Most people know they can hurt their chances of receiving a line of personal credit by making certain mistakes, such as paying bills late. But businesses, too, can blunder when it comes to applying for credit.
If your company recently applied for business credit and was rejected, it’s not alone. A recent survey of banks and asset-based lenders found they rejected more than a third of all businesses’ applications for loans, according to Pepperdine University’s 2013 Capital Markets Report. If your business credit application is denied, what should you do?
The first step is no different than when a personal loan is denied. Before exploring other loan options, you should try to find out why the application was denied. According to the Federal Trade Commission, you should submit a written request for the reasons within 60 days of the denial, and the creditor must give you the specifics in writing within 30 days of the request. Consider discussing any concerns you have with your lender, and you may be able to resolve the problems. The Equal Credit Opportunity Act prohibits creditors from denying a loan based on reasons that have nothing to do with your creditworthiness, per FTC regulations.
In the Pepperdine study, a company’s size or economic concerns were rarely cited as the reasons for declined loans. The top reasons instead were linked to the quality of the business’s earnings or cash flow, or to the fact that a company lacked sufficient collateral.
After being denied business credit, it may be tempting to apply for a personal line of credit for your business. However, experts warn against mingling personal credit with the financial assets of a business because it increases the liability of shareholders or partners of a corporate entity.
So instead of turning to personal credit, the next thing you can do if your business credit was denied is take a good look at your own business. Examine how it rates on the financial metrics that can best predict default — the exact scenario lenders want to avoid. Similar to a pre-approval process for a personal loan, a business credit report is one way to see how your firm stacks up against its peers.
Below are five financial metrics that Sageworks Inc., a financial information company, has identified as the best predictors of default, so if you’ve been denied credit, consider working to improve your company’s measurements in these areas.
Cash to assets. This is a key measure of liquidity that indicates how much flexibility a firm has to deploy cash or access liquid accounts in order to make good investments, says Lawrence Litowitz, a partner at strategic advisory firm The SCA Group LLC. Managing your accounts receivable to ensure you’re getting paid as quickly as possible and managing inventory to avoid tying up cash are two ways to improve this metric.
EBITDA to assets. Comparing EBITDA (earnings before interest, taxes, depreciation and amortization) to a company’s assets helps show how efficient the business is. Improving this metric often involves either raising revenues (without a similar increase in expenses) or cutting costs. Not easy tasks, but using customer suggestions or improving planning are a few ways to boost revenues. Review overhead expenses, such as telephone and equipment, or revisit vendor contracts to seek expense savings.
Debt service coverage ratio. This is measured by comparing EBITDA to a firm’s current portion of long-term debt and interest expense, so boosting EBITDA with some of the suggestions above could yield improvement in the ratio. One effective way to tackle the debt and interest side of this ratio is to cut expenses and apply the savings toward paying principal on the debt.
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Liabilities to assets. This ratio indicates how much of your assets are financed through debt, as opposed to through profits from the business, so improving this metric is all about reducing your debt. The Better Business Bureau recommends making the biggest debt payment possible each month, especially for credit cards, which typically carry high interest rates that otherwise accrue interest payable, another liability account.
Net income to sales. This is a fundamental measure of how profitable your business is. Cutting operating expenses can be a short-term way to boost this ratio, but it can also backfire, so tread carefully. For example, skimping on equipment maintenance could lead to more expensive repairs or replacements. Longer-term goals required to improve profitability involve lowering production costs and increasing higher-profit sales.
Running a successful business isn’t a sprint; it’s a marathon. In the same way, addressing issues that contributed to a credit denial may take months, or even years. But in the long run, the efforts should help you win not only a loan but also a better, more lucrative business.
Image: Siri Stafford