Because capital is crucial in building a business, almost every business needs a loan sooner or later. This guide is designed to help owners and operators of small businesses apply for business loans.

What kinds of Loan, Credit and Terms Are Available

Lenders offer several types of loan products. You will want to select the one that best matches your company's needs and intended use of the funds. The depth and amount of financial analysis performed by the lender will vary with the amount of the loan request, the duration and the availability of collateral.

Three Types of Loans/Credit

1. A line of credit is a short-term revolving credit agreement. You have access to a certain amount of money for a specified period of time during which you can borrow, repay and borrow again. This type of borrowing is appropriate to finance temporary needs such as accounts receivable or inventories. Most lenders require companies to "clean up" the loan by paying off the outstanding balance under the line of credit and keeping it unused for 30 days.
   
2. A term loan is a loan for a stated period of time--usually three to ten years, depending on the purpose of the loan. A term loan is appropriate when you are planning to expand the business, finance equipment, or improve or acquire commercial real estate. 
   
3. A Letter of Credit is not technically a loan, but an extension of credit. The lender's credit is substituted for yours to enable you to buy goods on credit or to enter into a contract requiring a bond or deposit. The lender makes a legal commitment to pay a third party regardless of your ability to pay when payment is due. A lender may require liquid collateral to make sure that you will have the cash when payment is due.
   

Be Prepared to Answer Questions

After you've gathered the financial information, you and your accountant can do preliminary ratio analyses in advance. You will then know what questions you will most likely be asked. For example, if your receivables are turning more slowly than last year, ask yourself why and what you can do or have done about it. If sales are decreasing, do you realistically expect an improvement? If not, what do you need to do to insure that the company's debt service coverage is not impaired? What does your credit report show and how should you present it if there is a problem?

Be Precise About Your Loan Request

Be clear about the loan you are requesting, including three basics:

1. How much do I need? 
2. What will it be used for? 
3. How will I repay the loan?
4. What collateral can I offer?

Provide Backup Details: If you want financing for new equipment and its installation, say so, and provide written cost estimates. Don't pad your loan request for "what‑if ' scenarios, ask only for what you actually need. When requesting additional working capital, be sure to document the specifics. For example, tell how you plan to use the funds to pay down accounts payable or add inventory.

Outline Your Payback Plan: As you and your accountant plan how your company will repay the loan, remember that lenders generally prefer repayment that matches the purpose of the loan. For example, you can show how an equipment loan can be paid back while the financed asset is depreciating at a rate and amount to ensure that the depreciated asset value is always greater than the remaining loan value.

Similarly, if you request a loan to finance a large inventory purchase that you will deliver to a customer in 90 days, you would request a short-term loan that would be repaid as you collect the receivables from the sales of this merchandise.

Be Forthright: As you and your accountant work with the lender through the loan application process, many questions will be raised. Do your best to answer each one completely and to volunteer to get more information if necessary. Your integrity and cooperation are appreciated by lenders. Lenders are in business to make loans, yet they must satisfy stringent Professional and regulatory requirements with your assistance.

Be Prepared to Sign...and Sign: Many first‑time borrowers are surprised by the amount of legal paperwork involved in a business loan. Generally, your loan package will include a note, loan agreement, security agreement, required UCC Uniform Commercial Code) financing statements, guarantee forms, and disclosure documents. You can get copies of the documents to read in advance of closing if you wish.

Be a Long‑Term Thinker: Once your loan is approved, your relationship with the lending institution continues. You'll want to honor the alliance by keeping your lender informed about your company's performance. A lender who knows your business and understands its opportunities and shortcomings can offer you valuable advice on other financial services. When it's time for another loan, your credibility is already established.

Cash Flow: Funds generated by company activities during a period; e.g., when depreciation and other non‑cash expenses are added to net income, the result is cash flow from operations.

Clean-up: With regard to a line of credit, a requirement that there be no loans outstanding for a stated period of time.

Contingent Liabilities: An obligation which may or may not become due in the future, based on a prior action; e.g., a loan guaranty is a contingent obligation to pay if the borrower does not.

Debt Service: Amount of loan principal and interest to be repaid during a specific period.

Floating Rate: An interest rate on a loan that changes (floats) when another rate, such as the prime rate, changes.

Intangible Asset: As used in a conventional banking sense, any current or non‑current asset that would rarely be used for borrowing collateral; e.g., prepaid expenses, deferred charges and good will.

Leverage: The amount of cash and near cash assets in excess of liabilities due and coming in a stated time period.

Non-Cash Expenses: Expenses not requiring the outlay of cash, such as depreciation and amortization.

Prime Rate: A base rate established by a lending institution from time to time, commonly used to determine changes in floating rate loans.

Revolving Credit: A loan arrangement permitting the borrower to borrow, repay and re‑borrow periodically, according to terms agreed on in advance.

Subordinated Debt: A debt obligation that cannot be repaid until some other obligation has been paid first.

Underwriting: The process by which a lender evaluates the risks to the lending institution of a loan request and the decision whether the risks are within the lender's policies.

Working Capital: The excess of current assets over current liabilities.

Reproduced with permission from: "A Guide to Business Loans, What Your Lender Looks For, " by CoreStates, First Pennsylvania Bank. This article was originally published in the August/September edition of Entrepreneurial Edge.