Can High Sales Lower Credit Risk?
Banks do not easily approve home loan applications of businessmen. The documentation process is more elaborate, and banks issue many caveats. In the eyes of the bank, there is always the possibility of a businessperson losing his livelihood.
Banks look into the nature, score and profitability of the business you run to be reasonably sure that you will be able to repay the loan. Greater the chances of payment of debt, lower the credit risk.
MakaanIQ tells you how increasing revenues can help entrepreneurs lower credit risk.
What is credit risk?
Credit risk is the risk of default on a debt that arises when the borrower fails to make monthly payments. Credit risk is an estimate of the likelihood of the borrower not being able to pay off the debt. Credit risk says much about the credibility of an applicant. If a borrower is credible, his credit risk will be lower. If your credit risk is low, the bank is more likely to approve your loan application.
How does rising revenues lower credit risk?
Banks assess the credibility of businessmen by look at sales figures. Sales figures give banks a fair idea of the profit potential of your business. High profitability ultimately lowers your credit risk.
Banks examine the turnover (i.e. annual sales volume net of all discounts and sales taxes) of your business, and expect this to not decline below acceptable levels. The acceptable level, however, varies from bank to bank. For instance, if the turnover of your company declines by 20 per cent over a period of three years, profits tend to fall, and so do the chances of receiving credit or getting your home loan approved.
Similarly, if the bank finds an increase (regardless of whether it is constant or unexpected) in turnover, you will be expected to justify this. The bank will expect you to support your claims with documentation, like statements on increase in investments, marketing target, product diversification etc.
What are the common tools used to assess credit risk?
Every financial document of a business has a story to tell. Banks evaluate all the financial documents you submit to decide whether it is wise to lend to you. Before banks take into account the lending parameters, they analyse the financial books and estimate various ratios like liquidity, profitability, leverage and activity.
Banks estimate these ratios to have a fair idea of how long the business will take to pay off their short and long-term debt obligations. Banks also get to know how soon the assets (i.e. stock or a product) are converted into cash, the ability of your business to generate earnings relative to sales, and whether assets exceed liabilities or if it is the other way round. Banks also get to know more about net cash receipts, long-term debt relative to equity, and many such factors.
How do lenders assess loan agreements with high credit risk?
When lenders assess loan agreements with high credit risk, they look at the borrower's probability of default, the size of the loan, recovery rate and past credit history. Apart from these precautionary measures, banks have an internal grading system that ranks assets based on the quality of loan and credit risk characteristics.
- You can disclose sufficient assets, personal collateral and financial reserves to prove your credibility to the lender.
- If you are a start-up entrepreneur, or if it is a new business, you must provide evidence of a clean financial track Proofs of success in similar business endeavour will raise the odds of your loan application being approved.
- Banks look at the qualifications and experience of entrepreneurs to decide whether to grant a loan.