There are three key components to getting your funding request approved; cash, credit and collateral. This is true whether you’re taking out an equipment loan or lease, leasing a car, or financing a new home. All three components play an important role and understanding them will help clarify the financial process.
Cash Flow – The first key to receiving a lease or financing approval is to be cash flow positive. 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 annual lease payments. For example, if the business has net income of $75,000 with depreciation of $50,000, an insurer may consider that there is at least $100,000 available to pay for a new lease. If the lease requires annual payments of $50,000, it will likely be approved and if it requires $120,000, the application will be put on hold because the cash flow is too low based on history. Typically, the documents needed to verify cash flow are tax returns, financial statements, and bank statements.
Credit: Dunn & Bradstreet primarily records business credit scores for businesses. For small businesses, the financial transaction is sometimes guaranteed by all owners with more than 10% equity participation in the business. Consequently, personal credit (FICO score) plays an important role in lease approvals. A credit score of 700+ is required for “A” lenders and 650+ for “B” lenders. The main difference is that 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 on a business. The “weak link” will drag the group down to your credit level, so choose your partners wisely.
Guarantee: Not everyone has a credit score over 650 or owns a business that reports a large net income. Certain lenders provide leases to applicants that offer collateral in addition to the equipment being purchased. Good collateral is usually heavy machinery, construction equipment, stock certificates, certificates of deposit, or business and personal real estate. Even a retirement account can be used as collateral. Small items less than $10,000 in value and electronic equipment are not currently considered acceptable collateral. Currently, the strongest warranty is commercial ownership and often a requirement for any solar or LED upgrade.
The most desirable financial approvals are based on a minimum level in each of these key areas. If a company lacks one or more of these criteria, it may still be approved if it has superior strength in just one key component. Lack in all three areas means trouble getting approved and the best business strategy would be to increase sales and further grow the business before considering adding additional debt.