How Banks Assess Your Risk Level

While the media talks about the lack of credit that’s available for small businesses it is important to realize that banks and lenders do want to make loans. They are in the business to lend money because that’s how they make money. The risk involved is minimized depending on factors related to the company’s sales revenues, credit standing, years in business, etc. However, due to the recent economic downturn, certain risks that banks and lenders were once willing to accept are no longer acceptable. This doesn’t necessarily mean that there is no money to lend it simply means that the standards have changed.

Less risk means lower rates and returns for the banks, but in this economy it is all about minimizing risk and exposure. Banks and lenders are more focused on lending to creditworthy businesses at a lower rate, rather than a riskier business at a higher rate, simply because of the state of the economy. The lending parameters of major banks are driven more by economic climate than anything else. For example, if the economy was booming than banks would be willing to take on much more riskier loans simply because the economy is in a healthy state. So what can you do to be considered as a low risk so your business can qualify for a loan or line of credit? Each of these areas plays an important role for lenders when determining your risk level: Capacity – This is an evaluation of your ability to repay a loan or line of credit.

This includes cash flow, payment history, and additional cash sources. The best way to show your capacity is with favorable business credit scores, a solid bank rating (minimum of a low 5), a well designed business plan and/or prior year(s) financials that show you can produce enough cash to repay the loan. Capital – Typically, a company's owner must have his own funds invested and at risk in the company before a financial institution will be willing to risk their own investment. How much skin you have in the game is very important and can make the difference between an approval and denial. Collateral – Commercial real estate, heavy machinery, business equipment, inventory, stocks and bonds, and other expensive business assets that can be sold if a business fails to repay the loan are considered collateral.

Conditions– Be prepared to prove that the conditions are right for your business. Make sure there is market potential, an industry, positioning, competitiveness, and experience to back up your plan. Character –Lenders have to believe that a business owner is a reliable individual who can be depended on to repay the loan. Some areas they look into include personal credit ratings, education, and work experience. When applying for financing, don't forget the importance of personal relationships. Apply for a loan or a line of credit at a bank where you already have a positive business relationship. Also, make an attempt to meet with the person who will be evaluating your application, such as a bank's lending officer, rather than the teller who handles your day-to-day banking transactions. The less risk you pose to a bank or lender the greater the chance you have for securing the financing you need at the best interest rates possible.

Getting More Working Capital for Your Business

Lanette Tucker has been with Paragon Financial for 2 years and knows all things factoring.   Paragon Financial was founded in 1994 with the initiative to afford growing businesses an alternative to conventional bank financing. When banks either couldn't grant funds or bestowed too little, Paragon could promptly offer them a steady stream of cash through the factoring of their account receivables.

A common scenario today in business is having a low credit line from your bank.  Lets say you have a $50,000 dollar line of credit with your bank.  You have a long-standing, excellent relationship with your bank but in today's economy it is simply just not enough.   Your credit line is maxed out and the true need of your business is financing of $200,000 or $300,000 dollars to keep your business growing.  What can you do in this situation?  Your business has good credit, the orders are coming in and you are growing at a steady pace.  The only way to take your business to the next level is to secure that much larger line of credit.  What is the solution?

Your business can leverage against your receivables through invoice factoring or purchase order financing through a factoring company.  An experienced factor can work directly with your bank on a subordination agreement allowing you to leverage receivables financing to get the working capital you need to grow your business.

First, what is bank subordination?   A subordination is when a 2nd lender, in this case the factor, asks the 1st lender, the bank, if they will allow the business to take on an additional lender.   Bank subordination agreements are commonly done when leveraging accounts receivable and purchase orders. The accounts receivable or PO's are assets that are used to secure a working capital line of credit.   One of the most common ways lenders will work with each other is through subordination.  Allowing the business to take on both a traditional line of credit and a factoring line of credit

A factoring company can work with your bank and create a bank subordination agreement where their $50,000 dollars is covered by other assets and then a factor can fund against your accounts receivable or purchase orders up to 95%.  This allows the business to take on larger jobs, fund payroll each week and pay for other expenses.  The key is working with a factoring company that has existing relationships with banks and has the experience necessary to compete the transaction. 

Factors are often able to finance your business when a bank will turn you down.   Your bank needs to keep the depository relationship.  Factors do not concern themselves with this because they are not a bank.  Factors simply buy your existing accounts receivables or purchase orders in order for that business to obtain immediate cash payment of the accounts.  They just want to get your the critical cash your company needs to grow your business.

Can't get a business loan? Look into these two alternatives

Sooner or later every business will need financing to be able to survive and grow to the next level. This is true for every company, regardless of size. If you are a business owner and you need money,...

Sooner or later every business will need financing to be able to survive and grow to the next level. This is true for every company, regardless of size. If you are a business owner and you need money, your first stop is likely to be your bank.

Banks offer a number of financial products, but business owners generally try to get business loans or lines of credit. While both can help you grow your business, they are also very hard to qualify for. Banks usually require that the business have significant assets, collateral and 3 years of audited financial statements.

What if you don’t meet these tough criteria? Are there any alternatives?

There are two financial products that may be able to help you significantly. Let’s look at two statements:

a) I have a lot of money tied up in slow paying invoices - and/or -
b) I have a big purchase order and cannot afford to pay my suppliers

If you can answer yes to either of these statements, you can benefit from either factoring or purchase order financing. Both are great alternatives to bank loans.

Factoring provides you with financing based solely on your slow paying invoices. The financing is determined by your invoicing. If your invoicing grows, so does your financing.

Purchase order financing is ideal for distributors, wholesalers and resellers who work with large purchase orders but cannot afford to pay their suppliers. The purchase order financing company pays your suppliers and helps you deliver the sales. They get paid once the end client pays the invoice for the delivered products.

Both invoice factoring and purchase order financing are easy to qualify for and available to businesses regardless of size. They are ideal products for businesses that are growing.