By Tarek El-Sheikh
VP of Credit Risk Management, Camino Financial
Have you been denied a small business loan because of bad credit?
Well, don’t worry.
It is not the end of the world and there is still hope to get the small business loan you deserve. Remember, weak credit is not always the reason for denial. Many bad practices by small business owners result in business loan denials and are easily adjustable in a matter of a couple of months. There are no shortcuts to building appropriate fundamentals of a business and, unfortunately, many small businss owners try to take a short cut. Here we describe the importance of good credit and the details in this article will help you understand simple do’s and don’ts. If you want to get off to a fundamentally correct start on your business and quickly become eligible for business credit, follow these four steps for success.
1. Separate Business Expenses From Personal Expenses
It is not wise to use your business bank accounts to pay for your rent, insurance or to eat out and shop. Seriously. You need to look at your business as a different entity and learn to identify your expenses. Separating your business and personal expenses is not only best practice, but necessary!
Stop using your business bank accounts for personal use
Front loading your personal expenses onto your business account may be a way to decrease your business taxes. It may also seem easier to manage one combined bank account but it will come back to bite and hurt your approval probability when applying for a business loan.
How combined expenses affect your business loan application
Okay, but how does it affect the probability of getting approved for a business loan? Here’s the deal. When the underwriter takes a look at your business bank statements it will show very tight business cash flows (deposits – withdrawals). This demonstrates no room for further business debt. In addition, if your business bank account is linked to your QuickBooks, your business tax returns and business financials will dramatically drop. This would show further signs of tight debt capacity leading to a denial.
2. Deposit All Cash to Your Business Account
Even if you transact in cash, deposit the funds please. There is no other way to prove your business growth and the true size of your business. Besides, keeping your cash under a mattress or stored away somewhere is just not safe or smart!
Deposit any and all business cash into the business bank account
Make it a ritual to make a trip to your nearest bank location to deposit all your cash once a week or however often you need to, and make it a routine. Once you start doing this, you will be able to monitor and manage your cash flows much better. trust me, there is nothing more important than having a clear picture of your business.
What happens if you do not deposit business cash
If you do not deposit the funds, they will not be considered at underwriting which can lead to a denial or a lower loan amount than what you truly deserve. A larger or growing business increases your probability of approval. It may also increase your approved loan amount. Makes sense, right?
3. Give Yourself An Income
Yes, you are the business owner and this is your business. But, you have to play by the rules! Simply taking money in the form of cash withdrawals or checks will result in tight business cash flows (deposits – withdrawals).
Do not withdraw cash and checks from the business bank account for personal use
This demonstrates your business entity has no room for further business debt. It is not recommended to withraw cash and checks from your business bank account to make personal payments or to pay for a family vacation. Your business bank account should be used for business purposes only, for example paying your employees, suppliers or for inventory.
Why paying yourself is a good idea
Now, if you need funds, pay yourself a monthly W-2 or 1099 income. Yes, you can be an employee in your own business. Your business is a separate entity on its own. Paying yourself W-2 or 1099 income will allow the underwriter to consider this as an extra income. Extra income means higher probability for approval and/or a higher approved loan amount. It’s a win-win situation. Don’t be afraid to start doing this now. Of course you need to do a little homework, perhaps with the help of an accountant or someone who can evaluate your business in order to determine how much to pay yourself. Or you can simply analyze your business yourself to figure this out.
4. Avoid Using Personal Credit Cards for Business
While it may be easier to attain a personal credit facility, this will not build your business credit and if you are planning to apply or re-apply for a business loan soon, it is best to start building business credit. Avoid using personal credit cards, auto loans and loans to support the business under any and all circumstances.
Build your business credit sooner rather than later
You need to start building your business credit as early on as possible. You have options, for example you can take out a small 6-12 months business loan or get a small business credit card from AMEX or any bank. It is all about the relationship with the lender when it comes to business loans. Start building a relationship with your banker now.
If you start with these 4 steps today, you are on the road to building your business credit. It may seem like a lot of work, but actually it is just about re-framing your mind, practicing a little discipline and staying aware of your progress. You will see that in just a few months, the changes in your behavior will have a huge impact on your business credit! While it will take some time to build your business credit in order to submit a successful business loan application, this does not mean you have to stay out of touch with your banker or stop learning what else you can do to build your business credit. Stay proactive about your progress and soon enough you will have the business credit you need to apply for a business loan.