What Lenders Actually Assess When They Underwrite Your Business

Most founders prepare for a lending conversation the way they prepare for an equity pitch. Story, growth, market size, ambition. Then the sanction takes four months, comes back at 60 percent of the ask, with a collateral condition nobody mentioned in the first meeting. The disconnect is structural. The relationship manager you met does not approve your loan. A credit officer you will never meet approves it, working off a standardised note built around repayment capacity, security cover and behavioural data. If you do not know what goes into that note, you are negotiating blind. Here is what actually gets tested.

Cash accrual is the number, not EBITDA

Lenders do not lend against profit. They lend against the cash left over after everything else has been paid, and they measure it as debt service coverage ratio: cash accrual divided by annual principal plus interest. Most banks want a minimum of 1.25 times in the first full year and an average above 1.5 across the tenor, and they compute it on your projections after applying a haircut, usually 10 to 15 percent on revenue.

Take a business doing INR 60 crore of revenue at a 12 percent EBITDA margin, so INR 7.2 crore of EBITDA, with INR 2 crore of depreciation. The promoter asks for a INR 20 crore term loan over five years at 9.5 percent. Year one interest is roughly INR 1.8 crore and principal INR 4 crore, so debt service is INR 5.8 crore. Cash accrual is profit after tax plus depreciation: 7.2 less 2.0 less 1.8 gives PBT of 3.4, tax at 25 percent leaves 2.55, add back depreciation and you have INR 4.55 crore. DSCR is 0.78. The loan fails on arithmetic before anyone looks at the business.

Stretching the tenor to seven years still leaves coverage below 1.0. The honest answer is that this balance sheet supports roughly INR 13 crore of amortising term debt, not 20. At that quantum over five years, debt service falls to about INR 3.8 crore against cash accrual of INR 5.0 crore, giving 1.33 times. Run this calculation yourself before you ask. If you walk in with a number the cash flow cannot carry, you have told the credit officer you do not understand your own business.

Working capital is assessed against your cash conversion cycle, not your ambition

Term debt and working capital are underwritten on completely different logic, and founders routinely conflate them. A cash credit or overdraft limit is sized against the gap between when you pay for inputs and when you collect from customers. Under the traditional turnover method still used for smaller limits, the assessment starts at 25 percent of projected annual turnover as the working capital requirement, with the bank funding 20 percent and the promoter expected to bring the remaining 5 percent as margin. For larger exposures, banks build the number from your operating cycle: inventory days plus receivable days less payable days.

The point is that a longer cycle does not automatically get you a larger limit. It gets you questions. If your receivable days have moved from 55 to 90 over two years, the credit officer reads that as either weakening collection discipline or revenue bought on credit terms you cannot afford. And the sanctioned limit is not the money you can draw. Drawing power is recalculated every month from your stock and book debt statement, after margins of typically 25 percent on inventory and 40 percent on receivables, with anything over 90 days old excluded entirely. Businesses discover this at the worst possible moment, when they need the limit most.

The balance sheet test is about resilience, not size

Three ratios do most of the work. Total outside liabilities to tangible net worth tells the lender how much of the risk you carry versus how much they do; above 3 times, most banks get uncomfortable and above 4 they typically decline or ask for additional cover. Interest coverage, EBITDA to interest, shows whether ordinary trading absorbs the finance cost, and below 2 times you are one bad quarter from stress. Current ratio, ideally above 1.33, tells them whether short-term money has been used to fund long-term assets, which is the single most common way an otherwise healthy Indian SME ends up in trouble.

Tangible net worth is where founders get surprised. Intangibles, deferred revenue expenditure, promoter loans that are not subordinated and, critically, receivables from group entities all get stripped out. A balance sheet showing INR 15 crore of net worth can be assessed at INR 9 crore once related-party exposure is deducted. That reassessment changes your leverage ratio, your eligible quantum and your pricing in one step.

Behaviour is weighted more heavily than you think

Credit teams now triangulate three data sets that used to be checked separately: 12 months of bank statements, GST returns and the audited financials. Divergence between them is the fastest way to lose a case. Reported turnover that does not reconcile to GSTR-3B, or bank credits that do not reconcile to either, converts a credit discussion into a diligence exercise.

Then there is conduct. Cheque returns, even for technical reasons. Days the account ran over the sanctioned limit. Delayed submission of stock statements. Statutory dues in arrears, particularly PF, ESI and GST, which sit senior to the lender in a recovery scenario. Your commercial bureau report and the promoter personal report are pulled together, and personal credit conduct matters, because the personal guarantee is almost always on the table. None of these are judgement calls. They are flags in a system.

The RBI Directions amended with effect from 1 April 2026 prohibit banks from insisting on collateral for micro and small enterprise loans up to INR 20 lakh and push appraisal towards viability and repayment capacity rather than asset ownership. That is a meaningful shift at the small end. It does not change anything above that threshold, where security cover, guarantee structure and covenants remain fully negotiable and fully consequential.

What this means for how you prepare

Pricing follows risk, and risk follows preparation. With the RBI repo rate held at 5.25 percent and most working capital limits repo-linked, the benchmark is the same for you and your competitor. The spread is not. That spread is set by your internal rating grade, which is set by the ratios above and by how much work the credit officer has to do to get comfortable.

So do the work before you ask. Compute your own DSCR at the quantum you want and adjust the ask if it does not clear 1.25 times. Reconcile your GST, bank and book numbers, and be ready to explain any gap in one sentence. Clean up related-party balances a full year before you approach a lender, not a week before. Size the working capital limit off your actual operating cycle and be able to defend every component of it.

A lender is not evaluating whether your business is good. They are evaluating whether they get repaid on schedule in a scenario where it does not go to plan. Argue on that basis and you will get a better answer, faster.

Disclaimer

This article is for general information only and does not constitute financial, investment, tax, legal, or professional advice. The views expressed are for general informational purposes and should not be relied upon as a substitute for advice specific to your business or circumstances. Please seek appropriate professional advice before making any business, financial, investment, or transaction-related decision.