All businesses require finance for various reasons like expansion and growth. However, for small business owners, obtaining finance is difficult. Some loan applications are rejected for valid reasons. However, there are a few that are rejected due to an error made by the applicant.
While some of these mistakes may be immediately rectified, certain errors may take a long time to be corrected. Here are seven common reasons why business financing applications are rejected.
1.Low credit score
Some businesses may have low credit scores. Furthermore, owners or directors may also have low scores. This is considered to be an important factor by lenders. Financial institutions generally do not approve business loan applications with low business or individual credit scores. This is because it reflects poor repayment history. To prevent such situations, it is crucial that entrepreneurs have a firm grip on the financial aspects of their business and maintain a high credit score.
2. Inadequate security
Most lenders offer loans against security because the risks under unsecured financing are very high. Providing secured loans reduces the lenders’ risks because they may sell the collateral to recover the amount in case of defaults. Furthermore, the business loan interest rates for secured financing are lower. However, if the business owner does not have adequate security to cover the loan amount, the lender may reject the loan application. This may be possible even if the business has good profitability and cash flows.
Several business owners are ignorant when they provide collateral against the loan. If they offer security that has a significantly higher value than the borrowed amount, there may be some problems in the future. They may not have sufficient collateral for future loan applications. It is recommended business owners use retained earnings, owner’s equity, or fixed assets as collateral to apply for a loan.
4. Insufficient cash flows
Every business aims to make profits through its regular operations. Financial institutions offer business financing to help businesses expand and grow their profits. However, if businesses are unable to show adequate cash flows, getting a loan approval would be difficult. This is because cash flows directly impact the repayment capability of the entrepreneur. Insufficient cash flows reflect the business’ incapability to make timely repayments. However, adequate cash flows are not sufficient to ensure approval of the loan application. Lenders consider several other factors before approving the application. Robust cash flows are positively perceived by lenders and increase the possibility of loan approval.
5. Cash-dependent business
In case the business receives huge cash payments from buyers, lenders are reluctant to offer loans. This is because the owner may not report all the business income, which impacts the loan servicing capability. To overcome this limitation, business owners are advised to provide customers other options to make payments. This gives an assurance to the lenders and the possibility of rejection is reduced.
6.Low business value
It is possible that the lenders are not comfortable with the growth prospects of a business. Financial institutions rely on market capacity, financial statements, and ratios to make lending decisions. In case a business seems incapable of growth in the future, lenders are apprehensive and often reject the loan application.
7. Over-leveraged business
If the business already has a significant amount of outstanding debt, the lenders are wary of lending additional money. Over-leveraged businesses are perceived as high-risk and face rejection by lenders. It is recommended that entrepreneurs settle existing debt before availing of additional loans to prevent falling into debt traps.
Having understood the common reasons why business loans in India are rejected, it is crucial to remember that the most important asset for small ventures is the entrepreneur. His vision, capability to develop relationships, and operational abilities are the important foundations of a successful business. If lenders are confident on the entrepreneur’s capabilities, they may be willing to negotiate on other factors and approve the loan application.