Written exclusively for SMEpost.com by Harshvardhan Lunia, Co-Founder & CEO of Lendingkart Technologies

The universal law of business states that ‘money makes money’. Every businessman is well-aware of the scope and opportunity that the influx of capital can bring to their business. This is where acquiring loans from financial institutions becomes vital, especially for businesses operating in the MSME sector.

Additional working capital in the form of loans helps in scaling up and the smooth operational functioning of the business entity. Today, MSMEs can acquire loans from a variety of financial institutions. It includes conventional financial institutions such as banks, asset-based lending comprising loans secured against balance-sheet assets, hybrid instruments such as convertible bonds, and advanced alternative lending platforms that facilitate loans through partner NBFCs.

Anyone can apply for a loan in India. However, financial institutions often take a multipronged approach before approving a loan application and granting access to the valuable financial resources that can be very vital for a business to reach its full potential. Here’s a list of 5 crucial aspects that lenders check before disbursing credit:

Revenue Generation

Before extending credit, lenders ensure that your business is based on a sustainable business model and has been generating considerable revenue in light of the market standards and conditions. Age of the business and the area it is operating in, are also benchmarks against which the creditworthiness is measured. Strong cash flows and the ability to generate enough revenue for EMI repayment are imperatives. It is advised to keep these factors in mind, make appropriate changes in your budget regularly and monitor results.

Age of the organisation / Entity

Age of an organisation / entity is one of the key factors during the assessment of a loan application. Being operational for a relatively longer period of time directly translates into much greater industry-specific expertise of the business organisation. This naturally increases its likelihood to survive rough market conditions. It is thus treated as a strong indicator to predict the probability of timely repayment of loan. Additionally, it provides a higher amount of data that the lending entity can analyse.

Debt-to-income ratio

Debt-to-income (DTI) ratio of a company is the ratio of monthly debt and liability payments of a company with respect to its gross monthly income. Businesses must keep their DTI ratio as low as possible because it paves the way for a smoother loan approval process. The DTI ratio helps a lender to determine the amount of additional debt that the company can handle safely and securely while simultaneously assessing the credit risk that it already possesses. As per latest industry reports, although the maximum limit for DTI ratio is 43%, nevertheless, businesses must strive to keep their debt-to-income ratio even lower.

Credit History

Businesses must pay special attention to their credit history, or the debt repayment record of their enterprise. This is the most decisive factor during the loan assessment process as financial institutions put a great emphasis on the assessee’s debt repayment record. Debt repayment record maintains the debt history of an organisation and a track record of liabilities so far. This is used to predict the possibility of timely payment by the loan applicant. These liabilities comprise prior credit repayment history and can include electricity bills, credit card payments, telephone bills, and other forms of payments. It must be noted that a high credit score with even a recent bad credit history can invalidate a loan application entirely.

Credit Score

Credit score is a three-digit numerical expression based on the credit report sourced from the credit bureau and determines the creditworthiness of a loan applicant. A high credit score displays that the applicant is more likely to make time-bound payments for the loan disbursed. Today there are multiple credit information companies, which offer credit score rating services. These include CIBIL, Equifax, Highmark, and Experian. It is advisable for businesses which are planning to seek loans in the near future to check their credit history and score every three months. This helps them determine how various financial actions are affecting their credit score which they may not realise otherwise.

Additionally, one must take special note of the following to avoid loan application rejection:

1. Refrain from co-signing somebody else’s loan application as being a standing guarantor on a defaulted loan can terminate your own loan application.
2. Avoid getting remarks on your credit report. Despite having a good credit score, this can adversely affect your loan proposal.
3. File your income tax returns in a timely manner and make sure that it does not have any inconsistency for at least two years.
4. Make sure you have appropriate paperwork including written business plans, financial projections, business credit reports, bank statements, etc. This significantly boosts the likelihood of your loan approval.
5. Avoid adverse effects of a weak cash flow on your loan proposal. Reduce your expenditure or increase your revenue before applying for a loan.

Taking loan by and large depends more on statistics and mathematics than your skills and business acumen. Be calculative while preparing your loan proposal and make sure that your business generates greater return on investment than the effective rate of interest. Also, ensure you go through all the terms and conditions and included hidden charges in your overall calculations.