September 19, 2014 Credit en_US 4 Business Financing Pitfalls to Avoid

4 Business Financing Pitfalls to Avoid

By Suzanne Kearns September 19, 2014

Here are four pitfalls to avoid when applying for a loan, and some tips about how to avoid them.

Pitfall 1: Having No Credit or Bad Credit

Lenders typically look at both personal and business credit. Review your personal credit reports. You can get a free personal report from all three credit reporting agencies once a year here. You’ll find your business PAYDEX score at Dun & Bradstreet, and also at Experian. If you don’t already have a D&B number (DUN), you should apply for one immediately.

Here are some tips to help improve bad credit:

  • Make sure your credit reports are accurate. If not, contact every credit reporting agency and ask that they be corrected.
  • If the marks are accurate, but there was a legitimate reason for a late payment, you can submit an explanatory statement that will be seen by the people looking at your report.
  • If the bad marks are legit, you’ll have to wait. Bad marks stay on your report for seven years. In the meantime, make sure your score is as good as it can be by making all payments on time and not carrying high balances on your credit cards.

If you’re a startup with no credit history, or someone who prefers to deal in cash, you’ll need to build up a good credit history if you want to get approved for a small-business loan. Some steps to take to build credit before you apply are below.

  • Think about incorporating your business to establish a separate legal identity.
  • Open a business bank account and use it for all of your business transactions.
  • Open supplier accounts and a business credit card account and charge small amounts to them every month, then pay them off early. If you have trouble qualifying for a credit card or vendor account, start with your local office supply store.

Pitfall 2: Not Having Sufficient Collateral

Collateral can often be used to fortify a loan application. Collateral can be in the form of business equipment and machinery, real estate owned by the business, inventory, or cash on hand.

Here are some things to consider when deciding on collateral:

  • Know the real value. Banks use the fair market value of your assets.
  • If you have a loan against the asset you want to use as collateral (such as property), the lending bank can refinance the loan and claim the title so the property can be used.
  • If you’re using your accounts receivables as collateral, banks won’t lend on 100 percent of their value. Depending on the age of the invoices, they’ll loan between 70 and 90 percent of their total face value.

Pitfall 3: Not Having Enough Cash Flow

The bank will need to know that you have enough cash flow to pay back the loan. Start increasing your cash flow before you apply for a loan, so you can show the bank a history of sufficient income.

Here are some ways to increase your cash flow right away:

  • Make a concentrated effort to collect bad debts.
  • Reduce or eliminate as many expenses as you can.
  • Think about factoring your outstanding invoices.
  • Look closely at staff schedules and eliminate unnecessary hours.
  • Teach your employees the art of up-selling and add-on sales.
  • Focus on marketing to your existing customer base.
  • Ask for terms from your suppliers and pay the invoices early to get a discount.

Pitfall 4: Waiting Until the Last Minute to Apply for a Loan

The loan approval and funding process takes time, sometimes as long as three months. Begin preparing your paperwork as soon as possible, and understand that the process will take time.

Avoiding the common pitfalls when applying for a loan can help you be in a stronger position if you decide a loan is the next best step for your business.

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Suzanne has been a full-time freelance writer for 20 years. She’s written for numerous business and financial publications such as Entrepreneur, Reason Magazine, Home Business Magazine, and Money Crashers. Read more