Why do SME Loans get rejected?

SME finance is majorly the funding of small and medium-sized enterprises. This segment plays a major role in offering huge employment opportunities to lower capital costs and also help in the industrialization of rural areas. It also contributes to domestic production and also increases export earnings. SMEs play a vital role in the development of the nation.

Reasons why SME Loans get rejected

It is a common phenomenon that small business owners’ demand loans but financial institutions say no. The majority of the applications for SME loan get rejected. Given below are some of the reasons for this denial of the loan-

1. Limited Collateral

It is seen that financial institutions feel that SMEs are high-risk groups, so they demand high-value collateral for lending loans. The collateral can be in the form of vehicles, property, account receivables, inventory, and saving accounts. The SME financing application is turned down by the banks if you don’t submit the right type of collateral. You can also offer your personal assets as collateral if you don’t have sufficient business funds.

2. Bad credit score

A credit score represents the worthiness of a person’s business or his personal assets. Financial institutions consider both personal and business credit scores before they approve your loan. So, many times it is seen that the personal credit score of the person leads to default. Factors like late payment, default payment, and court judgment result in a poor credit score. If your low credit score is the reason due to which you are not getting the SME loan, then you should take the necessary steps to repair it.

3. High Debt Utilization Rate

Banks and financial institutions review your gearing ratio, which is the level of your business debt in relation to its equity capital. If this ratio is higher, the risk is also higher. So, in such cases, your loan request might get rejected. You should make sure that you keep a track of total credit limits and maintain reasonable debt usage.

4. Incomplete application

One more reason why financial institutions deny the application of a loan is because that application is not complete. Before applying for an SME loan you should double-check the list of documents that you are submitting. These documents include tax returns, business plans, financial statements, bank statements, legal documents, etc.  You can even hire someone who can do all the paperwork for you or you may submit all the applications via an online platform.

5. Not asking enough money

It might seem unusual but traditional financial institutions reject your application if you don’t ask for a huge amount. The cost of servicing large volumes of small financing is not worth the work and time. Such institutes prefer choosing larger financing as it is more profitable for them. You should review your financial projections and business plan so that you can ensure that you are not underestimating the amount of actual capital that your need.

6. No evidence of strong cash flow

If you don’t show enough business cash flow cycle then also your application might get rejected. This is to understand if you have enough cash flow so that you can cover your business expenses and also repay the debt amount. These banks will raise red flags if you are spending enough money on your business and not receiving much. You need to maintain a healthy cash flow but maintaining healthy cash flow is a challenge for small businesses. The main reason behind this is that the third-party suppliers are paid before the business actually gets paid for their services.  You need to make sure that a proper cash management system is maintained so that you convey a good message to the banks and financial institutes.

Advantages of an SME Loan

1. They are easy and quick. Business loans have become easier to access and apply for.
2. SME loans come with flexible repayment options.
3. The interest rates for SME loans tend to be lower as they are backed by good government schemes.
4. The loan helps grow and expand your business. You can invest in all the necessary tools like machinery, manpower, technology, and equipment with the help of this loan.
5. You receive tax benefits under the Income Tax Act. The profit used for repaying the loan amount is exempt from tax.

It is very common that the SME Loan gets rejected. It might seem frustrating in the advance, but you shouldn’t get disheartened. It is nothing personal and you can always try again. You just need to keep in mind the above-mentioned points so that your application gets passed.  Small businesses need monetary support to carry out various activities like resource building, inventory storage, etc. Major financial institutes can give you a competitive edge by partnering in your growth story by offering a loan.