Lenders examine finances, credit history, paperwork and management before saying yes
A business owner may spend years measuring progress through sales, customers, assets and the ability to keep operations moving. A financier sees the same business through a different lens.
That difference may barely register while the company is operating normally. It becomes much harder to ignore when the business needs outside financing for its next move.
Kuching SME Development and Advancement Association protem committee chairman Paul Fong said many small and medium enterprise (SME) owners know when their financing applications have been rejected, but do not necessarily understand why.
“The problem is that many small and medium enterprises do not understand why their loan applications are rejected,” he told Sarawak Tribune.
Fong, who is also a business associate at Kuching Business Centre under LiVIVA Advisory Group, said factors ranging from collateral and documentation to repayment capacity, credit records, existing debt, business capital, customer or supplier concentration, management and succession could influence the outcome.
Four financing profiles
From a financing perspective, Fong divides SMEs into four broad groups, which he calls the Platinum Card, Gold Card, Credit Card and Fraudulent types.
He said the classification was based on observations drawn from hundreds of financing applications handled by LiVIVA Advisory Group founder Dato’ Jonas Lee.
“From a financing perspective, I have categorised SMEs in our country into four major types,” he said.
The Platinum Card Type, which he estimated accounts for 20 per cent, represents businesses that are generally well prepared for financing.
“These SMEs have systematic operating methods, complete accounts and supporting documents, proper tax records, while their businesses and profits are growing normally.”
Fong said such businesses are generally the most readily supported by banks and development financial institutions, describing them as the institutions’ “first choice” when considering financing applications.
The Gold Card Type, accounting for an estimated 40 per cent, consists of businesses that may already have financing but whose existing facilities are insufficient or poorly matched to their operational and expansion needs.
“The loan application is simply not sufficient for the company’s business operations, or the loan package is not complete, and therefore cannot effectively help the company’s development and growth,” he said.
Another 30 per cent falls under what Fong calls the Credit Card Type, where weaknesses in financing readiness make it more difficult for institutions to establish the company’s actual financial position.
“Banks are also often unable to find out the company’s real profits and operations,” he said.
Incomplete application documents and adverse credit records are among the characteristics he associates with this group.
The remaining 10 per cent falls under what he describes as the Fraudulent Type, involving alleged attempts to obtain financing through fictitious businesses or fabricated records.
“For SMEs in this category that apply for loans from banks or development financial institutions, their real purpose is to defraud the bank or development financial institution of money,” Fong said.
“They forge documents to get money, such as setting up a fake company, forging company registration documents, forging bank statements or other documents.”
What financiers examine
Lee said the way financing applications are assessed has evolved since he published an SME financing guidebook in 2015.
The guidebook identified 16 common reasons applications could be rejected. Today, Lee groups the assessment into three broad areas: internal scoring, sector risk and supporting documentation.
For internal scoring, information about an applicant can be fed into technology-based assessment systems before the application proceeds further.
“The system will automatically filter the application. If the application fails the scoring system, you have no chance to proceed,” he said.
Factors entering that assessment can include the applicant’s industry, the company’s track record, repayment history and directors.
The second consideration is sector risk.
“They will categorise certain industries as very high risk,” Lee said.
He cited construction as an example, saying an otherwise strong applicant could still be rejected if a financial institution had decided to limit its exposure to that particular sector.
“Whatever the reason, your documents may be very strong and your record may be good. That is because of your sector,” he said.
The third area is documentation.
“Lastly, it is all your documentation, such as your financial statements, bank statements and personal income tax,” he said.
Once an application moves beyond those broad filters, the assessment becomes increasingly specific.
Collateral and paperwork
Fong said insufficient collateral is among the common reasons an SME may have its financing application rejected or the amount approved reduced.
Financial institutions consider the security value of the collateral alongside their clean-portion policies and their assessment of the borrower’s creditworthiness.
He illustrated this with a property valued at RM500,000.
“The bank’s collateral valuation is estimated at RM350,000, or 70 per cent of market value.
“If the bank is willing to take on a maximum Clean Portion Risk of RM500,000, then the maximum loan amount can reach up to RM850,000,” he said.
Under his example, the RM850,000 could comprise RM425,000 in term financing for a property purchase or refinancing and another RM425,000 through an overdraft or multiple trade line for working capital.
For SMEs without sufficient collateral, Fong pointed to government-backed guarantee schemes, saying Credit Guarantee Corporation Malaysia Bhd provides financing guarantees of up to 80 per cent while Syarikat Jaminan Pembiayaan Perniagaan Bhd provides guarantees of up to 70 per cent.
“With government guarantees, the risk borne by the bank is reduced, so banks are willing to grant higher loan amounts,” he said.
However, he said some guarantee facilities also carry additional costs.
“CGC has also increased the guarantee fees for some guarantee facilities. This has indirectly increased the financial burden on SMEs,” he said.
Collateral is only one part of the assessment.
Depending on the applicant and financing facility, Fong said institutions may require identification documents for directors, owners and guarantors, two years of personal tax records, company registration documents, three years of accounts and, for newly established businesses, projected accounts for the next five years.
Other documents can include the latest draft accounts, debtor and creditor statements, six months of company bank statements, existing financing offer letters and agreements, vehicle or machinery financing records, tenancy agreements, property titles and relevant licences or permits.
Common weaknesses include an inability to provide current financial information, debtor and creditor statements or credible projections for a new business.
Even complete documentation can become a problem when the figures do not agree.
