There are three key components to getting your finance request approved; cash, credit and collateral. This holds true whether getting an equipment loan or lease, leasing a car or financing a new home. The three components all play an important role and understanding them will help clarify the finance process.
Cash Flow – The first key to receiving a lease or finance approval is to have positive cash flow. An underwriter will add net income to a portion of depreciation (and any other non-cash expenses) and the resulting free cash flow must exceed the amount of the annual lease payments. For example, if the company has a $75,000 net income with $50,000 in depreciation, an underwriter may consider that at least $100,000 is available to pay a new lease. If the lease requires annual payments of $50,000, the lease will likely be approved and if it requires $120,000, the request will be pending because the cash flow is too low based upon history. Typically, the documents needed to verify cash flow are tax returns, financial statements and bank statements.
Credit – Business credit scores for companies are primarily recorded by Dunn & Bradstreet. For small businesses, the finance transaction is sometimes guaranteed by all owners with more than a 10% equity position in the company. Consequently, personal credit (FICO score) plays a large role in lease approvals. A 700-plus credit score is required from “A” lenders, and 650-plus are required by “B” lenders. The main difference is an “A” lender will finance a higher dollar amount at a lower interest rate and offer more options. Understanding how this works is important in determining the effect of partnerships in a business. The “weak link” will drag the group down to their credit level so pick your partners wisely.
Collateral – Not everyone has a 650-plus credit score nor owns a company that reports a large net income. Certain lenders provide leases to applicants who offer collateral in addition to the equipment being purchased. Good collateral is typically heavy machinery, construction equipment, stock certificates, certificates of deposit or commercial and personal real estate. Even a retirement account can be used as collateral. Small items under $10K in value and electronic equipment are currently not viewed as acceptable collateral. Currently, the strongest collateral is commercial property and often a requirement for any solar or LED upgrade.
The most desired finance approvals are based on a minimum level in each of these key areas. If a company is lacking in one or more of these criteria then they can still get approved if they have superior strength in just one key component. A lack in all three areas spells trouble for getting approved and the best business strategy would be to build up sales and grow the company further before considering adding additional debt.