Entrepreneurs never know when inspiration will strike. Many people already may have been inspired by a revolutionary idea for an innovative new product or service. But, as most entrepreneurs know, coming up with an idea is the easy part; it’s much more challenging to turn the idea into an actual business opportunity.
According to the U.S. Small Business Administration, more than 627,000 new businesses are started each year. Unfortunately, not all businesses are set up for success because, on average, more than 595,000 close their doors each year.
One common reason a business closes is the inability to properly manage cash flow. Cash flow is the largest determining factor of a small business’ success or failure. Most startup businesses will require at least some funding from a bank or other financial institution. Before a company opens its doors, there should be a plan for managing cash flow and creating safety nets for times when it’s slow.
As a result, we are often asked what banks and other lenders look for in order to agree to offer a business loan to a startup. As entrepreneurs prepare to enter the marketplace, here are some of the most important factors that financial institutions want to see in a business plan to approve a loan.
Financial institutions rely on business plans to not only make decisions on lending but also to determine the best mix of banking products and services that will appropriately benefit their business customers.
Having a business plan is critical for both the business owner and the financial institution. Not only does a business plan provide a road map for research, it also drastically increases the chance for success, namely consistent growth and investment. For startups, a business plan allows entrepreneurs to create a blueprint that includes creation, operation, promotion and success of the company in specific details.
A business plan that extensively states the vision, strategy and future of the company is more likely to sell a lender on the idea. Within the plan, lenders look for additional details outside of the financials, such as a prospective company’s industry analysis to determine if the mission aligns with the needs of the area and whether there is enough available market share to be profitable.
Entrepreneurs also should undertake comprehensive market analysis that includes demographics of prospective customers and their spending habits, as well as key competitors. Equally important is to clearly explain the point of difference the planned company offers in comparison to its competitors and how that distinction will influence purchases.
Realistic financial projections are a critical point that lenders will review. Do they compare with industry standards, and are they in line with the current performance of similar businesses? One of the biggest mistakes entrepreneurs make in preparing their business plan is to inflate financials beyond industry averages. Lenders recognize this stretch and, more often than not, will see it as an area of concern.
In addition to profit and loss projections, lenders review anticipated cash flow for the next three to five years. Business owners typically think about costs and expenses compared with sales, but timing and delays play a big role in managing cash. Loan officers look closely at accounts receivable and inventory turnover ratios, which are other indicators of good cash flow cycles. Higher turnover ratios are desirable as they indicate management does not hold onto excess inventories and inventories are highly marketable.
Proof that stakeholders know their business or have a record of success helps a plan stand out when it is under review. Applicants should include extensive profiles of the business partners, management team, investors and any other key players involved in the business endeavor. Collaboration or partnerships with individuals who have a history of business acumen bodes well for budding and seasoned entrepreneurs alike.
Financial institutions prefer proof of a secondary source of repayment in the event a business struggles. Those sources include cash savings, a strong guarantor with liquid assets, excess collateral, etc. Banks must protect depositors with every loan, so proof of alternate sources for repayment is critical for loan applicants.
A banker’s best advice for prospective business owners: Do your homework. Simply put, know the industry, create a point of difference, outline a solid and realistic balance sheet, and assemble a reputable and experienced team.
Lenders want to help small businesses succeed, and the legwork done in the planning stages can be a strong indicator of the success that may follow.
Kala Forehand is a business banking manager for Arvest Bank. She can be reached at email@example.com.
Fishing retail shop Modern Outdoor Tackle moved; Healthy Spot LLC opened; and Springfield law firm Strong, Garner & Bauer PC changed names and moved its office.