Why? It's because you need to be deemed a qualified borrower in order to get credit approval for your small business.
Even though banks have the principal economic function of granting loans or line of credit, they are being conservative about it because of a high risk in uncollectable debts.
Translation? If banks give out loans to everybody who asks for it and for some reason or other, those borrowers do not pay them, there would be serious financial trouble for the banks. So their solution is to have a stringent set of rules which when you put it in simple terms is that if you're not a qualified borrower, then your loan application would be denied.
So how do banks determine if one is a qualified borrower or not? There are six aspects that banks study:
- Character - This is the reputation of your business. This includes your personal credit history.
- Capacity - Do you have the legal authority to sign for the loan or not? This is pretty basic. There would be a contract you need to sign and it's legally binding so banks would check if you're the one authorized to ask for a loan.
- Cash - The bank you're asking a loan from would check the cash flow of your business. Now, you may say that your business is doing fairly well in the market but banks also deduct other expenses (ie: other credit) from your business' reported income and that would determine whether you'll be able to pay off the loan and the interest it will accrue over time or not.
- Collateral - This serves as security. If for some reason you won't be able to pay what you owe, the item or property you used as your collateral would be held as payment.
- Conditions - Banks would check on the economy and how it would affect your business. The bottom line is, would you have the ability to repay the bank at the set terms even if the economy suffers another financial blow? Or would your business be blown away as well?
- Control - Your application should meet with written loan policies and it should withstand even if laws or banking regulations suddenly change.
You have to remember that banks do not just rely on your words or recommendations from your friends. They would also contact other lenders which you may have done business with as well as the local or regional credit bureau to check on your credit history.