What the bank looks at before lending money to your small business
Asking for a loan shouldn’t be a surprise in either direction. The bank decides with numbers, and almost always the same ones. If you know them and calculate them yourself beforehand, you arrive at the meeting knowing what they are going to tell you and with your answers ready.
The underlying question: will you be able to repay it?
The bank’s whole analysis boils down to that. To answer it, it looks at three things: how much you generate, how much you already owe and whether you have a margin for the unexpected. Each one has its indicators.
How much you owe compared with what you generate
The most widely used indicator is financial debt / EBITDA:
Financial debt ÷ EBITDA for the last 12 months
EBITDA is, in simplified terms, what your business activity generates before interest, taxes, depreciation and amortization. The result is read in years: a 2 means that, with what you generate in a year, you would need two years to repay all your debt with banks and finance companies.
Its variant, net debt / EBITDA, subtracts the cash you already have in the bank. If you have €300,000 of debt, €100,000 in the bank and EBITDA of €100,000, your financial debt / EBITDA is 3, but your net debt / EBITDA is 2.
Each bank and each sector uses its own benchmarks, so there is no magic figure. What is always looked at is the trend: if the indicator rises year after year, debt is growing faster than your ability to pay it.
Whether you have enough to pay the interest
Interest cover says how many times your EBITDA covers the interest you pay:
EBITDA for the last 12 months ÷ Financial expenses for the last 12 months
With EBITDA of €100,000 and €10,000 of interest a year, cover is 10 times: comfortable. If it were 2 times, a bad season would put the payment of interest at risk, and the bank knows it.
Whether you can hold up day to day
Even if the company is solvent in the long term, the bank wants to see that you are not tight on cash. For that it looks at:
- The current ratio: what you have in the short term (cash, customers, stock) versus what you owe in the short term.
- Collection and payment periods. A collection period that stretches or stock that grows for no reason suggests the loan is going to plug a working capital hole.
- Your history with the bank: overdrafts, returned direct debits, installments paid late. All of that weighs as much as the accounts.
Margins
A business with a good gross margin withstands a drop in sales better than one that is running tight. The bank compares your margins this year with previous ones: if they fall, it will ask why and what you are going to do.
How to prepare for the meeting
- Calculate the indicators yourself beforehand, with the accounts of the last year and the current one. That way they don’t surprise you.
- Explain what the money is for and how it is repaid. “For working capital” convinces less than “to finance the stock for this customer’s order, which is collected in 60 days”.
- Bring a cash flow forecast that shows when the money that will pay the installments comes in. You can start from how to make an 8-week forecast.
- Keep your collections up to date. Healthy receivables say a lot about how you manage.
- Compare offers by adding up interest and fees, not just the rate. We explain it in Credit line, factoring or confirming.
Frequently asked questions
What is a good debt/EBITDA ratio?
It depends on the sector and the bank, and there is no single figure that works for everyone. What matters is that you can explain yours, that it doesn’t rise year after year and that your forecast shows how you will pay the installments.
What happens if my EBITDA is negative?
Then debt/EBITDA cannot be calculated and the conversation with the bank changes: it will want to know why and when it will be positive again. It usually asks for more guarantees or a specific plan.
Does the bank look only at the annual accounts?
No. Besides the accounts, it looks at your company’s history with it and with other banks, the recent trend and, increasingly, how you are doing this year. Bringing the current year’s numbers helps.