• HOME
  • Business
  • Important questions to ask yourself before applying for a business loan

Important questions to ask yourself before applying for a business loan

  • Last Updated : June 12, 2023
  • 705 Views
  • 6 Min Read
a pink piggy bank on a pink background

Whether you're just starting out or have been in business for a while, financing is probably something you've thought about. There are many ways to fund operations, and the most common option small businesses choose is to get a loan. In this post, we'll look at some of the things you should weigh when considering a loan.

Firstly, though, it's important to know that there are other options—and we're not just saying that for the sake of saying it.

What type of financing does your business need?

There are three primary ways to fund your business.

Borrowing: Banks and private lenders have a range of loans you can choose from, with flexible duration, interest rates, and conditions based on your needs and ability to repay. Your loan can be secured against a property or asset, or it can be unsecured. If you receive a loan, your business will owe that sum of money to your bank/lenders.

Equity: Currently the most popular option for startups, equity loans offer large upfront capital in exchange for a share of your business, meaning lenders become investors in your company. You'll have to justify your spending decisions to them.

Self-funding: It's the least expensive option—but also the most expensive. By that I mean most business owners don't have thousands of dollars in savings or assets to invest in their business. But if you have the money, self-funding is the most liberating choice because your business will owe nothing to anyone. Businesses that self-fund through personal assets or revenue are described as being "bootstrapped." Business grants offered by the commonwealth and state governments and industry bodies may also come under the self-funded category. Though your business won't be liable to repay these loans, you'll still have to report your spending decisions to the funding agency. This is why applying for grands can be a long and arduous process; the funding body will thoroughly vet your business case before offering you a grant. Here's more on how to apply for government grants.

Getting a business loan: Addressing the basics

How much are you willing to pay for the loan application process?

There are many steps to climb and hoops to jump through between applying for a loan and becoming fully funded. Most individual business owners don’t have the technical knowledge or time to extensively research and evaluate their options. If you’ve ever mentioned to anyone that you’re considering a loan, chances are you’ve been told to talk to a financial advisor or lending agent. That’s good advice. Financial professionals are fluent in money-speak, and their input can go a long way in helping you understand how much you can borrow and how much interest you can comfortably afford.

However, consultations aren’t cheap. Before you decide to apply for a business loan, consider how many advisors you’ll need to consult during and after the process. At the minimum, you’ll incur:

• Accountant's fees
• Financial broker's fees
• Application and ongoing loan expenses such as transaction, exit, and maintenance fees
• Costs for acquiring necessary documentation
• Personal time spent or the fees for a proxy

Here's a more comprehensive list of fees you might incur during your loan application process. Clearly, there’s a lot to think about. For many businesses, investing in these advisory services is thoroughly justified—their purpose and the value of the loan far outweigh the initial costs. But for other businesses, the initial costs might be more than they're worth.

Can you really afford to repay your debts?

Having a large debt can be demoralising, but it's often a necessary evil in business. While evaluating your loan options, think about your business in the long term. Analyse your current financial status, your goals, and your intentions for the loan money (acquiring capital assets vs. funding operations). Consider how your interest might impact your operational decisions and whether you’ll have enough cash flow to repay your loan.

The Australian Tax Office has a free business viability assessment tool you can use to understand how well your business is doing and what it’ll take to successfully manage your loan. Compare your business' benchmarks—such as expenses to turnover rates, rent to turnover rates, and cost of sales to turnover—against industry standards to gauge your borrowing ability.

Banks usually use a standard eligibility criteria when assessing your application. They look at your character, capacity to repay loans, existing and desired business capital, your ability to meet loan conditions, and the credibility of the collateral you secure against your loan.

RBA cash rates: The Reserve Bank of Australia has kept interest rates at 0.1% throughout the pandemic, but as inflation concerns grow, the RBA is set to initially increase its rate in June 2022, and again, possibly up to 1% by the end of the year. This means getting a loan will become more expensive, so if you're considering a mid-long term loan, you should factor in a rise in your repayment rate.

What do you need for your loan application to be successful?

Your loan application needs a strong business plan. Make sure you have a clear case for your business finances and a costed plan for what you intend to do with the loan. I like to think of it as handing down a budget to parliament—expect every piece of it will be scrutinised, cross-verified, and questioned. The stronger your business plan, the easier it'll be to convince your lenders their money is in safe hands.

You can download a business plan template from the business.gov.au website. Use that as a guide to inform your own plan. If you already have a business plan for internal reference, draw from it to create a version specifically for your loan application. Even though it'll be similar, having a highly-customised version addressing your target audience (banks and lenders) will help you address any concerns banks might raise.

Apart from a strong business plan and an executive summary of your business process, you’ll need supporting documentation to prove your financial credibility. This includes financial statements, business outlooks and forecasts, previous spending priorities, and property leasing documents (if you’re a smaller business or a startup). Even with all these documents, your bank will run a credit check on you to make sure you can meet your interest liabilities.

As you can imagine, all this will take time. As you start your application process, have realistic expectations about when you’ll receive your loan.

Are you aware of these common application mistakes?

If you’re going to all the trouble of applying for a loan, wouldn't it be wise to ask for a couple hundred thousand more, in case of a rainy day? It’s a simple enough assumption, but it’s best not to ask for any more than you need. Banks consider every loan application individually, and they'll want to ensure you can afford the amount you’re asking for. If your bank thinks you’re asking for more than you’re worth, you might unnecessarily delay the process, particularly if they require documentation to prove your credit worthiness.

A successful loan application also depends on your costing. If you’re applying for a secured loan, it’s crucial to valuate your assets accurately—if you overvalue your assets, you won't be able to use them as security for subsequent loans you apply for.

If you're repaying other loans while applying, convey this to your bank. It’s an important factor in determining your loan amount and interest rate. Discuss your application process with your bank—feel free to ask questions and clarify concerns. If you’d rather have flexible interest rates, talk about the implications, such as early repayment fees.

Above all, be upfront and transparent with your lender about your current financial status and your intentions for the loan. Even small, inadvertent mistakes can complicate your application process. If you’re unsure, talk to a loan advisor. It’ll save you a lot of time and energy in the long run.

Read next: Top 10 loan and financing options for small businesses in Australia

Related Topics

Leave a Reply

Your email address will not be published. Required fields are marked

The comment language code.
By submitting this form, you agree to the processing of personal data according to our Privacy Policy.

You may also like