When an organization is seeking loan finance, lenders will consider several factors. They will obviously be concerned with the return they receive and ensuring that return is reasonable given the level of risk default.
Other important factors that lenders consider before granting a loan are:
1. Purpose -
Loan to finance new businesses are likely to be risky. Lenders will be particularly careful to assess the business’s growth potential, strategy and the abilities of management to put their plans into effect. Borrowing to finance increase in working capital should normally be short-term and hence bank overdrafts be used. Lenders will be very cautious of funding long-term substantial increase in working capital because of the scope offered for poor management.
2. Amount -
The lender will wish to make sure the amount that is being requested is a reasonable estimate of the amount the borrower will need. The lender will be concerned if the borrower is not asking for too much, or more than is needed for the particular purpose. This consideration is linked in with the customer’s wealth and ability to repay. The lender will also be concerned if the borrower appears to be asking for less than he or she really needs, and may need more later.
3. Repayment -
The lender will want to make sure that the terms of payment are clear and that the borrower will be able to obtain sufficient income to make the necessary repayments. The lender will therefore examine the borrower’s accounts for signs of problems such as declining profits, excessive gearing or poor control over working capital
4. Term -
The lender will be sure that the term of the loan is appropriate, and in particular, whether the term appears consistent with the timescale of the income stream that will be used to finance repayment
5. Security -
The lenders will ask for security and may be concerned that the security is adequate. However, the likelihood that the advance will be repaid is the most important requirement for a loan. A lender should not lend money to a person or business that has got the resources to repay it with interest, even if it also has security for a loan. Security for the loan gives the lender the right to take certain assets if the borrower defaults. Security is only a safety net.
On a final note, the capital base of a company should be expressed in meaningful terms. A poor profit may translate into a high return on investment if the capital base is measured in historic terms. Inflation hinders the attempt to measure company performance on a consistent basis and thus could cloud the judgment of providers of capital in seeking out the most profitable areas for investment.
