When Should Small Business Owners Take a Business Loan?

Any business needs money to begin, expand, grow, and sometimes sustain in a challenging environment. Nothing is better than self-earned money, but there are situations where the company’s cash reserves are not enough. It might need external funding, and business loans are one of the most accessible ways to secure cash when needed. While business loans can help a company grow, they can also pull it down. Hence, it is crucial to think through this before taking out a business loan. In this article, we will understand how small business owners could approach business loans and make the most of them.

Assess the Requirement for a Business Loan

Do You Need a Business Loan?

A business loan may be needed when your reserves are not sufficient to meet expenses or when you need to make a major purchase.

Why Do You Need It?

A business may need the loan to start up, buy equipment, fund a marketing campaign, expand, meet working capital needs, and more. Once you have the need in place, put it in a quadrant if it is urgent and essential or important but not urgent. It can help you determine if the expense can wait till you have the reserves to fund it internally without affecting an opportunity at hand.

Work Out The Opportunity Cost

A small business might have multiple opportunities. However, grabbing every opportunity and expanding aggressively with debt funding can be too risky. What if the opportunity does not yield sufficient returns to repay the debt? You need to identify the opportunity cost and take a business loan for those that have higher and assured returns. 

Is There An Alternative? 

While the business loan is an option, you should also identify alternatives. For instance, if you plan to buy equipment for a small order, you might want to consider leasing the equipment. If you need a loan for working capital, you could work out a deal with your supplier for delayed payments or short-term credit.

A business loan is a viable option when the investment yields higher and regular returns after factoring in debt repayment.

Can Your Business Repay the Loan?

Once you know you need to borrow and have worked out the amount, you can chart a loan repayment plan before taking a loan.

The capital investment for which you took the loan should help you generate enough cash flow to meet the debt obligation.

For instance, a logistics company might borrow to buy delivery vans. The business should crunch the numbers and identify how many deliveries they need to make to repay the debt or pay monthly loan installments. During budgeting and cash flow forecasting, you must add the loan installment and maintain loan provisions for periods of slow revenue.

Charting out a forecast and budget for loan repayment will help you understand the type of loan and the loan terms your business needs.

How to Identify a Suitable Business Loan for Your Business Need?

Finding the right business loan can help you repay the debt without stressing your cash flow or compromising on future capital expenditure.

Several types of loans are available for specific needs, such as startup loans, commercial real estate loans, working capital loans, purchase order loans, business acquisition loans, equipment purchase loans, and more. 

A small business also has options around loan terms:

• Repayment length: Short term, long term, flexible
• Interest rate: Fixed or variable
• Collateral: Secured, unsecured
• Covenants: The lender might require you to have a certain amount of reserves

Loan terms depend on the lender, loan type, your business credit score, and financial records.

While there are various loan options, your small business should be eligible for them.

How to Prepare for a Small Business Loan Application

Banks and lenders verify your company and its ability to repay the debt before giving a loan. They might require certain documents. If satisfied, they can offer you favourable loan terms. Take time to prepare loan application documents from the lender’s perspective.  

• Comprehensive Business Plan: One way to vet a business is to study the business plan that explains in detail the company’s goals, expansion strategies, risk management, and financial projections. It tells lenders how organized your business is and asses the risk involved.
• Financial Records: A business plan is futuristic, while accurate financial statements and tax returns are your past achievements. These records help the lender assess your business cash flow and ability to service debt. The lender might determine interest rates, loan amounts, and collateral requirements based on these records.
• Credit History: Always check your personal and business credit scores before applying for a loan. A high credit score of 650 and above shows you are regular on bill payments and are less likely to default on the loan. This could increase your chances of getting better credit terms.

Common Mistakes to Avoid

Personal guarantees: Avoid taking a business loan on a personal guarantee. If the business defaults on the loan, a personal guarantee could put your personal assets at risk.   

Loan scams: While hunting for the best loan terms, beware of “too good to be true” offers. They could be loan scams. Here are some tips to identify a loan scam:

• If the lender offers no-credit-check guaranteed loans
• If the lender oversells the loan with a “limited-time offer”
• The lender asks for advance payment or processing fees before disbursal of the loan. In a genuine case, this fee is deducted from the loan amount.

A business loan is a big decision with a long-lasting impact. It is good practice to seek professional assistance.

Contact DNTW Toronto LLP for Expert Financial Planning Advice

A trained business advisor can assess your financial situation, compare loans of different lenders, analyze loan terms, help you prepare the necessary documents for a loan application, chart out a loan repayment plan, and get you the most cost and tax-efficient loan. Moreover, the business consultant can help you access alternatives such as government grants and financing options for small business owners. To learn more about how DNTW Toronto LLP can provide you with accounting and financial planning expertise, reach out to us online or by telephone at 416.924.4900.