparison rate. The comparison rate is the nominal interest plus any associated loan fees and charges divided over a universal term and assumed loan size. It’s often referred to as the ‘true’ cost of a loan, despite the fact that your loan size and loan term will often differ substantially from those used in comparison rates.
The nominal interest rate doesn’t include the cost of any additional loan fees and charges, so it will always be lower than the comparison interest rate. It can be a good idea to factor in comparison rates when evaluating which lender is offering you the best interest rate, rather than just relying on nominal rates.
How do I refinance a business loan?
You should regularly do a cost/benefit analysis of your current business financing (for example, every two years). If this analysis reveals that there are more attractive financing options available to you, then refinancing is an option to consider.
For example, in two years from now you might have a lower risk profile or otherwise be able to source a more attractive variable interest rate (eg if you lock in a 2-year fixed interest rate business loan product now).
Make sure that you include all the costs of refinancing in your evaluation. This includes any exit fees you may be charged for terminating your current business loan product early, as well as any application fees for your new loan product.
Depending on your risk profile, the strength of your application and the amount you want to refinance, you may be able to negotiate to reduce or eliminate these fees.
Can I get a business loan to buy a franchise?
Franchises can be viewed by lenders as a stronger business model than independent businesses, especially if the franchise has a track record of success. You might be able to negotiate comparatively better business loan terms and conditions for buying a franchise. Some lenders specialise in providing franchise loans.
What do lenders think of business loans?
Business loans can be very profitable for lenders, especially if they are for large amounts. Most lenders want to develop long-term relationships with successful businesses. If you have a strong application, they will be keen to provide you with funds and to potentially negotiate their terms and conditions.
How we can help you with your business loan
Business loans can be complex. We have a lot of experience dealing with the various business loan products offered by different lenders. We can help you identify the right type of business loan and the right lender for your needs. We can also help you to prepare a strong application and to negotiate the most favourable loan terms and conditions.
Contact us today to discuss your finance needs.
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