Most small business owners spend weeks researching loan options, interest rate comparisons and talking to lenders, but skip the one thing that actually makes a lender say yes. Creating a budget prior to applying is not a mere formality. Lenders can quickly determine whether a loan applicant has conducted prior research or merely compiled figures hastily when a budget is developed before a loan application.
A good budget gives a lender an indication that you know your business, and you have control over your finances, and most importantly, you know how you will pay them back. Without it, excellent business ideas can fail to get passed out.
How Creating a Budget Changes the Outcome of Your Loan Application
Lenders are looking at more than just your credit score. They want to know if your business can realistically take on new debt and not hit a wall in three months. Having a budget gives them that in black and white.
Think like the lender. They’re betting you’re good with money. A clean, tight budget demonstrates discipline. This means that the business isn’t just running on gut instinct, but is being run with some financial structure. According to the U.S. Small Business Administration, cash flow, debt obligations and operating expenses are usually key elements of the underwriting process for lenders.
What to Include When Creating a Budget for a Business Loan
This is where most business owners either get the deal done or lose the lenders’ confidence all together. There is no complicated formula or software program when it comes to creating a business budget.
1. Fixed and Variable Expenses
Fixed costs include rent, insurance, payroll and loan repayments. Some variable costs are not fixed month to month (inventory, shipping and seasonal marketing costs). You should list them both separately. Lenders want the whole picture, not the low hanging fruit.
2. Revenue Projections (Based on Reality)
Projections should be based on actual historical performance, not best case scenarios, and should be for a minimum of 12 months. If the business has been around for 2 or more years use that information. If it’s more recent, industry benchmarks from the Bureau of Labor Statistics or trade associations can help ground the numbers.
That is a mistake a lot of small business owners make, cash flow is not profit. A business can look good on paper and still run out of cash. Cash flow is the key concern for lenders, as it shows how much money is actually available to make repayments each month.
3. Existing Debt and Repayment of the New Loan
List of any existing lines of credit, loans for equipment, or leased items. When considering a loan, lenders rely on Debt Service Coverage Ratio (DSCR). DSCR, as calculated by lenders, is a test of whether the client has sufficient income to clear all debts, including the one whose figure is being calculated. Before submitting anything, incorporate the new loan’s estimated monthly payment into the budget.
How to Create a Budget for a Business That Lenders Will Actually Believe
The best way to create a budget is to build it for the business first and then show it to the lender and not build it for the lender. Honest construction of numbers will withstand scrutiny. These are the practices that separate a good budget from a bad one:
- 12-24 months of actual bank statements to establish your foundation
- Use separate personal and business finances for your application
- Have a CPA or bookkeeper look over the final document
- Be conservative on revenues and a little generous on expenses
- Be sure your budget matches the tax returns you will be submitting with your application
Budgeting Mistakes That Kill Loan Applications
Creating a budget in the wrong way can be just as bad as no budget at all. And lenders cross reference and check everything and these are the mistakes that quickly raise red flags.
- Inflating revenue estimates to make the business appear more profitable than it actually is
- Ignoring irregular costs such as annual software renewals or equipment maintenance
- Mixing personal and business expenses
- Submission of a budget that is inconsistent with the bank statements on file
Conclusion
Ultimately, the reason to create a budget before a business looks for a loan is less about the paperwork and more about showing that the business is a good investment. This is one of the strongest messages a small business owner can give a lender. Anything that puts any applicant ahead of the majority of people walking through that door is a thing. A business that has a budget that is honest and detailed and future-looking.
Figures don’t lie and nor does a well thought out budget. So get your finances in order before you approach any lender. That kind of preparation will say more than any pitch ever will.
