Loans can be a huge help for growing businesses. They can help you serve more customers faster, negotiate better terms with your suppliers, and generally make managing cash flows a lot easier—but how do you know when your business is ready for a loan? Today, we’ll share 5 simple questions that will help you understand if and when you might be ready to get a business loan.
Are you missing out on business opportunities due to lack of working capital?
As a rule of thumb, you want to borrow money only when you can put it to work and make even more money—that’s how you will be able to pay for interest and still come out with a profit at the end. For growing businesses, this usually means you have the opportunity to bid for a new project, get a new customer, or fill a big order.
If you find yourself having to turn away good business opportunities just because you don’t have enough working capital to fund the project or order, then it’s probably a good time to start considering a business loan.
How much profit do you expect to earn by taking this loan?
Once you’ve identified your business opportunity, the next step is to understand exactly how much value you expect to create. For business loans, the best measure of that value is usually profit. You might be increasing profit directly through additional sales or indirectly through things like better operating efficiency, but increased profit is still probably your end goal.
While you don’t need to predict your future profits with 100% accuracy, you should be able to come up with an estimate. If you can’t, be careful because that might be a sign that your identified business opportunity isn’t a good one.
If you’re unsure about your estimates, you can always be conservative and lessen your expected profit to get a “safe” estimate. What’s important is that you get an idea of how much debt you can afford.
How long will it take you to pay back the loan?
This is highly dependent on the reason why you’re taking the loan in the first place but, similar to estimating your expected profit, you need to have an idea of how long it will take to pay back the loan.
If you’ve already estimated your profit in question 2, this should be fairly simple. Just compare when you expect to get paid by your customer against the repayment plans offered by your loan provider.
For example, if you are taking a business loan to fund a 3-month project, you can expect to pay back the loan after 3-4 months. You might not be 100% sure about when customers will pay you, but that’s where the specific features of your loan plan can come in handy. Loan products like First Circle’s Revolving Credit Line allow you to repay early with no added fees. That means you can give yourself some allowance by choosing a longer loan period and repaying early if there are no delays.
What are your loan options and how much do they cost?
Now that you have a good understanding of your financing needs, it’s time to start assessing the options available to you. If you’re not quite sure where you can get a business loan, check out the “Where to get a business loan?” section in our recent article on The Basics of Business Loans.
Contact a few lenders and find the cost of their loans based on the interest rate, fees, potential lock-in period and other terms. It can be overwhelming to compute for this, but most lenders will be more than happy to help you.
Just make sure that you are comparing offers on the same basis because not all interest rates are used in the same way and other terms can have a big impact on your final cost. Getting the total peso-value you will be paying is usually a good way to make sure you are comparing offers properly.
It also helps to take note of any non-monetary costs. For example, one loan offer might be cheaper in terms of interest, but you would have to put up your house as collateral. This means you could lose your house if something goes wrong. Risks like that have big potential costs, so you should consider them in your comparison.
Is your expected profit more than your expected loan cost?
As a final step, compare the best loan offer to your expected profit. Will you have enough profit left after paying for the loan to make everything worthwhile? If you won’t have much profit, are there any other benefits that might be valuable to you?
For example, if you take the loan to serve a new customer but only break even on this project, do you expect to get more profitable projects from that customer in the future? What is the cost of not taking the loan? Will it result in delayed delivery for your existing customers? Will it give you a bad reputation and harm your future prospects? These are all important things to consider.
Like most things in business, no one can tell you the “right” or “wrong” answer. It’s always up to you, but we hope this short article has given you a bit more clarity on which questions to consider and how you can make a decision that suits your business.
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