fbpx
Site Loader
What-is-credit-assessment-and-how-does-it-work-

What is credit assessment and how does it work?

Are you thinking of borrowing money to grow your business? If so, you might have done some research into the application process and into the many available online lenders.

You might have noticed as a part of the process, lenders will seek to perform a credit analysis before providing the funds to the borrower. In this article, we will discuss what a credit assessment is, how it works, and ways in which you can improve your business’s creditworthiness.

In a nutshell, a credit assessment is a lender’s process to determine your ability to repay the loan and how risky it is for them. Before providing credit to a business, the lender needs to feel secure in the borrower’s ability to repay that debt. As the lender’s main source of income is interest on the repaid debt from the borrowers, they cannot go around handing out cheques to people who can’t afford to pay them back. They would simply go into default themselves. 

So what exactly are they looking for when conducting a credit assessment? What are some of the potential red flags? And what are some positive signs to look for in someone who is good with money and can repay the debt? 

Below are some of the criteria lenders will analyse when making their final decision if your business qualifies for funding:

Credit rating

Your credit rating/score is usually the starting point for many lenders when considering to lend money. Your credit score is your history of borrowing money and paying debts on time. It can usually be a culmination of all credit cards, loans (including mortgages, personal loans and car loans etc.), phone plans, and bills. 

If you have a good history of paying on time, your credit score will generally be higher. If you simply have not borrowed money and have no history to show in doing so or have not paid bills yourself, then this could impact your score negatively. Of course, if you have borrowed money or been responsible for bills and have not made payments on time, this will also affect your score.

Although this does not mean that all hope is lost, you can still be eligible for credit even with a lower score, the lender will then often look for other ways to minimise their risk such as requesting collateral or applying a higher rate of interest. You can also begin to improve your score by starting with small financial payment obligations such as a phone plan and building your history. You can find out more about credit scores, including how to obtain your credit score here

Time in business

Lenders will also check how long your business has been operating for. It’s an important criteria as it not only gives the business credibility but also a longer credit history for the lender to analyse and assess. This doesn’t mean that you won’t get a loan if you haven’t been operating for that long. It simply means you have to find the right lender to support you. And potentially pay a higher interest rate or have specific loan terms that reflect your business’s young age and the therefore increased risk to the lender. Make sure to do your research since lenders typically have different minimum “time in business” requirements. At Lumi we require a business to have been operating for at least 6 months for example. 

Cash flow 

An obvious indicator of whether or not a business can repay debt is to look at the cash flow coming into the business. At this point of the credit assessment, lenders will seek to look at end of financial year statements, bank account statements and assess total liabilities including utilities, rent, and wages. If they can see enough money is coming through to handle the extra loan repayments on top of the current financial requirements, then acquiring the funds will become more likely. Lumi has a helpful online calculator that you can use to work out your best repayment option.

Projected sales 

The lender will make a prognosis of the financial future of the business and benefits from seeing a business plan. Having a business plan ready to show the lender can be extremely advantageous. Lenders may like to see where the money is going to go and how this will help grow the business and thus the sales. Which all leads to a positive showing in the ability to repay the loan.

History of bankruptcy 

An important step in the credit assessment process is to check if anyone involved in the direct repayment of the loan has ever filed for bankruptcy. Again this does not mean that all is lost if there is someone involved who has previously filed for bankruptcy. But the lender has the right to know and use this in their decision-making process.

How can your credit assessment affect your application?

Your credit assessment can impact your ability to borrow money. However, the outcome can be both positive and negative. Lumi has a clear and easy application process that will also give you a good idea of how your credit assessment will work.

Let’s look at an example. A restaurant has recently experienced some difficulty with sales due to a lack of stability in their kitchen staff. They had to replace the chef several times in the same year. This has impacted the quality of the food and as a result, they have lost loyal customers. The restaurant has previously had difficulty paying for bills on time. They are now looking to improve their situation by providing a better wage to their new chef, a new menu, and a restaurant fit-out. Unfortunately, upon applying for a new unsecured loan their financial statements are showing reduced cash flows and a troubling credit history. 

Upon determining the risk of the borrower, the lender might suggest for them to secure the loan and instead use collateral such as property to ensure they can repay. They might still be able to borrow the money they need. 

Lumi has the same helpful processes in place to enable small businesses to thrive. 

Now another example, Bill is looking to expand his boxing gym by opening a new location. His method of training has been a success in the local community. Memberships are through the roof and cash flow is abundant. He just needs a large sum to fit out the new facility and get started. He presents a strong business plan to the lender and also has 2 years of experience in the industry in owning and operating the current gym. The lender deems this as a reduced risk and is able to quickly provide Bill with the funds to secure his new premises without asking for collateral.

There are many ways you can prepare for your credit assessment. Make sure you know your situation and research you options. If you’re ready to apply, check out our business loan offering at the Lumi website.

Disclaimer: All examples provided in this article are fictitious.

Post Author: Vanessa Muller

Leave a Reply

Your email address will not be published.