As you seek financing for a business expansion, it helps to understand how bankers work and how they evaluate loan proposals

It’s well known that banks earn most of their money by charging interest on the money they lend. Lesser known are the constraints that affect bank lending decisions.

If you know how bankers think and the rules they must follow, you will be better able to prepare a sound financing proposal – and understand the reasoning behind the bank’s final decision, whether in your favor or not.

Essentially, the funds a bank uses to make loans come mainly from deposits – in other words, money borrowed from depositors. The interest a bank charges for a loan is not much more than interest it must pay to the depositors. The bank must compete both for the deposits that make loans possible, and for the customers borrowing money. These opposing competitive forces keep interest rate spreads (margins) thin.

Typically, only 7 percent of the money available for a bank to lend comes from owner investment equity. That means that 93 cents of every dollar available for loans comes from deposits. Banks must also keep substantial cash equity, earning almost no interest, tied up in loan loss reserve accounts.

Limited risk

While in theory banks could earn more interest by making riskier loans that other banks decline, banks live under regulatory limits for risk. Furthermore, riskier loans are more likely to go into default. Just as a large unpaid account destroys the profits of many sales for a business, an unpaid loan can wipe out much of a bank’s profits.

Making bank profit margins even thinner are the high overhead and operating costs. Banks are highly regulated by state and federal governments. The intense oversight adds costly documentation, process controls and compliance staff to bank operations, adding significantly to operating overhead. Thus, lenders must be exceedingly careful about their decisions to lend the money.

What banks want to see

In making a loan request, it is important to present your project, your business and yourself seriously. By preparing, and by getting a third-party evaluation before you approach the bank, you can make a good impression at your first bank meeting.

Your request is essentially a sales pitch for you and your team, supported with historical data and factually supported projections. It is hard to overcome a bad first impression on the banker by seeming unprepared, unknowledgeable or unrealistic.

From the banker’s perspective, financing a substantial expansion for your business is a bit like financing a brand-new business. You will need to convince the banker that the market is favorable, that your team has the expertise to enter the new market, that you have the working capital to pay for expansion, and that the new sales will generate enough new cash to repay the loan.

New financing is somewhat easier for companies that have existing loans with a given bank, because they have already given the bank considerable information about their business. However, if in that position, you still must demonstrate the ability to repay, and you must have enough collateral to secure the new loan.

Loan documentation requirements may vary – your prospective lender will tell you what information you must supply. Common requirements include:

Purpose of the loan.

History of the business.

Financial statements for the past three years.

Schedule of term debts.

Aging of accounts receivable and payable.

Projected opening-day balance sheet (new businesses).

Lease details.

Amount of the owner’s investment in the business.

Projections of income, expenses and cash flow.

Signed personal financial statements.

Personal resumes.

Business plan.

The bank team cannot evaluate your loan request until you submit all of the required documentation. The evaluation process itself is interactive, and you will be asked additional questions and clarifications along the way.

How banks evaluate requests

Banks evaluate loan requests using standardized measurements, financial performance ratios and evaluation tools. Typical analysis measures include debt-to-equity ratio, current ratio, quick ratio, collateralization, consistency of margins, aging of accounts receivable, consistency of the cash cycle, comparison of the ratios to industry standards, breakeven analysis, management of cash flow, cash flow available for new debt payments, worst-case scenarios, and potential swings in the economy.

Worst-case scenarios can include unexpected events such as production costs twice as much as projected, getting only half of anticipated sales, or a key person leaving.

Basically, the bank team will evaluate your business creditworthiness using the Five Cs of credit analysis:

Collateral available to secure the new loan.

Capacity or cash flow available to repay the new loan.

Capitalization – enough permanent investment in the business to operate safely.

Character – the owner’s history of honoring all obligations.

Conditions for the project are economically favorable.

Positive vibes from your banker are a good thing, but you do not really have a yes or no answer until the evaluation process is complete and the bank loan committee makes its decision. You will not be present at the loan committee meeting – your banker must make the pitch. The committee will also evaluate issues beyond your control, such as the bank’s current loan portfolio mix and economic risk.

Take these steps first

In seeking financing, never think you can do it alone. One of the best ways to insulate yourself against business failure is to find and work with a mentor – someone with business experience who can guide and assist you. The Small Business Administration ( offers information and common-sense advice.

Local mentors are available at your SCORE chapter, Small Business Development Center (SBDC) office, or local Economic Development Corporations. Their expertise is either free or low-cost – and it is extensive, encompassing both individual consulting and classes.

SCORE is not everywhere, but chapter volunteers, who are retired and active business people, know the ropes. SBDC offices are often located at regional colleges or business assistance centers, and they also provide business experts and classes.

Many communities or counties have a local economic development corporation. The best of these groups are well-connected business and community leadership collaborations. Members are often experts in local financing, regulatory issues, politics and markets. They often have access to flexible business financing and can help resolve common issues, such as insufficient collateral.

Considering alternatives

These volunteers will help you ask and answer important questions that enable you to see your project from the banker’s eyes. They can help you avoid wasting time by asking important questions. For example, do you really need a loan? Or, can you finance the expansion by reducing investment in declining or low-profit lines of your business?

What will a banker think about your request? Will he or she see enough collateral and cash flow to make the loan? Will he or she see a solid team, exceptionally knowledgeable in the current and potential business markets? What are your backup plans if the sales don’t materialize, or if the economy slides downward?

If you are a very small business – small loans are unprofitable for banks to make – will the banker see a growing business that will evolve into a profitable future customer?

Bankers evaluate loan requests with a standard process that you can use ahead of time to prepare your request. Mentors can help you to identify and overcome project weaknesses before you approach the bank. By making your request more professional, you will create a more favorable impression about the quality of your business.

Perseverance is important. Get to know more than one banker, and visit more than one bank. Banks base their decisions on many factors in addition to the evaluation of your project’s financial strength. So don’t take a negative answer personally.

Keep asking and keep refining your project. No matter the outcome, the work is not wasted. The very evaluation process gives you a better picture of the strengths, weaknesses, opportunities and threats to your business.


Kenneth Stubbe is a certified Economic Development Finance Professional and a Certified Economic Developer.

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