“Discrepancies in documents, turnover and data will cause banks to doubt the applicant and reject the loan,” Fong said.
When the numbers do not add up
The amount requested provides another test.
“Generally, loan amount will not exceed one-third of applicant’s turnover. To get a RM1 mil loan, turnover must be at least RM3 mil.
“Applied for RM1 mil loan but 3-year average turnover only RM1.5 mil. The bank only approved RM500k,” Fong said.
The intended use of the financing also matters.
“Different facilities have different purposes. A working capital facility cannot be used for property purchase or renovation,” he said.
Repayment capacity is assessed separately.
“Annual loan installments cannot exceed two-thirds of profit before tax.
“If annual installments = RM50,000, then the company must earn at least RM75,000 profit before tax.
“SMEs should understand their repayment ability to increase approval chances.”
Credit history can further influence the assessment, including the records of company directors and guarantors.
“For example, director in arrears, or guarantor for someone else who defaulted, or sued by suppliers.
“Therefore, it is advisable to repay on time, understand guarantor responsibilities, and handle financial disputes carefully.”
The way a company manages its bank accounts and existing facilities can provide further warning signs.
“Insufficient funds can lead to a ‘Morning Call’ from the bank. Three bounced cheques can result in blacklisting, while more than three late payments recorded in the Central Credit Reference Information System (CCRIS) within a year make rejection very likely,” Fong said.
Existing borrowing is another consideration.
For development financial institutions, he said a company’s existing long and short-term liabilities together with proposed new borrowing should not exceed three times its net assets or shareholders’ funds.
Commercial banks, meanwhile, assess existing financing facilities together with the proposed borrowing against the same measure, he said.
“Simply put, for every RM1 of assets an SME has, it can borrow RM2 or RM3 from development financial institutions or banks,” Fong said.
Where net assets or shareholders’ funds are insufficient, he said an SME may need to inject additional capital to strengthen its financing position.
Concentration and management risks
Financiers also examine how dependent a business is on individual customers or suppliers.
“In other words, the fate of the SME depends on one or two customers or suppliers.
“If these major customers or suppliers terminate cooperation with the SME for any reason, the SME’s turnover will be directly affected. In severe cases, it may cause the company to be unable to continue operating.”
Fong said banks and development financial institutions generally regard a customer or supplier accounting for more than 25 per cent of transaction volume as a concentration risk.
“Banks will conduct deeper analysis on these major customers or suppliers. If the management or financial condition of these major customers or suppliers is unstable, the bank may reject the loan,” he said.
Businesses facing such concentration can provide sales contracts or letters of intent to demonstrate the durability of those commercial relationships, while gradually diversifying their customer or supplier base.
The assessment may differ where a major customer or supplier is a listed company, international group or government-linked company, he added.
Eligibility for the particular financing facility is another hurdle.
“Every loan facility launched by banks or development financial institutions will set some basic conditions.
“For example: minimum years of company registration, minimum company turnover, specific business sectors, specific loan purposes,” he said.
For newly established companies without an operating record, Fong said rejection risk can be particularly high.
“Since it is a brand-new company with no business record, if it applies for a bank loan, the chance of rejection is as high as 99%,” he said.
He pointed instead to CGC’s Biz Mula-i as a facility intended for newer businesses.
“So as long as SMEs find the right financing channel, getting a loan is not difficult,” he said.
Management quality can also influence the assessment.
“If the applicant’s company management system is chaotic, staff turnover is very high, and it affects company operations, then banks will lose confidence in the company and will not consider approving the application.
“Banks will review the qualifications and experience of the applicant’s key management,” he said.
That concern can extend to succession.
“If these key people are old and there is no successor to manage the company, banks may also worry about the risk of no succession and be unwilling to lend or only approve short-term loans,” he said.
Fong advised owners to strengthen weak management systems and identify and train potential successors before succession becomes an immediate financing concern.
When RM1 million turnover still looked like RM10,000 capital
Fong cited the case of a transportation sole proprietorship whose experience illustrated how a growing business can appear much weaker in its accounts than it actually is.
The owner had registered the business for RM60 many years earlier and began operations with RM10,000 in capital.
Over time, annual turnover grew to RM1 million and the business was generating what Fong described as good profits.
When the owner sought working-capital financing for further expansion, however, the application was rejected.
“After investigation, it was found that the company’s accounts recorded the Capital Employed as only RM10,000.
“In fact, the SME owner had injected funds many times to buy transportation vehicles for business operations.
“But these amounts were not recorded in the accounts, causing the business capital shown in the accounts to be too low.”
Fong said the case demonstrated why accounting records need to keep pace with the development of the business.
“Therefore, proper accounting records cannot be neglected. Sole proprietors should increase their Capital Employed regularly to reflect the true capital of the business,” he said.
For Sdn Bhd companies with insufficient funds, he said paid-up capital could similarly be increased where necessary to strengthen net assets or shareholders’ funds and improve financing eligibility.
“In special cases, banks or development financial institutions can also pre-approve the loan and make ‘increase paid-up capital’ one of the conditions before loan disbursement,” he said.
Beyond correcting the capital position, Fong identified three stages in financing planning: establishing the purpose of the financing, understanding the SME’s financial strength and minimising financing costs.
Before approaching a financial institution, he said owners should examine their operating record over the previous three years, repayment history, competitive advantages, profitability and available collateral.
“Only by understanding their own strength can SMEs request the financing package they need from financial institutions,” he said.
