When you are looking for business funding, primarily funding to support business growth, it is quite easy to fail to notice one essential question; can your small business actually afford the small business borrowing? Here are some of the steps to take to decide whether your small business can afford a small business loan.
Debt Service Coverage Ratio
To know what you can borrow, you first need to realize that what you could afford to pay back. In turn, this will require you to estimate your debt service coverage ratio. To put it simply, the debt service coverage is the ratio of cash you have available to service debt.
What Lenders Consider About Your DSCR
Every lender has different set of standards in relation to comparing your debt service coverage ratio. The majority will play it safe and keep in mind that 1.25 the minimum to approve a small business loan, while others will be more careful and keep in mind that 1.35 the minimum appropriate. Moreover, these standards may not be constant. They will vary across special types of loan and are probably to be evaluated frequently as the financial system moves from boom to recession and back again.
You ought to additionally be organized for lenders to ask for your debt service coverage ratio from previous years to offer them an idea of trends in your business’ finances, specifically in case you’re in a phase of quick growth.
Another way of comparing whether or not you can come up with the cash for a small business loan is to take a look at your debt-to-income ratio. This approach considers a loan’s affordability and flexibility in the broader context of your other debts.
To calculate, you must estimate all your personal and business debt including everything from business loans to personal funding then divide the amount with monthly gross profits. Multiply the final figure by 100 and you’ve a percent that gives you an idea how much your income exceeds your debts.
This is a much less useful estimation to evaluate your readiness to borrow; however it is going to come up with a huge sense of the way you’re performing financially. On the whole, if your debt-to-income ratio is more than 36%, you need to consider twice about taking on an additional small business loan and you also need to get ready to face rejection in case you go ahead.
Loan Performance Analysis
Certainly, in case you need to assess your financial position from a further point of view, you should consider overall loan performance analysis. This method differs from the debt coverage ratio and the debt-to-income ratio in that it examines both aspects of the equation — the financial risks of taking over extra borrowing as opposed to the potential rewards of making an investment in business growth.
Basically, you’ll be attempting to investigate how getting small business loans will impact your business figures in the end. You’ll need to consider your current sales and profitability, and project what can realistically be achieved in case you take out the funding. It is essential when making this projection to be practical. If you are excessively constructive, you could find that getting further borrowing is far less beneficial than you initially consider. It is also essential to make this estimation along with your debt service coverage ratio.