5 Main Reasons Banks Turn Down Small-Business Owners for Loans

Last updated on September 14, 2018

If you are a small business owner, you would understand the importance of steady cash flow to keep your operations going. With the severe competition in the market, the stakes are higher than ever. New competitors are entering the market every day and are already pushing your already thin margins. In the wake of such competition, it becomes necessary for you to keep expanding and innovating in order to retain your competitive edge as well as retain the customers.

If you fall behind the competition, you won’t even know when your customers left you and opted for your competitor. This would spell disaster for your business, which you have managed to bring so far with your blood and sweat. But now that you have exhausted all your personal finances, what could you do to ensure that your business keeps treading on the growth trajectory. So, what are your options really?

Why are financial institutions becoming strict?

Well, as a matter of fact, borrowed funds are the only option for small businesses as you just lack the resources to go for raising equity through shares. Financial institutions such as banks and non-banking financial corporations offer various types of collateral free loans for MSME to help you fund your business requirements and ensure that you honour your liabilities on time. Earlier, it was effortless for small business owners to get bank funding as the banks were upbeat about their future prospects and looked at small business loans as an excellent opportunity to maximize their profits.

But in the wake of recent developments like frauds, rising NPA’s, and lack of funds, financial institutions such as banks and non-banking financial corporations have become much more stringent while processing loan applications regarding business loan for MSMEs. They now scrutinize all applications very seriously, and if there is even a slight discrepancy, they will reject the application straight away.

Why do you need to exercise caution?

In such a scenario, if you are a small business owner and looking for small business loans for the expansion of your business, you must pay attention to the reasons we have mentioned below. These are the reasons due to which banks have been turning down the applications of small business owners for loans. If you are preparing to proceed ahead with your application for a business loan and want to ensure that your application goes through, then you should pay attention to all the details and ensure that you do not make such mistakes that others have made because if your application is rejected once, then the chances for approval subsequently become slim.

Reasons for rejection of loan application

Following are five of the primary reasons that lead to denial of loan applications of small business owners: –

• Bad Credit History: – Credit Score and Credit History are the most important criterion for most of the lenders when they process a loan application. It is mandatory to have a good credit score as it reflects that you are a responsible borrower and pay your EMI’s on time. Having a poor credit score is a red signal for lenders as it signifies that you are less likely to repay your EMI’s on time and are highly irresponsible with your personal as well as business finances. If your credit score is below the specified threshold, then it is better that you first work towards repairing your credit score with the help of a professional and once it is above the required limit, then proceed ahead with the application. It would significantly enhance your chances of being successful with the loan application. 

Similarly, if you are a new business or a start-up, chances are you might not have any credit history at all. This would be detrimental to your procuring bank finance as most lenders want to lend money to a business who has a decent credit history and can make payment on time. If you do not have a credit history, then you should wait for some time and develop a proper credit history to be able to be successful with your loan application.

• Poor Cash Flow: – Lenders assess a business’s cash flow to understand its ability to repay the EMI’s on time. Having a good cash flow is essential for a company to be able to pay the liabilities such as bills, wages, suppliers etc. on time in addition to the monthly loan payments. But some companies such as start-ups do not have enough cash in their reserves because they must purchase the goods and services against cash payment and sell their products and services on credit basis. If you are a small business owner, then you must assess your cash flow before deciding to proceed ahead with your loan application. If the cash flow is weak or inadequate, then it is likely that the banks may reject your application. 

• Lack of Collateral: – Financial institutions want to ensure the safety of their funds and have to be sure that if businesses are unable to make the loan repayments on time then how can they recover their money. That is why most banks would ask for collateral to be kept as a security for their loan. If the business owner is unable to offer the required security in the form of real estate or gold or any other fixed asset, then the chances of the loan getting approved are slim. Similarly, as a start-up does not have a long credit history, banks want to be sure that their money is safe, in such scenarios they demand collateral and if the business owner is unable to provide the collateral, the application will get rejected. 

• Time in Business: -Financial institutions also assess the duration of time for which you have been in the business, and that is why they ask for proof of continuity. They will be asking for your financials, tax returns, income tax returns, audited reports for at least three years. Lenders expect the business to be profitable for the period of last three years so that they can understand if the business is worth lending their money to. If your financials so wild fluctuations or a downward trend, then the banks would think twice before approving the application. Unsecured business loans are only extended to such entities which have been in operation for an extended period of time, businesses which are relatively new and do not have any credit history must present collateral to be eligible for a loan. 

• Lack of Vision: – Financial institutions like banks offer loans based not only on the past performance but also on the future projections. As such it is required that the business plan that is submitted along with the loan proposal should be comprehensive and cover every important aspect. Any haphazardly put together business plan would indicate that you are not serious about the work and reflects poorly on your management skills. 

As such it would be better if you can avail services of a professional such as a chartered accountant to prepare your plan. You should also take some time while putting the business plan together and revise it numerous times so that no critical question is left unanswered. You should also keep handy a copy of all relevant financial and legal documents to be submitted with the application.

It is not that banks are out to reject your application somehow, but due to the turmoil that most leading banks have been going through, they are extra cautious. If you can put together a good proposal for collateral free loans for MSME and back it up with a good track record, the chances are that your plan would be approved, and you would be able to take your business to greater heights.