Can Your Business Qualify for a Loan? Let’s Find Out

Meet Onyango. A skilled mechanic who owns a small auto repair shop in town. Onyango’s garage is well-known for its excellent service and trusted repairs.

But Onyango has a dream. He wants to expand his shop into a full-service automotive center, complete with state-of-the-art equipment, more mechanics on staff, and a comfortable waiting area for his customers. 

However, there's a roadblock on the path to Onyango's aspirations.  He needs money to actualise his dream. 

This is where business loans step in. So, what exactly is a business loan?

It’s borrowing money from a bank or a lending company to improve your business and then paying it back over time with interest. 

These loans are like the engine for business owners like Onyango, giving them the financial power to rev up their ambitions.

This article will explore what business loans are all about and how they can help businesses grow. 

We'll discuss why they're crucial, the types available, how to choose the right one, eligibility criteria, and how to pay back smoothly. 

Let's get started.

The Role of Business Loans

Business loans are solely meant for business purposes. Lenders can penalize you if you use them for personal expenses like buying a new house or vacationing. 

Here are the specific purposes of a business loan.

• Expand your business: When you want to open a new location,  renovate an existing space, or seize a new opportunity.
• Buy equipment: Need a new machine or a fleet of vehicles? Business loans can cover the cost.
• Stock up: Keep your shelves full by using a loan to buy inventory.
• Handle surprises: A business loan can save the day when unexpected expenses, like repairs or compliance issues, pop up.
• Cash flow support: Prevent cash flow hiccups by using a loan while waiting on payments.
• Payroll security: Ensure your team gets paid on time, no matter what.

Read Also: All You Need to Know About Business Loans In Kenya.

Assessing Your Business's Financial Health

Knowing the financial health of your business can help you make more informed decisions about the direction to take and how to allocate resources. 

To gauge your business’s financial health and long-term sustainability, evaluate the following four areas of your business.

1. Liquidity

Liquidity measures a business’s ability to meet its short-term financial obligations promptly. To assess liquidity, consider:

• Current ratio: Divide current assets (like cash and accounts receivable) by current liabilities (like bills and loans due soon). A ratio above 1 suggests good liquidity.
• Quick / Acid-test ratio: This is similar to the current ratio but excludes less liquid assets like inventory. It gives a more conservative view of liquidity.

2. Solvency

Solvency assesses a company's ability to meet its long-term financial obligations. To evaluate solvency, look at:

• Debt-to-equity ratio: Divide total debt by shareholder equity. A lower ratio indicates less financial risk.
• Interest coverage ratio: Divide earnings before interest and taxes (EBIT) by interest expenses. A higher ratio suggests better solvency.

3. Operating efficiency

Operating efficiency measures how well a business manages its resources to generate profits. Key indicators include:

• Inventory turnover: Divide the cost of goods sold by average inventory. A higher turnover is better.
• Accounts receivable turnover: Divide sales by average accounts receivable. A higher ratio means faster collection of payments.

4. Profitability

Profitability reveals how well a business generates profits from its operations. Key metrics to consider include:

• Gross profit margin: Divide gross profit by total revenue. Higher margins indicate more profitability.
• Net profit margin: Divide net profit (after all expenses) by total revenue. A higher percentage signifies greater overall profitability.

Read Also: 10 Strategies That Can Help You Grow Your Business in Kenya

Eligibility Criteria for Business Loans in Kenya

Every lender has bespoke eligibility criteria. As such, always review the specific requirements before applying for a loan.

This way, you can avoid the frustration of applying for loans you may not meet the qualifications for, saving you time and effort.

Here are some of the most common eligibility criteria that lenders typically consider when evaluating loan applications:

1. Business registration

A lender may ask for specific documentation depending on your business structure:

• Certificate of registration for solopreneurs.
• Certificate of incorporation if you're a limited company.
• Other necessary permits and licenses.

2. Time in business

Lenders often want to know how long your business has been operating. Startups might find securing loans more challenging than businesses with a few years of established history, especially if applying for a business loan via a bank.

3. Personal credit history

Lenders use your credit history to gauge your creditworthiness and risk as a borrower.

Read Also: Common Characteristics of Highly Effective Entrepreneurs

4. Business banking history

Lenders may review your business's banking history to assess your financial stability and cash flow. They could ask for account statements and transaction history.

5. Revenue, profits, and cash flow

Lenders want to ensure you have the means to repay the loan. According to the lenders, be prepared to provide:

• Bank statements.
• Balance sheets.
• Accounts receivables.
• Cash flow statements.
• Profit and loss statements.
• Tax compliance certificates.

6. Demonstration of future business viability

Lenders want to see that your business is likely to succeed. This might require:

• Cash flow projections.
• Updated balance sheets.
• Income statements.

7. Current debt

Lenders consider your existing debt obligations, such as outstanding loans or credit lines. Reducing existing debt can enhance your eligibility.

8. Purpose

Clearly stating the loan's purpose helps lenders understand how you plan to use the funds.

Read Also: How to Make Your Small Business Competitive

8. Collateral

If the loan requires collateral, you must offer assets like real estate, equipment, or inventory as security. Collateral reduces the lender's risk.

9. Business plan

A well-structured business plan can help lenders understand your business goals and strategies.

The Importance of a Business Plan

A business plan is instrumental for business loan eligibility. It’s important, especially for start-ups, as they often lack revenue, profits, and financial statements. 

Here's why a business plan is crucial for loan eligibility.

1. A well-crafted business plan showcases your business idea's viability, outlining how it will succeed in the market. 
2.  It allows lenders to gauge your potential to generate revenue and repay the loan.
3. Lenders use your business plan to assess potential risks and your strategies to mitigate them. 
4.  A business plan clarifies why you need financing, what you'll use it for, and how it will benefit your business. 

