When is a loan necessary? This is a question many small businesses face from time-to-time. Borrowing money can be expensive and it introduces another level of risk to your business, but it can also open the door to many opportunities for growth.
So when should you consider getting a small business loan? Here are three key points you should consider when deciding whether a loan is in the best interest for your business.
The benefits of loans for small businesses are clear—it allows quick funding for short-term or sudden issues. However, the reasoning behind your decision to borrow any amount of money is incredibly important. Some of the most common reasons are often attributed to up-front costs of business growth opportunities, covering costs for late paying clients to allow the business to continue to run, debt consolidation, buying established businesses, as well as repair and on-going costs. These are often good reasons to consider taking out small loans because they support the growth or progression of your small business. Thinking about the reason for the loan is a good step in identifying if you really need the loan.
Often mistakes can be made when taking out loans. Sometimes business owners can get so caught-up in the need for a loan that they rush the process and overlook certain factors that could become issues in the future. These factors often prove to be things like the assumption that your late-paying client will start paying by the time your loan obligations need to be met, moving your debt to avoid defaults rather than negotiating an agreed outcome with the original lender, or simply misunderstanding the terms and conditions of your loan agreement. Take time to read through the terms and conditions and assess your scenario to make sure it’s right.
You also need to ensure that your business is not put in a situation where the loan would cause a detrimental impact on its survival. Small business owners should avoid two circumstances that can cause major issues.
The first circumstance revolves around adding extra debt that doesn’t increase revenue or sales. In the industry, we refer to Good Debt and Bad Debt. Good Debt has a clear link to improved sales, whereas Bad Debt does not. Bad Debt is often a result of poor-paying and non-paying customers, leaving a business short on cash to pay its own expenses, like wages, rent and utilities. Borrowing to cover this shortfall does not improve sales; therefore, it is usually detrimental to the health of the business. Finding alternative ways to manage aged accounts is the preferred outcome to borrowing in this circumstance.
The second circumstance revolves around consolidating debt for the wrong reasons. Consolidating debt can be a more efficient way to manage repayments, but unless the consolidated repayment reduces your expense, it can be detrimental to the business. Additionally, consolidated debt with a higher repayment will have a negative effect on cash flow.
Once you have decided that a loan is right for you, Limba can help! But make sure the reasoning has a link to benefiting your business, take the time to read the terms and conditions, and make sure the circumstance isn’t detrimental to your cashflow.