When applying for a business loan as a sole proprietor, you must disclose your income to prove you can afford it. Lenders typically consider both your business and personal income and debts when deciding whether you qualify. Because you own a small business, you must provide the bank with copies of your tax returns as proof of personal and business income. They will look most closely at the adjusted gross income figure from your filed tax returns.
Adjusted Gross Income vs. Gross Income
Gross income is a combination of total income, which includes wages, dividends, capital gains and income from your business. Adjusted gross income, or AGI, is your gross income minus special adjustments, such as qualified moving expenses, student loan interest deduction or the deductible portion of your self-employment tax. These adjustments reduce your taxable income, which is the amount used to calculate your tax liability.
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Bank Procedure
Business owners might find it more difficult to obtain a loan because of bank verification requirements and the methods used to calculate income. As a self-employed individual, you must provide your two latest income tax returns and business profit-and-loss statements as verification of income. Most lenders use a combination of the profit-and-loss statement and an average of your AGI to determine whether you can afford the loan. Although you lower your tax burden by claiming various adjustments to income, having a lower AGI could limit your loan options.
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Debt-to-Income Ratio
In addition to your income, lenders also calculate your debt-to-income ratio to determine how much loan you can afford. After calculating your monthly income, the lender will calculate your monthly debt, which might include a mortgage, car loan, personal loan, credit cards payments and the anticipated loan payment amount. The lender will divide your total monthly debt by your monthly income to determine your debt-to-income ratio. In most cases, a favorable debt-to-income ratio is less than 40 percent.
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Other Factors
While your monthly income and debt-to-income ratio are key factors in determining whether you qualify for a small business loan, they are not the only factors used. Lenders will also evaluate your cash-on-hand, employment history and your credit score. Your credit report will provide detailed information on how you handled loans in the past. This information can be especially helpful if your debt-to-income ratio is near the 40 percent mark.
