It’s a common scenario all SME owners face: Simply when your company requires help with cash flow, you can’t seem to get a business loan. Even when banks reject your application, they might not tell you why. Here are some insights.
1. Your company’s paid-up capital (PUC) is too low
Financiers like to see a reasonable PUC for your company, which signifies that the Directors/Shareholders have “skin-in-the-game”. This minimizes the risk of fraudulent companies and is a strong incentive for business to achieve profitability in order to repay the loan.
If the PUC is very little (e.g. just $1), it might indicate that the directors are not confident of the business.
Banks or financiers don’t want to feel that they are financing your whole company; they prefer to co-share the risk with you. One way to accomplish this is to have a reasonable of PUC, along with evidence of retained earnings from previous operating years.
2. Legal suits over the previous couple of years
All legal suits are captured on the director’s individual records and company’s publicly-available ACRA records. Various legal suits affect credit assessments in a different way but are typically bad due to the implications regarding the company’s behaviour.
The worst record a company can have is a credit facility legal suit, where another bank had actually taken legal action against the company to recover funds. It decreases the confidence that the company will be able and willing to pay back new loans.
Most business loans have duration of between 1-3 years and many financial institutions will not risk any danger of future personal bankruptcy.
3. Your company appears to be in a “High Risk” industry.
Banks compute their direct exposure based on the group of industries noted in the Singapore Standard Industrial Classification (SSIC) code. If your company happens to fall within this broad high-risk classification, you will most likely be assessed together. For example, Civil Engineering may not be in construction itself, but still considered within the Construction Industry and hence, assessed together.
4. A lot of return cheques
There are lots of factors for bouncing cheques but the ones we are speaking about are, return cheques due to insufficient funds. Too many return cheques (> 1 month) within 6 months indicate that the company is likely dealing with cash flow issues and might be unable to repay a new loan.
It would also reflect unhealthy book-keeping practices within the business, even if it’s not due to inadequate funds. When they have uncertainty in a company’s repayment ability, banks hardly ever extend loans. They prefer to finance normal operating or expansion functions and hardly ever for bridging functions or to tide the business over challenging periods.
5. Debt-Servicing Coverage (DSC) Ratio too low
A business’s DSC ratio shows how much profit it produces annually compared to their loan repayment obligations. A greater DSC would imply a higher likelihood of a business having the ability to sustain its loan obligations with earnings, and therefore most likely that you would get a loan.
e.g. Your present DSC is 1.5 x, due to existing loans. If the requested new loan is approved, your DSC ratio falls to 0.8 x which suggests that annual profits are no longer able to support the repayments.
Formulae listed below.
DSC Ratio = Net Operating Income / Debt Service
Net Operating Income = Net Income + Amortization and Depreciation + Interest Expense + Other Non-cash Items
Debt Service = Principal Repayment + Interest Payments + Lease Payments
In summary, a bank’s perspective on whether your business would be eligible for a loan is not hard to understand. Before one embarks on a business, you would have already assessed whether your business can be profitable and the cash flow required to sustain the business. As banks and financial institutions are adopting automated credit assessment tools, one of the parameters would be a company’s profitability. Hence a loss-making company would trigger the system to “immediately fail” the credit assessment. So plan well, and have your financing in place first so that you do not scramble for when you need it urgently.
TYPES OF SME FINANCING FACILITIES
Unsecured business term loans
Government financing schemes
- SME Micro Loan
– For local SMEs with annual turnover $1M or less OR employees 10 or less
-Maximum funding amount $100K
-Repayment period up to 4 years
- SME Working Capital Loan
-For local SMEs group annual turnover<$100M or group employment size < 200
-Maximum funding amount $300K
-Repayment period up to 5 years
- Equipment and machinery loan
- Commercial and industrial property loan
- Factoring and receivables invoice financing
- Trade financing
- Business overdraft
TYPICAL INTEREST RATES
- Unsecured business term loan interest rates range between 8% to 12% p.a. effective rate.
- Government financing schemes bears interest of about 7% to 9% p.a. effective rate.
- Secured loans for equipment and machinery loans interest ranges between 2% to 7% p.a. flat rate.
- Revolving facilities such as trade financing and factoring interest is between 6% to 9% p.a. effective rate.
- Property financing is the cheapest form of financing with interest between 2% to 4% p.a. effective rate.
- Interest rates varies between different banks.
HOW TO INCREASE YOUR CHANCES?
- Positive Revenue and Profitability
- Pick the right time to apply for a business loan – banks need time to put up for approval
- Understand what you need and choose the right loan product
- No return cheques
- Healthy bank balances
- Maintain a good personal credit record (Credit Bureau Search <6 times)
- Declare a reasonable amount of annual income (minimally $35K pa).
- Good payment record on personal credit lines
Article by: Shamir Wahid
Shamir Wahid is the founder of Dayn Advisory LLP, which is a mortgage and loan advisory business to assist individuals and business owners source for the best rates from the various banks and financiers. He has more than 8 years of banking experience and used to work across various areas in Retail, Corporate and Private banking (including Islamic finance) for one of the largest banks in Southeast Asia. He is also currently the Assistant Honorary Treasurer for Singapore Malay Chamber of Commerce Industry.