Want A Business Loan? Here’s What You Need To Know First
6 mins read
Learn how to build creditworthiness and optimise every business loan application for an easy “yes”.
Picture this:
It’s a sunny Thursday afternoon and you get a random message from an acquaintance you haven’t spoken to in a while. After stilted pleasantries, they tell you why they reaching out: they need a loan to sort out an important (and urgent) need, let’s say paying a bill. Now, you want to help, but the amount they’re asking for is… quite substantial. How can you be sure their story checks out? Or that they’ll pay you back when they say they will?
In other words, how do you know they’re creditworthy?
If you’ve been in a similar dilemma before, then you’ve gotten a glimpse into the inner workings of how lenders make credit decisions. In this article, we’ll expand that glimpse into a clearer understanding of what creditworthiness means, why it matters and how you can build it to unlock better financial opportunities for your business.
Creditworthiness: The Basics
Whether it’s a bank reviewing loan applications or your neighbourhood trader deciding whether to give eggs to their ‘customer’ on credit, every lending decision hinges on one key factor: trust.
In everyday life, we might base trust off a gut feeling or how well we know someone. But, in business, it’s something that must be assessed more objectively. That’s where creditworthiness comes in.
It’s what lenders use to determine if, how much, and under what terms to extend credit to an applicant.
The 5C Framework
So, how do lenders determine if your business is creditworthy? Many use a simple evaluation framework known as the 5 Cs of Credit: character, capacity, capital, conditions and collateral. Let’s break them down.
Character: Will you repay the loan?
Character reflects your reputation and track record. Lenders want to know if you’re responsible, reliable, and likely to follow through on your commitments. To assess this, they often look at:
– Your credit history (personal or business): Have you taken credit before? If so, did you repay as agreed?
– Your payment behaviour: Do you stay on top of recurring business expenses like rent, leases, or electricity bills?
– Your background: Some lenders may ask for references or review your business history. Others might even take a peek at your digital footprint to get a fuller picture.
Capacity: Can you repay the loan?
Character determines if you’re willing; capacity determines if you’re able. Even if you’re trustworthy, lenders need to know you have the financial ability to repay. Capacity assesses your income, cash flow and current debt load. It answers questions like:
– Does your business generate enough revenue to cover the loan, while maintaining regular day-to-day operations?
– How stable is your income?
– Are you already carrying too much debt?
This is why lenders often request bank statements and/or profit and loss records.
Capital: How much have you invested in your business?
Capital looks at how much of your own money or resources you’ve put into the business. Lenders tend to trust business owners who have some skin in the game because it shows commitment and reduces risk of default. If you’ve taken financial risks of your own, it signals that you’re serious about the business’s success and not just relying on borrowed funds to make it work.
Collateral: What security can you offer the lender?
Collateral is any asset you can pledge to secure a loan. If you’re unable to repay, the lender can recover their losses by claiming the asset. Common examples include property, equipment, inventory or vehicles.
That said, not all loans require collateral. Many modern lenders (including us) are moving away from collateral-based lending. Instead, we use tech-enabled credit scoring models to assess creditworthiness, making it easier for MSMEs to access the financing they need. You can read more about our thoughts on the importance of alternative credit assessments here.
Conditions: What’s the bigger picture?
Conditions are any external factors than can influence your ability to repay a loan, such as your industry, the state of the economy, and how you plan to use the funds. Lenders use this broader context to assess risk.
For instance, a seasonal business applying for a loan during off-season might face different terms than if it were to apply during a peak season. Some industries are more vulnerable to shifts in government policy or regulation, while others are shaped by socio-economic trends. These nuances matter. They help lenders estimate how likely your business is to generate revenue consistently and ultimately repay the loan.
So, how do you build creditworthiness?
Now that you know what lenders look for, the next question is: how do you actually build creditworthiness and make sure your business scales the 5C check? The good news is, it’s not about making big, dramatic moves, especially if you’re a small business. It’s more about being consistent, responsible and intentional. If your business doesn’t have a credit history yet, here are some practical steps you can take to build or show that you’re credit worthy.
Build a Healthy Financial Track Record:
Have you ever heard the phrase “you need money to make money”? This might be true in come cases, but not when it comes to building creditworthiness, especially for small businesses. Lenders generally care more about good financial management than deep financial pockets. And good financial management, in practice, looks like putting your capital to good use, reinvesting profits and shorwing that you’re building something that will stand the test of time.
Another signal of good financial management is keeping your business finances separate from your personal ones. Set up a business account, process all transactions through it and keep clean records. Additionally, pay your bills, leases and invoices on time. These simple practices signal that your business is reliable and responsible, two qualities lenders deeply care about.
Develop a Comprehensive Business Plan
A well-structured business plan signals to lenders that you have a clear vision for your business’s future and a strategic approach to achieving that vision. It helps them understand how you intend to use borrowed funds to drive success for your business.
When preparing a loan application, you should also consider putting together a pitchdeck alongside your business plan.
Consider Starting Small
If your business is just starting out or has little to no credit history, it’s a smart move to begin with modest loans or credit lines. Starting small helps you build a track record of responsible borrowing and shows lenders that you understand your business’s capabilites. Small amounts are typically easier to manage and repay, and they’re often more accessible to small businesses as they may come with less stringent terms or be collateral free. Over time, consistent good loan management and repayment will build trust and expand your access to bigger funding opportunities.
If you’re new to borrowing, make sure you’re working with a responsible lender. You can learn how to spot one by reading our thoughts here.
Build Trade Credit
A smart (and often overlooked) way to build creditworthiness is through trade credit. As a business owner, you may have built good relationships with suppliers or other business owners who let you buy goods and services and pay later (or in installments). That is trade credit and, beyond convenience, it is a great way to show that your business honours financial agreements. When these opportunities come up, ensure you document them clearly as part of your financial records and always pay on time. This will help you build a positive credit history and strenghten your credibility with lenders.
Be Transparent and Communicative
Trying to make your finances look “better” than they are, especially by manipulating inflows and outflows, can do more harm than good to a loan application. Lenders value honesty over perfection. Being upfront about your business’s financial situation builds trust and shows that you’re serious about managing credit responsibly. Transparency also signals integrity and a commitment to ethical business practices, which can work in your favour when you’re being assessed for funding. One of the easiest ways to ensure transparency is by using digital bookkeeping or accounting tools that keep accurate records and make it easier to share your financial story.
Our Final Thoughts
Accessing credit, especially for MSMEs in this part of the world, can be tough, but it doesn’t have to be a mystery. By understanding how lenders think, and what they’re looking for, you can make smart moves to improve your creditworthiness. Remember that this isn’t something that will be achieved overnight; it takes time and consistent effort. With patience and commitment, you can set your business up for financial opportunies that will help you achieve your dreams.
So, the next time someone asks you for loan, take a moment and think like a lender. Those 5Cs could be the difference between extending kindness and funding an onigbese.
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