When applying for a business loan, it's essential to prepare a detailed business plan and fully inform the lender about your proposed venture. This information helps the lender to make its decision and provide you with the right type of finance and advice.

Decisions to make

Making the decision your business needs a loan, is only the first step. There are a number of things to consider before you approach a lender; how much do you need to borrow; what type of loan will you need; how long will you need it for; can the business afford to repay the loan, interest and any one-off or ongoing fees that come with the loan; what security can you offer the lender and how this affects the interest rate offered.  Online repayment calculators are a good tool in researching options but make sure you take the following into account:

Access to funds you borrow

If you need to access the funds on a semi regular basis (i.e. to help with cash flow to keep the business operating while waiting for your customers to pay for goods etc.), 'at call' loans such as an overdraft or line of credit are designed for this purpose.  However, if you need the funds to buy a new business or equipment etc. to expand your existing business you will need the funds 'upfront'.  This is also known as a ‘fully drawn advance’ and provides you with the entire loan amount all at once.

Loan terms

Loans provided upfront will need a portion of the loan plus interest paid back at regular intervals. The repayment amount will depend on the term or length of the loan. The longer the loan term, the lower the monthly repayment. To determine the loan term suitable for your business you will need to calculate how much you can afford to service the loan. Be aware that the longer the loan term the more total interest you will pay. Loans that are at call have no fixed terms.

Ongoing funding

This is the average amount of an overdraft or line of credit that is used at any one time. E.g. You may wish to have an overdraft limit of $20,000 to provide money for the occasional big expense, but usually you won't use more than $5000 of that credit limit on average. So in this case $5,000 is the level of ongoing funding you need.

When applying for an overdraft limit, things to watch out for are:

• higher the overdraft amount higher  the fees
• clauses where the lender can demand repayment of the whole loan at any time

Fixed or variable interest rate

The choice of rate will affect the stability of repayments, overall cost of the loan and the loan features available. With a fixed rate loan the lender bears the risk of interest rate moves, while with a variable rate you will bear this risk. Ultimately, the choice of variable or fixed rates will depend upon how much free cash flow your business generates after you have paid all your expenses, including loan repayments. If your business has a low profit level, a variable rate loan repayment may rise beyond your ability to pay.

Loan security

Loans can be secured or unsecured by various types of assets, including residential, commercial, rural property or business assets. Alternatively, some loans are unsecured by any asset. Generally the less you provide for security the higher the interest rate will be. Be aware the lender has the legal right to seize any property or asset you offer as security if you can't repay a loan on time.

Fees

There can be fees which can make a loan less attractive than it first seems. These include one-off fees such as establishment/application fees, exit/discharge fees and early termination fees or regular fees such as service fees or line/credit advance fees. The Business Loan Finder tool includes the cost of set-up and ongoing fees in the average monthly repayment to give you a better idea of the true cost of the loan.

Seek advice

The information provided here will provide you with a range of possible finance options. It is important to seek advice from your accountant or business advisors before approaching a lender for a loan.

Tip: Prepare a cash flow statement to plan your cash flow and work out how much you need to borrow.

Plan the business, plan the finance

Lenders will ask for a lot of in-depth information about the financial history of the business. It's also important for you to create a convincing and detailed business plan, as much as for your benefit as for the lenders'. The information you use to build your business plan may also be needed by the lender to assess your project. This includes both the past and future plans for your business, the people working in it and the market itself.

The outcome of your application is strongly influenced by how well your proposal is researched and how well it is presented.

Visit the Small Business Tool Kit for assistance with developing a tailored business plan.

Risk assessment

Banks and other lenders will look at your businesses risk profile when considering your loan application. Understanding what lenders look for and what they consider risky will help you present your business in a favourable manner.

As a general rule, lenders look for:

• the level and nature of your security (what you're offering to give them if you can't repay the loan)
• your ability to make regular loan repayments (cash flow risk)
• your ability to ultimately repay the debt (business risk), including any other debts you might already have

You need to be able to assess the level of cash flow or business risk in your specific circumstances. A projection of the cash requirements of the business is most important to a lender, as it is the actual cash left after expenses that will repay the loan, not income. It also shows you are an effective manager.

A lender's perception of risk

The following factors can influence your lender's perception of risk. If a number of these areas apply to you and your business you may need to consider another source of finance.

Start up businesses

A new business start-up represents one of the highest risk areas for a financier. It incorporates financial risk, business risk and management risk.

Without security you will have limited chance of getting a loan. You could consider funding part of the business through leasing or hire purchase, using the equipment as security or debtor finance, using your invoices outstanding as security.

Lack of business history

If you have not run a business before then the financier will see you as a potential ‘management risk’.

Industry sector

Risk assessment may take into account issues such as levels of competition in the industry, barriers to entry, profitability profile/number of business failures and current economic conditions.

Seasonal nature of your business

If your business has a strong seasonal nature, such as swimsuits, agriculture or travel a financier will be concerned about how you would deal with the cash flow pressures in the off season.

Lack of planning, market knowledge and finance skills

If the financier considers you lack some of the basic all-round management skills to operate a successful business, it will increase the perception of risk.

Poor credit history

Most financiers will run a routine credit check as part of the normal finance approval process.

Source: Business Victoria