What lenders actually check before approving working capital

Two weeks before your stock arrives, your bank declines the working capital facility, citing insufficient collateral. Or perhaps a private lender approves the loan but demands a 25% equity stake because they could not verify your recent SARS tax clearance or CIPC status. These scenarios highlight why the approval process is rarely about the loan amount you request, but rather how transparently you can prove your financial health.

In South Africa, the gap left by traditional banks has allowed alternative lenders to step in for SMEs, yet they still conduct rigorous due diligence to protect their capital. As the Small Enterprise Finance Agency (SEFA) notes, access to funding remains a primary hurdle for local businesses. Understanding the specific metrics lenders scrutinize, from cash flow consistency to management stability, is the only way to position your application for success rather than rejection.

The method used by lenders to assess working capital applications

Lenders use a combination of quantitative and qualitative methods to assess working capital applications. Quantitative methods involve analyzing financial data, such as revenue, expenses, and cash flow, to determine the business’s ability to repay the loan. Qualitative methods involve evaluating the business’s management team, industry, and market trends to assess the business’s potential for growth and repayment. Lenders may also use credit scoring models to evaluate the creditworthiness of the business and its owners. For example, a lender may use a credit scoring model that takes into account the business’s payment history, credit utilization, and credit age to determine its credit score.

In addition to credit scoring models, lenders may also use other tools, such as financial ratios, to evaluate the business’s financial performance. For example, a lender may use the current ratio, which is calculated by dividing the business’s current assets by its current liabilities, to determine its ability to meet its short-term obligations. A current ratio of 1:1 or higher indicates that the business has sufficient current assets to meet its current liabilities. Lenders may also use the debt-to-equity ratio, which is calculated by dividing the business’s total debt by its total equity, to determine its level of indebtedness. A debt-to-equity ratio of 1:1 or lower indicates that the business has a manageable level of debt.

Financial statements and credit history

Financial statements, such as the balance sheet and income statement, are critical components of the working capital application process. Lenders use these statements to evaluate the business’s financial performance and identify potential risks. For example, a lender may review the business’s income statement to determine its revenue growth, profit margins, and expenses. A business with a strong revenue growth rate and high profit margins is more likely to be approved for working capital. Lenders may also review the business’s balance sheet to determine its asset base, liabilities, and equity. A business with a strong asset base and low liabilities is more likely to be approved for working capital.

Credit history is also an important factor in the working capital application process. Lenders use credit reports to evaluate the business’s payment history and credit utilization. A business with a good credit history and low credit utilization is more likely to be approved for working capital. In South Africa, businesses can obtain their credit reports from credit bureaus, such as TransUnion or Experian. The cost of obtaining a credit report can range from R20 to R100, depending on the credit bureau and the type of report required.

A worked example of the working capital application process

Let’s consider an example of a business that applies for working capital. The business, which is a PTY LTD company, has been in operation for five years and has an annual revenue of R5 million. The business has a current ratio of 1.5:1 and a debt-to-equity ratio of 0.5:1. The business’s credit score is 650, which is considered good. The business is applying for a working capital loan of R1 million to finance its operations and expand its product line.

The lender reviews the business’s financial statements and credit history and determines that it is a good credit risk. The lender offers the business a working capital loan of R1 million at an interest rate of 15% per annum, with a repayment term of 12 months. The business accepts the offer and uses the loan to finance its operations and expand its product line. Over the next 12 months, the business repays the loan in monthly installments of R92,000. The business’s revenue grows by 20% over the next 12 months, and its profit margins increase by 15%.

How to apply for working capital

To apply for working capital, businesses should prepare a comprehensive funding application that includes their financial statements, credit history, and business plan. The application should also include a detailed breakdown of how the loan will be used and a repayment plan. Businesses should also ensure that they have a good credit history and a strong financial performance. In South Africa, businesses can apply for working capital from alternative lenders, such as Business Funds, or from traditional banks, such as Standard Bank or Absa. The application process typically takes between 2 to 5 working days, and the cost of the loan can range from 10% to 20% per annum, depending on the lender and the type of loan.

Businesses should also consider their B-BBEE status and ensure that they comply with the relevant regulations, such as the Broad-Based Black Economic Empowerment Act. They should also ensure that they comply with the Protection of Personal Information Act (POPIA) and the Companies Act. In addition, businesses should consider their cash flow management and ensure that they have a good system in place to manage their cash flow. This can include implementing a cash flow forecasting system, which can help businesses to predict their cash flow and make informed decisions about their funding requirements.

Common mistakes to avoid when applying for working capital

There are several common mistakes that businesses should avoid when applying for working capital. One of the most common mistakes is not having a comprehensive funding application that includes all the necessary documents and information. This can include financial statements, credit history, and business plan. Businesses should ensure that they have all the necessary documents and information before submitting their application.

Another common mistake is not having a good credit history. A good credit history is essential for securing working capital, as it demonstrates the business’s ability to repay its debts. Businesses should ensure that they have a good credit history by making timely payments and keeping their credit utilization low. In South Africa, businesses can check their credit history with credit bureaus, such as TransUnion or Experian, and can take steps to improve their credit score.

Businesses should also avoid applying for too much funding, as this can increase their debt burden and reduce their ability to repay the loan. They should also avoid applying for funding from multiple lenders, as this can increase their credit inquiries and reduce their credit score. Instead, businesses should apply for funding from a single lender and ensure that they have a comprehensive funding application that includes all the necessary documents and information.

• Not having a comprehensive funding application
• Not having a good credit history
• Applying for too much funding
• Applying for funding from multiple lenders
• Not having a clear repayment plan

Checklist for working capital applications

Before submitting a working capital application, businesses should ensure that they have the following documents and information:

• Financial statements, including balance sheet and income statement
• Credit history and credit score
• Business plan, including cash flow forecast and repayment plan
• Identification documents, including company registration documents and tax clearance certificate
• B-BBEE certificate, if applicable
• POPIA compliance certificate, if applicable

Businesses should also ensure that they have a clear understanding of the loan terms and conditions, including the interest rate, repayment term, and fees. They should also ensure that they have a good system in place to manage their cash flow and make timely payments. By following these steps and avoiding common mistakes, businesses can increase their chances of securing working capital and achieving their business goals.

To check your funding readiness and to determine the best funding options for your business, check your funding readiness with our free tools, visit our website for more information. You can also visit the Companies and Intellectual Property Commission (CIPC) website for more information on company registration and the South African Revenue Service (SARS) website for more information on tax compliance.

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