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Accounting & Business Management Specialist
My Blog​
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What Lenders Look For On Your Tax Returns
| Posted on June 14, 2016 at 4:33 PM |
What Lenders Look For On Your Tax Returns If you’re applying for a short-term loan with a repayment period of 18 months, the lender will be much less interested in your tax return than in your bank statements and deposits. The debt won’t be outstanding for all that long, so these lenders just want to make sure that you’re pulling in enough revenue to cover your daily or weekly payments. If you’re applying for a loan with a longer term, the lender will be interested in your business’s profitability. They want to make sure you’re making money over the long term, so your strong financial track record and balance of profits and losses will become more important. The most important part of your tax returns, in the eyes of any lender, is going to be your income. But it’s important to understand the other parts of the paperwork that you’re turning in as part of your loan application: your tax returns are one of the primary representations of your business and its finances. What Is Important? INCOME The first and most important thing is going to be that first section on any tax return: your Income. Tax returns will show a lender your annual revenue which is a key metric for them in deciding whether or not they should offer you a loan. Revenue is the total amount you pulled in from sales less the cost of those goods and any returns in order to give you your gross profit. This number will get added to any additional income you received such as dividends or interest to then provide you with a total income figure. Many lenders will ask you to submit returns from multiple years: the SBA, for example, asks for 3 years’ worth of tax returns for a 7(a) loan application. This gives lenders an idea of how your revenue has changed over time. If it’s been stable or increasing, that’s a good sign: it means that you’ll be more likely to make repayments on time. Usually, lenders want to see a debt-coverage ratio of at least 1.2, although 2.0 is even better. It basically confirms if you have the cash flow to cover your debt payment—so if you’re applying for a loan with a monthly payment of $1,000, your monthly cash flow (sales-expenditures) will need to be at least $1,200. DEDUCTIONS These are your expenses which include everything that costs you money to operate your business. These deductions will be subtracted from your total income in order to come up with an “ordinary business income” or “taxable income” figure. For some businesses—especially those with sharp accountants (like Cypress Consulting) who’ve saved them money by generously claiming deductions—this final income figure will look low and may even show a loss. This is always great for saving tax money, but not always so great for loan applications, because you’ll want to show the highest possible income. There is a method lenders use to adjust for this where they add-back certain expenses that are deductible for tax purposes but generally do not dictate the operating costs of the business. Some of these expenses are depreciation, interest and officer compensation. If you’re a sole proprietor who’s filled out a Schedule C, you don’t need to worry as much about these add-backs. Employer compensation won’t be taken into account, for example, because your business’s profit is going straight into your personal tax reporting. It’s much less complicated. BALANCE SHEET On a 1065 or an 1120 tax form, you’ll see a section called “Schedule L,” which is a balance sheet of your assets and liabilities. If you are a sole-proprietor, you would need to provide a separate balance sheet from your accounting system to show your businesses assets and liabilities. Lenders will gather information about your loans, your accounts payable, your real estate, your stock—any figures that express your assets, liabilities, and shareholder equity—at the beginning and end of the tax year. The lender could also request a more detailed balance sheet from you. This is where bookkeeping software like QuickBooks can prove extremely useful because your business activity is kept in detail and easily accessed. SCHEDULE E If you’re a corporation filling out an 1120, on line 12 you’ll see that you have to report “Compensation of Officers.” It will also refer you to Form 1125-E, which is a more detailed form that you’ll need to fill out and attach if your total receipts are over $500,000. Also known as “Schedule E,” this form could be extremely important for loan applications because it will show ownership percentages. With many loan applications, the lender will look at the personal finances of any owner with more than 20% ownership. They might even require a personal guarantee. In Summary, Lenders want to make sure that you’ll be able to make your payments on time without a problem for the length of the loan, which requires solid revenue and cash flow. |
Categories: Business Strategy, Tax Preparation
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144 Comments
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9:12 AM on June 30, 2016
It’s pretty good post. I just stumbled upon your blog and wanted to say that I’ve really enjoyed reading your blog posts. In any case I’ll be subscribing to your feed and I hope you post again soon.
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Thomas Webb
11:43 AM on November 1, 2017
I have to agree. All the tax returns from your business reflect with all the business liabilities. I think some of the terms in your blog is good to learn just like the Malta Yacht VAT has been describing before I start doing business.
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11:49 AM on December 10, 2017
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Lawrence Todd Maxwell
5:57 PM on October 8, 2018
I admire people who keep sharing valuable stories through great writing. I'm glad to have read this blog. Thanks and hope to read more soon.
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