Jovan Johnson, MBA, CFP®, CPA/PFS
Whether you’re launching a startup or seeking to expand your current operations, securing a small business loan can be instrumental in realizing your entrepreneurial vision. However, navigating the loan application process can be daunting, especially given the stringent approval rates prevalent in the lending landscape. Nonetheless, there are many resources available to businesses trying to figure out how to apply for a small business loan.
As of November 2023, the Biz2Credit Small Business Lending IndexTM reveals a mere 13% approval rate for small business loans at large banks, with small banks slightly more favorable at 19.7%. These figures highlight the challenges entrepreneurs face when applying for a small business loan.
Given these hurdles, it’s imperative to approach the loan application process with meticulous preparation. Imagine yourself in the shoes of a lender: What criteria would you prioritize in assessing a business’s eligibility for a loan? Fundamentally, lenders are interested in gauging the creditworthiness and risk profile of prospective borrowers. Consequently, gaining insight into your company’s financial health becomes key.
Before applying for a small business loan, consider following these steps to showcase the financial health of your business. This will increase your chances of securing funding.
How to Apply For A Small Business Loan in 5 Simple Steps
Step 1: Establish and Build Business Credit
Qualifying for a small business loan hinges greatly on the strength of your business credit profile. Without it, securing financing can be an uphill battle. Fortunately, building your business credit is a manageable task that can significantly enhance your eligibility for loans and other financial opportunities.
Begin by applying for a business credit card. Financial institutions typically evaluate your personal credit profile when considering your eligibility for a business credit card. If your personal credit score is low, prioritize improving it before applying.
In addition, financial institutions will require your company’s Employer Identification Number (EIN) and state articles of incorporation to open a business credit card and bank account. Upon approval, ensure responsible use of your business credit card by making timely payments and maintaining a low credit utilization ratio.
To further solidify your business credit profile, engage with the primary business credit bureaus—Experian, Equifax, and Dun & Bradstreet. While Experian and Equifax automatically generate business credit profiles, Dun & Bradstreet requires you to apply for a DUNS number, which you can obtain for free on their website.
Establishing a good business credit profile can lead to lower interest rates, higher credit limits, and increased access to funding opportunities. Remember to check your business credit report periodically for fraud and errors. There are many great credit monitoring services available such as the three bureaus themselves.
Establishing and managing your business credit is fundamental to positioning your company for success in securing a small business loan.
Step 2: Prepare Essential Financial Statements
When applying for a small business loan, lenders typically request several key financial statements to assess your company’s financial health and evaluate its creditworthiness. These essential documents include the profit and loss statement, balance sheet, and cash flow projections.
1.) Profit and Loss Statement
Also known as an income statement, the profit and loss statement offers a comprehensive overview of your business’s revenue and expenses over a specific period, such as annually or quarterly. Lenders rely on this statement to gauge your business’s profitability and financial performance over time.
2.) Balance Sheet
The balance sheet presents a snapshot of your company’s financial position at a specific moment by detailing its assets (what you own), liabilities (what you owe), and equity. This document provides lenders with insights into your business’s financial health and solvency, helping them assess factors like debt-to-equity ratio.
If you utilize bookkeeping software, generating a profit and loss statement and balance sheet becomes more manageable, streamlining the process of compiling these crucial financial documents.
Some lenders may prefer that your financial statements undergo auditing or review by a Certified Public Accountant (CPA). If you require professional assistance in this regard, check out our accounting services page.
3.) Cash Flow Projections
Cash flow projections offer a forecast of your business’s future revenue, expenses, and profits over a specified period, typically up to five years. Lenders rely on these projections to assess your company’s growth potential and its ability to meet repayment obligations.
By dedicating time and effort to preparing these financial statements with accuracy and diligence, you substantially enhance your prospects of securing a small business loan. These documents serve as vital tools in showcasing your business’s financial stability and repayment capacity to potential lenders.
Step 3: Review and Reconcile Your Business Bank Statements
As part of the loan application process, lenders commonly request copies of your recent business bank statements, typically spanning up to three years. These statements serve as crucial documentation for lenders to verify your business income and assess your cash inflows and outflows. Ultimately, this information helps lenders in determining your ability to repay the loan.
You can access your bank statements online and should regularly review and check your statements for accuracy.
Step 4: Ensure that Your Business Tax Returns are Filed and Up To Date
As part of the loan application process, lenders commonly request copies of your past three years’ business tax returns. In some cases, they may also require personal tax returns. These documents serve as essential verification tools for lenders to assess your business income, financial stability, and compliance with regulatory requirements.
It is important to ensure that you maintain accurate and up-to-date tax records to support your small business loan application.
Step 5: Get Adequate Business Insurance Coverage
Insurance is an essential investment for small business owners, safeguarding both business and personal assets against a myriad of potential risks, including lawsuits, liability claims, and property damage.
Furthermore, many lenders, including institutions like the Small Business Administration, mandate sufficient insurance coverage as part of the loan approval process. Therefore, it’s crucial to carefully assess your insurance needs, maintain adequate coverage, and routinely review and update your insurance policies to ensure ongoing protection.
The specific type of insurance coverage required varies based on factors such as the nature of your business and its location. Common types of insurance for small businesses include:
1.) General Liability Insurance
2.) Professional Liability Insurance (Errors and Omissions Insurance)
3.) Business Owner’s Policy (BOP)
4.) Product Liability Insurance
By securing adequate business insurance coverage, you mitigate potential financial risks and ensure the long-term stability and resilience of your small business.
Final Thoughts
When it comes to obtaining financing for your business, there are various options to consider, including SBA loans, business lines of credit, equipment loans, microloans, and more. The type of loan you choose will depend on your business goals and specific needs. Once you’ve determined the most suitable type of business loan, crafting a well-prepared loan application significantly increases your chances of success. To further explore the different types of small business loans and find the best fit for your business click here.
I trust that this article has provided valuable insights to help you learn how to apply for a small business loan. Should you require further guidance tailored to your specific financial situation, don’t hesitate to schedule a consultation with our team of CPA and CFP® professionals. Additionally, learn more about our comprehensive accounting, tax, and business advisory services by visiting our website.
Disclosures
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