How An Underwriter Sees Your Business: 6 Considerations for a Successful Loan Application

If you’re applying for a business loan, both you and the lender most likely want the business to succeed. However, each party approaches funding from a different perspective. While you consider the business’s strengths and potential, the lender — or more specifically, the underwriter — considers what could go wrong.

Underwriters look at several factors when evaluating businesses for funding, from cash flow to debt levels. In times of economic uncertainty, such as an inflation spike or a banking crisis, underwriters place even more scrutiny on loan applications because the associated risks and costs are higher. 

As a small to midsize business owner, qualifying for traditional business loans can be challenging even in a healthy economy. This can be especially true if you have a new business and lack sufficient credit history. Putting yourself in an underwriter’s shoes can increase your chances of success by illuminating key financial information that is likely to impress or deter a lender.

How does an underwriter evaluate risk, and how can you build a loan application from an underwriter’s point of view? 

What is an underwriter?

An underwriter’s purpose is to evaluate a borrower’s risk. Underwriters are necessary across a variety of financial functions, including mortgages, insurance, equity investments and loans. They typically operate within a bank or other financial organization and may be supported by software to facilitate risk assessment.

When it comes to small to midsize business funding, underwriters want peace of mind that your business can pay back the loan under its terms. In other words, they want to know that the risk of lending has promising returns for their organization. Underwriting also helps determine the appropriate interest rates and terms for the borrower. 

How do underwriters evaluate businesses? 

Cash flow is an underwriter’s top consideration when evaluating a business’s financials. Essentially, they want to know that your business can meet its financial responsibilities with enough extra cash to manage uncertainties such as a recession or unexpected loss of income.

There are some key financial metrics that underwriters may observe to assess cash flow. Your operating cash flow statement, for example, represents cash flow from your primary business activities, excluding investments and loans, and indicates how reliably your business can cover its financial obligations:

Operating cash flow ratio = Operational cash flows / Current liabilities (accounts payable, short-term debts)

Underwriters typically require at least a 1.25 coverage ratio. This means that your business can meet recurring expenses, such as insurance and loan payments, with some cash left over. A 1.0 ratio, which indicates that you earn just enough cash to cover recurring expenses, is considered too tight by most underwriters. 
Underwriters may also look at your cash conversion cycle (CCC), a measure of how long it takes your business to turn inventory investments into cash flow from sales. Additionally, your balance sheet gives an underwriter an overview of your business’s assets, liabilities and shareholder equity, illustrating your financial health. Underwriters also consider the following:

• Your track record. Underwriters research your financial history to anticipate how you’re likely to make future decisions. For example, do you retain your earnings in the business or distribute most of your profits? Do you make bill payments on time? Do your earnings vary widely from year to year?
• Due diligence. Underwriters view errors, unbalanced balance sheets, late financial statements and unusual reporting formats as red flags.
• Debt. High debt levels may give underwriters pause. While debt levels vary by industry, a debt-to-equity ratio of 2.0 or less is generally considered acceptable. This means that your business derives no more than two-thirds of its capital financing from debt and one-third from shareholder equity, borrowing twice as much funding as it owns.
• Collateral and personal guarantees. What assets does your business have as security if you default on a loan?
• Industry-specific factors. Underwriters factor in your industry when considering risk. For example, your ability to make loan payments could be compromised if you run a seasonal business or operate in a higher-risk sector, such as travel or agriculture.

6 ways to approach your business finances like an underwriter

The secret to success when securing a business loan is to think like an underwriter. With a basic understanding of how an underwriter is most likely to analyze your finances, here are some strategies to consider before applying.

1. Maintain healthy financial metrics

You know underwriters prioritize balance sheets and cash flow when evaluating risk, so ensure that your cash ratios and other metrics are sufficient before applying. For example, a 1.0 cash ratio or less — or a CCC greater than your industry’s average — may warrant strategies such as reducing costs, securing more customers or using early payment discounts to boost cash flow. 

2. Keep reports consistent

If you haven’t already, consider hiring an accountant to ensure that your financial reports are accurate, complete and consistent. Because underwriters also like to see consistency in the numbers themselves, explain variations so that the lender doesn’t think your business is simply losing money. This may be relevant if your business is seasonal or has nonrecurring expenses, such as a new piece of equipment, that are throwing off your numbers.

3. Separate business and personal assets

Personal assets, such as vehicles or homes, run through your business are red flags for underwriters. Separating your business assets from personal affairs not only makes your business appear more established and credible but also makes it easier for underwriters to accurately assess your business’s financial health. 

4. Pay down debt

Paying off your debts and making on-time debt payments gives underwriters more confidence that you can repay loans. If you’re consistently paying off business-related debts, it also shows that you’re personally invested in the venture and its return on investment (ROI). 

5. Reinvest in your business

Personally investing in your business is viewed favorably by underwriters. These investments show that you have “skin in the game” — you’re committed to seeing an ROI, and are less likely to walk away from the business and your loan payment obligations. Besides paying down business debts, reinvesting in your business may take the form of using surplus cash to purchase new equipment, hire more staff or develop new products.

6. Ensure that you’re ready to apply

Your business might not be at a stage where it can surpass a 1.0 cash ratio, maintain a sufficient cash flow or meet other underwriter requirements. In this case, it’s often better to invest time and resources into building a balance sheet and financial history worthy of approval. If you’re not sure where your business stands or how to improve your metrics, consider hiring a financial advisor. This person has the expertise to help you make more strategic financial decisions and enhance your funding eligibility.

Beyond traditional business loans

Viewing your business finances from an underwriter’s perspective can not only improve your chances of loan approval but also help you access better terms and lower financing costs. 

However, even if you do your due diligence, your business may still struggle to meet underwriting requirements, especially during an economic downturn or inflationary period. Fortunately, funding alternatives such as early payment programs, asset-based lending or revolving lines of credit can be more affordable and accessible options.

To learn more about funding solutions to grow your small to midsize business, click here to connect with a C2FO team member.

This article originally published May 2017, and was updated July 2023.