Applying for a business loan? Why personal finances and credit scores matter
Many business owners are required to submit their personal finances and credit scores for commercial loan applications, but why? In most cases, the owner is the guarantor for the loan and either contributes or receives income from the business. In addition, it is common especially for sole proprietors, to mix personal and business finances. Since most of these transactions do not appear on financial statements, it is difficult to gain an accurate picture of the cash flow. Subsequently financial institutions run a global debt service calculation to understand the flow of cash.
The global debt service coverage ratio incorporates both the business’s and owner’s income and liabilities. The global debt service ratio calculates how many times the business/owner can pay off the loan and accounts for cash flow that may not show up on the businesses financials.
In addition to owner financials, financial institutions also ask for the credit scores of the business owner. In many cases, the business owner will be the one handling the business finances. Therefore, these institutions use the personal credit scores as an indicator of how they might handle the firm’s finances. If the business owner has a history of late payments and other delinquencies, then financial institutions may view this as foreshadowing future payment patterns. The underlying purpose of this due diligence is to attain a comprehensive risk assessment to hedge against the possibility of default.
Currently, many tools on the market help small businesses calculate their global risk level. For example, the Sageworks Probability of Default Model’s TruGlobal Analysis calculates the risk level of a business by incorporating the owner’s debt service and income. This credit report gives business owners access to a tool banks have been using for decades and can help business owners understand how a bank might view their loan application.