Overcoming Business Loan Rejections: Top 5 Challenges and Solutions for Small Businesses in India

In the dynamic landscape of Indian business, small and medium enterprises form the backbone of the Indian economy. These small and medium enterprises (SMEs) need to secure a business loan to fuel growth, manage cash flow, or invest in new opportunities. However, securing a business loan in India can be a challenging process, with many small business owners facing rejections from lenders.

Business loan rejection: Reasons, challenges & solutions

Whether you are a startup founder or an established small business owner, knowing the causes of these rejections and implementing proper strategies can help. This guide explores the top five reasons why small businesses in India face loan rejections and provides actionable strategies to overcome these obstacles.

1.   Low credit score: A barrier to loan approval

A credit score is one of the first things lenders check before approving a loan application. It reflects your creditworthiness and financial discipline. If your personal or business credit score is low, banks and financial institutions may perceive you as a high-risk borrower and deny the loan application.

Causes of low credit scores

• Late payments: Missing deadlines on credit card bills, previous loans, or EMIs can negatively impact your credit score.
• High credit utilisation: Using more than 30-40% of your total credit limit can indicate financial instability.
• Multiple loan applications: Applying for multiple loans within a short period results in frequent hard inquiries, lowering your score.
• Lack of credit history: New businesses or individuals without prior credit exposure may struggle with lower credit scores due to limited financial records.

How to improve your credit score?

• Make timely payments: Ensure all credit obligations, including loans and credit cards, are paid on time. Setting up auto-pay can help avoid missed payments.
• Monitor your credit score: Regularly check your credit report from credit bureaus like CIBIL and rectify any discrepancies.
• Reduce debt-to-income ratio: Paying off existing debts before applying for a business loan improves your creditworthiness.

Pro Tip: Consider taking a small loan or credit card and maintain a perfect repayment record to build your credit score.

2. Incomplete or inaccurate documentation: The silent loan killer

Banks and Non-Banking Financial Companies (NBFCs) require various documents to verify a business’s legitimacy and financial health. Missing or incorrect information can lead to automatic rejection.

Common documentation issues:

• Incomplete KYC documents: Missing PAN, Aadhaar, or business registration certificates.
• Incorrect financial statements: Errors in balance sheets, profit & loss statements, or tax returns.
• Lack of proof of revenue: Inconsistent sales records or no bank statements to support claims.
• Outdated business licences: Expired trade licences or GST registration issues.

How to ensure proper documentation?

• Keep financial records updated: update income statements, balance sheets, and other financial records regularly.
• Verify business registrations: Ensure GST registration, business licences, and tax filings are up to date.
• Work with a chartered accountant: A professional can help prepare accurate financial reports and documentation.
• Double-check forms before submission: Check all details before submitting the loan application.

Pro Tip: Always double-check your documents for accuracy and completeness before submitting a loan application.

3. Insufficient cash flow: Lack of support for loan repayments

Lenders evaluate cash flow to determine if a business can meet loan repayment obligations. A business with irregular or inadequate cash flow is considered high-risk, leading to loan denials.

Common cash flow issues:

• Delayed payments from clients: Late payments disrupt revenue streams, making loan repayments difficult.
• High operational costs: Excessive expenses reduce available cash for loan repayment.
• Seasonal business revenue: Businesses that rely on seasonal sales may struggle with stable cash flow throughout the year.
• Poor inventory management: Excess stock without sales ties up capital, impacting cash flow.

How to improve cash flow?

• Use cash flow management software: Tools like TallyPrime help track income, expenses, and outstanding payments.
• Encourage early payments: Offer discounts to customers for early payments to maintain a steady cash flow.
• Cut unnecessary expenses: Review operational costs and eliminate wasteful spending.
• Negotiate payment terms with suppliers: Extend credit periods with suppliers for improved cash liquidity.

Pro Tip: Use cash flow management tools to track and stabilise your inflows and outflows for better loan eligibility.

4. Lack of collateral: The roadblock for traditional loans

Many banks require collateral—such as property, equipment, or inventory—as security against loans. Small businesses that lack significant assets often struggle to meet this requirement.

Common collateral issues:

• No physical assets: Service-based businesses or startups may not have tangible assets to pledge.
• Already pledged assets: Existing loans may have already used available assets as collateral.
• Inadequate asset valuation: Some assets may not be valued highly enough to cover the loan amount. 

How to secure a loan without collateral?

• Apply for unsecured business loans: Some financial institutions offer loans based on business revenue and creditworthiness rather than collateral.
• Explore government schemes: Initiatives like the CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises) provide collateral-free loans.
• Build a strong business profile: A well-documented financial history and steady revenue can help secure unsecured loans.

Pro Tip: Explore unsecured business loans or government-backed schemes if you lack physical assets for collateral.

5. Unconvincing business plan: The deal breaker for loan approval

A strong business plan demonstrates to lenders that your business is viable, profitable, and capable of repaying the loan. If your business plan lacks clarity or feasibility, lenders may reject your application.

Common business plan mistakes:

• Lack of market research: No clear understanding of the industry, competitors, or target audience.
• Unrealistic financial projections: Overestimating revenue or underestimating costs can raise doubts.
• No clear loan utilisation plan: Lenders want to know how the loan will be used for business growth.

How to create a persuasive business plan?

• Include detailed market analysis: Show clear demand for your products or services.
• Outline clear financial projections: Provide realistic revenue forecasts based on historical data.
• Specify loan usage: Clearly state how the loan will help achieve business goals.
• Seek expert guidance: Consult business advisors or mentors to refine your plan.

Pro Tip: Craft a detailed, data-backed business plan that clearly outlines how you’ll use the loan for growth.

Conclusion: Empowering your business loan journey

Securing a business loan in India may seem daunting, but understanding these common rejection reasons and implementing strategies to overcome them can significantly improve your application. Remember, each rejection is an opportunity to strengthen your business fundamentals.

TallyCapital understands the unique challenges faced by small businesses in India. Its comprehensive financial management solutions can help you maintain accurate records, manage cash flow effectively, and prepare robust loan applications.

Don’t let loan rejections hinder your business growth. With the right strategies and tools, overcome these challenges and secure the required funding to take your business to new heights.