When a business owner goes to the bank for financing, it’s not just about having a good story or a long relationship with the institution. Banks follow specific frameworks when reviewing loan applications, and understanding those frameworks can make all the difference in getting approved and securing favorable terms.
In today’s environment of falling interest rates, many business owners are revisiting their growth plans or exploring refinancing options. Before you approach a bank, it helps to see how your company looks from their side of the table. In this article, we’ll explore the different financing options and how to set yourself up for success before approaching the bank.
Understanding the Types of Business Loans
Most business loans fall into a few main categories, each serving a different purpose and evaluated differently by the bank.
1. Equipment Loans
These loans are used to purchase vehicles, machinery, or other technology. The bank often secures the loan against the equipment itself, meaning if you default, the bank can claim that asset. Because there’s built-in collateral, equipment loans typically have slightly lower interest rates and longer terms, often three to seven years. The key question the bank asks is whether the equipment adds measurable value to the business and can hold resale value over time. Most banks will loan at 80% loan to value, so if you buy a $100,000 piece of equipment, the bank will cover $80,000. These are typically the “easiest” kinds of loans to secure from a bank.
2. Working Capital Loans
Working capital loans cover short-term needs like payroll, accounts payable, or inventory. These loans are more about smoothing cash flow and dealing with troughs in the cash cycle than buying assets. Since they’re usually unsecured or backed by receivables or inventory, banks assess them more strictly. They’ll want to see that the company generates reliable cash flow and has a clear plan for how the borrowed funds will turn into future revenue or cost savings. They are often benchmarked using a borrowing-base, meaning the amount the business can borrow is tied to the amount of ongoing accounts receivable that it has each month.
3. Lines of Credit
A line of credit functions more like a safety net. It’s revolving credit that can be used and repaid as needed, often for seasonal businesses or those managing cash flow timing differences. Because it’s flexible, banks want to see a strong track record of responsible cash management. Maintaining a healthy current ratio (current assets divided by current liabilities) and showing demonstrated profitability over time is key to securing and keeping a credit line in place.
4. Term Loans for Expansion or Acquisition
These larger, longer-term loans are used to fund business growth like buying and opening a new facility, buying another company, or investing in other long-term infrastructure. These are evaluated not just on past performance but also on the borrower’s strategy and future financial projections. Banks will scrutinize the business plan and pro forma statements to ensure the deal makes financial sense. Many banks will also partner with government-subsidized programs such as with the SBA to make these deals happen and take some risk off the table for them. Generally, they still follow the 80% loan to value rule and will require the owner to have skin in the game up-front as part of the investment.
What Banks Look For: Debt Service and Financial History
At the core of any lending decision is one key measure: the Debt Service Coverage Ratio (DSCR). This ratio shows how much cash flow is available to cover debt payments. Most banks look for a DSCR of 1.25x or higher, meaning your company should earn $1.25 in available cash flow for every $1 in loan obligations (interest + principal).
To determine that, lenders will review:
- Two to three years of tax returns
- Year-to-date financial statements (income statement, balance sheet, and cash flow statement)
- Aged receivables and payables reports
- Bank statements to verify liquidity
- Personal Financial Statements of the Owners
It’s not just about being able to hit the 1.25x ratio, since banks want to see a low-risk cash flow picture. They are looking for steady revenue, consistent margins, and strong internal controls. Businesses with clean, up-to-date records and reconciled accounts stand out immediately and create confidence in the numbers. Many small businesses are months behind in reconciling their books, and don’t have any budgets or forecasts created, which makes it hard for banks to convince their underwriting teams to take on the risk of lending, especially if the business doesn’t have a clear track record of success.
Many banks also require personal financial statements from the major owners so that if the company is unable to cover the debt service, the owners themselves will be able to satisfy the debt requirements. This means that owners should keep updated personal financials during the year and be ready to share that information as part of the application.
Covenants: The Rules After the Loan Is Approved
Even after a loan is granted, the bank still manages its risk through loan covenants. These are ongoing conditions you must meet for the duration of the loan.
There are two main types:
- Financial covenants: These set minimum performance requirements, such as maintaining a certain DSCR, keeping debt below a set threshold, or preserving a required level of liquidity.
- Non-financial covenants: These might include providing updated financials quarterly, maintaining insurance, or getting lender approval before taking on additional debt.
Violating a covenant doesn’t automatically mean default, but it often triggers higher oversight, additional fees, or required corrective action. Business owners who stay proactive with financial reporting and communication rarely run into covenant issues, and that transparency helps build long-term trust with lenders.
Why Clean and Forward-Looking Financials Matter
Many small businesses operate reactively, updating their books only at tax time and typically focusing on what happened in the past. From a bank’s perspective, a lack of regular financial statements and future planning is a red flag. Clean, consistent reporting tells the bank that you understand your numbers and manage proactively.
Equally important is having a forecast or financial model that projects future cash flow. A well-built forecast helps demonstrate how the loan will be used, when it will generate returns, and how repayment will fit into your budget. Lenders appreciate borrowers who can quantify their plan instead of making assumptions.
A good forecast should show:
- Expected revenue and gross margin growth
- Expense control strategies
- Projected debt service and cash reserves
- Use of borrowed capital
- Break-even analysis for new initiatives
This type of forward-looking discipline signals to the bank that you are managing your business, not just running it.
Are You Ready to Go to the Bank?
Before you apply, take a step back and ask yourself:
- Do I have at least two years of consistent profitability or strong cash flow (including on the tax return)?
- Are my financial statements current and reconciled regularly?
- Can I clearly explain how the funds will create measurable value for the business?
- Do I have a financial forecast that shows loan repayment capacity and profitable future?
- Am I prepared to meet potential loan covenants?
If you can answer “yes” to most of these, you’re in a strong position to approach a bank with confidence. If not, use this as a checklist to tighten up your financial operations before applying. The worst-case scenario is to spend weeks of time and hours building your request with a bank lender, only to get shot down by underwriting at the last step (this happens a LOT).
How We Help Our Clients
At Southcoast Financial Partners, we work closely with business owners to prepare for financing opportunities whether it’s an equipment purchase, a working capital line, or an expansion loan. Our team understands how banks think, and we have strong relationships with both local and national lenders that have led to millions in secured funding for our clients.
We help clients build clean, credible financials, develop forecasts that tell a story, and prepare loan packages that anticipate what a banker will ask. When it’s time to secure funding, our clients are ready to make their best first impression. Contact our team to see how we can help you with your financing needs.