Read Also: Eligibility Requirement for Business Loans in Kenya.

Now, let's outline simple steps for creating a business plan that demonstrates your need for financing:

Steps to create a business plan for financing:

• Executive summary: Start with a concise summary of your business idea, market potential, and financing needs. 
• Business description: Describe your business, including its mission, vision, and goals.
• Market analysis: Conduct thorough market research to demonstrate your understanding of your target market, size, and trends.
• Products or services: Detail your offerings and their features, benefits, and competitive advantages.
• Operational plan: Outline your business's day-to-day operations, including production processes, technology, and logistics. 
• Management team: Show that you have the expertise to lead the business to success.
• Financial projections: Create realistic financial projections, including sales forecasts, income statements, cash flow statements, and balance sheets. 
• Funding request: Specify the amount of financing you need and its purpose.
• Repayment plan: Outline your proposed loan repayment schedule, including interest rates and terms.
• Appendix: Include any supporting documents, such as market research data, resumes of key team members, and relevant legal documents.

Preparing Your Application

Here are some essential tips to help you prepare for your business loan application:

1. Research and compare different lenders to understand interest rates, terms, and eligibility criteria.

2. Pay bills on time, manage existing debt wisely, and correct any inaccuracies in your credit reports to maintain a good credit standing. 

3. Prepare relevant documents. Here are some key documents to have ready:

• ID/Passport
• KRA pin: 
• Necessary business permits
• Audited financial statements.
• Proof of collateral
• Payroll records
• Certified bank statements
• Business plan
• Certificate of business registration
• Certificate of incorporation: 
• Legal contracts and agreements

>>>>> Compare Kenya’s Top Business Loans

Types of Business Loans

Let’s now look at the different types of business loans.

1. Unsecured working capital loan: This loan provides funds for day-to-day operational expenses without requiring collateral. It's based on your business's creditworthiness.
2. Term loan (short and long-term): Term loans are lump-sum loans with fixed repayment schedules. Short-term loans typically last 2 to 24 months, while long-term loans can extend from 2 to 20 years.
3. Business line of credit: Offers a revolving credit limit you can draw from as needed.
4. Asset finance: They are meant for purchasing equipment or assets for your business. The asset itself often serves as collateral, reducing the lender's risk.
5. Commercial real estate: The loan is for purchasing, refinancing, or renovating commercial properties.
6. Invoice discounting: It aims at improving cash flow by allowing you to access a portion of your outstanding invoices' value before your customers pay. 
7. LPO financing (Local Purchase Order): LPO financing helps businesses fulfill purchase orders by providing funds to procure necessary materials or goods, ensuring you meet client demands.
8. Business credit cards: Business credit cards offer revolving credit for everyday expenses. They often come with rewards and benefits tailored to business needs.
9. Overdraft: An overdraft provides a line of credit linked to your business bank account. It covers short-term cash shortages and helps manage fluctuations in cash flow.
10. Cash advance: A cash advance offers a lump sum based on future credit card sales. 
11. Government loans: They offer financial support to businesses at lower interest rates and terms. They are designed to stimulate economic growth. An example is the Hustler’s Fund.

Read Also:  Types of Business Loans in Kenya.

Choosing the Right Lender

You can use our business loan finder tool to compare and select the best lender. 

When selecting the right lender, several critical factors should guide your decision:

1. Consider your funding needs and ensure the lender can provide the necessary amount. 

2. If you require funds quickly, look for lenders with streamlined application processes and fast approval times.

3. Shop around to find the most competitive interest rates and favorable repayment terms

4. Understand the lender's eligibility requirements.

5. Research the lender's reputation to gauge their reliability and responsiveness.

6. Be aware of additional fees or charges beyond the interest rate. These can include late payment fees or prepayment penalties.

7. Ensure the lender offers the type of loan that aligns with your business needs.

The Loan Application Process

The loan application process can vary depending on the lender and the type of loan you're seeking, but here's a general walkthrough:

1. Preparation: Gather necessary documents.
2. Selecting a lender: Choose one that suits your needs.
3. Application submission: Complete forms and submit documents.
4. Credit check and review: Wait for credit assessment (this can take a few days to weeks).
5. Underwriting: The lender evaluates your application.
6. Approval or denial: You receive a decision and loan terms.
7. Acceptance and closing: Sign agreements and fulfill requirements.
8. Funding: Funds are disbursed (timelines vary).
9. Repayment: Begin repaying the loan on schedule.

Read Also: 5 Ways to Identify a Good Business Opportunity

Preparing for Your Loan Repayment

Planning for loan repayment is vital for your business's financial health. It ensures:

• You avoid last-minute financial stress by knowing what you owe and when.
• Timely repayments improve your credit score, making future borrowing easier.
• Allocating resources for loan payments upfront lets you focus on business growth.

Tips for effective loan repayment

1. Understand your loan terms, including interest rates and payment schedules.
2. Develop a budget that includes loan repayments, helping you allocate funds effectively.
3. Make timely payments a priority to avoid late fees and penalties.
4. Keep business and personal finances separate to maintain clarity and organization.

Read Also: Business Loans in Kenya: What You Need to Know.

Wrapping Up

In this article, we've delved into the world of business loans and their role in fostering business growth. We've highlighted their importance, dissected various types, provided guidance on selecting the right fit, and shed light on eligibility criteria. 

In addition, we've equipped you with insights on navigating the repayment journey with ease. With this knowledge, your business can harness the power of loans to thrive and achieve its growth aspirations.