Borrowing Cause vs. Loan Purpose
In commercial loan underwriting, the borrowing cause and loan purpose are distinct but related concepts that lenders analyze to assess creditworthiness. Business owners can position themselves effectively in presenting their loan request to their bank loan officer when they understand the root borrowing cause(s) in addressing their cash needs and in structuring the appropriate loan repayment structure.
Borrowing Cause
The borrowing cause refers to the underlying business condition or financial need that necessitates borrowing. It is the reason the business requires external financing rather than funding the need internally. Common borrowing causes include:
Working capital shortfall – Cash flow gaps due to seasonal sales cycles, slow or extended accounts receivable collections, or rapid growth.
Asset-liability funding mismatch – Using short-term funds to finance long-term assets, leading to liquidity strain.
Expansion or investment – Business growth requiring capital beyond retained earnings and internally generated cash flows.
Debt refinancing – A need to restructure existing debt due to high-interest rates, balloon payments, or covenant issues.
Unexpected costs – Unplanned expenses such as equipment failure, legal costs, or economic downturns.
Operating losses are also considered a Cause when they lead to cash flow deficiencies that need to be covered by borrowing.
Non-recurring expenses – Such as moving, relocation, leasehold or property improvements.
Loan Purpose
The loan purpose refers to how the borrowed funds will be used. This is the direct application of loan proceeds, which must align with the business’s financial needs and justify the loan request. Examples include:
Purchasing inventory – To fund working capital shortfall from timing differences in the business operating or seasonal cycles, or to support sales and market growth.
Acquiring equipment – To expand production or replace aging assets.
Funding construction or real estate purchases – For business expansion or relocation.
Refinancing debt – To improve cash flow through debt restructure or reduce interest expense.
Covering payroll or operational expenses – During a cash flow shortfall.
Key Difference
While the loan purpose describes where the funds will go, the borrowing cause explains why the business does not have sufficient internal resources to meet the need. Lenders assess both to determine repayment ability, financial health, and risk exposure.
For example, a business seeking a $500,000 loan to purchase inventory may have a borrowing cause of working capital constraints due to seasonality such as jewelry retailer or department store in preparation for the year-end holiday season. Strategic business growth or expansion may result in multiple needs such as capital physical plant expansion, increased warehouse space, and additional inventory.
The business may then require long term financing for permanent capital as well as short term financing such as an increase in their line of credit to cover higher levels of inventory and accounts receivable.
Understanding both factors allows lenders to structure financing that matches the business’s actual needs.
