Why Lenders Care What’s On Your Tax Return

Deciding to apply for a business loan can be an exciting time. You’re paving the way to a new business or growth in your existing venture, your brain buzzing with ideas at the thought of bigger opportunities for success. But as you go through the loan process, passion and enthusiasm can quickly give way to complete panic over the tasks looming before you: preparing financial statements, filling out what can feel like never ending stacks of paperwork… It’s enough to make you want to forget the whole thing!

And then there’s the document requests, which can feel downright invasive. It’s pretty humbling to lay your income statements, tax returns, and other financials out for someone else to scrutinize. Would they have made the choices you did when you made them?

But the review has to be done, for the well-being of the lending institution, of course, but for your own good as well. After all, the main goal of the loan approval process is for lenders to make sure you can afford to pay back any loan you take on. Even if you’re optimistic about how the loan will pay dividends in the long run, you don’t want to overextend yourself financially.

Why Tax Returns Are Important to Lenders

Some might argue there are better ways to determine the financial health of a business and the likelihood with which a borrower will repay a loan. But tax returns, along with credit reports, remain the standard by which your creditworthiness is largely determined.

First, your tax returns will itemize your annual revenue. Revenue gives lenders an idea of how much money flows into your business. When year-over-year information is reviewed, lenders can look for important external factors that may need to be considered. Is the revenue sustainable and on an upward trajectory? Or did it occur due to something seasonal or circumstantial, possibly never to be repeated?

Second, losses will also be reviewed on your tax return. Lenders may dig to determine whether you have sufficient income to cover the new debt you’re requesting. True losses can be difficult to discern from creative (yet legal) accounting techniques your tax preparer may have used to minimize your tax exposure. Be mindful that there may be a fine line between reducing your tax burden through deductions and unwittingly giving the loan officer a low estimation of your income.

At the most basic level, tax returns will demonstrate your commitment to accurate reporting, along with your preparedness and willingness to adhere to ethical accounting practices. These and other intangibles will invariably add some context to the loan decision-making process.

The Loan Analysis Process Benefits Both Lenders and Borrowers

If you’ve ever wanted a brand new car, a nicer house, or any other luxury that may be just a bit beyond your means, you’re likely familiar with the misguided confidence that can follow assuring oneself that you really can make the payment if only you do X or Y. There may be months where your income is such that having “more house” or “more car” makes finances a little tight, but manageable. Other months, those same choices weigh like a boat anchor on your chest.

By reviewing your tax return as part of the loan assessment process, lenders can help avoid that sense of buyer’s remorse. If you can’t afford the loan, it probably won’t be granted to you, meaning you won’t be overextended. As frustrating as it can be to risk rejection for a business loan application, remember that loan officers do this every day and are ultimately trying to protect you as well as themselves.

There Are Misses, Too

Obviously this process isn’t perfect. Businesses aren’t always as successful as projected, and occasionally tax returns can present a distorted view of your business’s financial health. But generally speaking, it’s in the best interest of both the lender and the borrower. After all, it is the best way to verify revenue.

Your Tax Return Is Good and Your Loan Is a Go

Once your loan status has been determined, if you’re granted the funds you requested, you can have some confidence knowing the financial institution thinks you’re a solid bet. Plus, you can rest assured that the lender you’re working with is reputable enough to do its due diligence in vetting its loan customer base.

As you bite the bullet and hand over your tax returns with your business loan application, remember that you’re showing a commitment to the best interest of your business. Undergoing that degree of financial scrutiny can be a painful process, but when it’s over, you’ll sleep soundly at night knowing that the loan you’ve signed up for is one you can truly afford.

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Meredith Wood
Meredith Wood is the Editor-in-Chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more. Meredith is also the Senior Financial and B2B Correspondent for AlleyWire.

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