When You Should or Shouldn’t Get a Small Business Loan
Will a business loan help you capture a new opportunity? Or do you find borrowing money too risky? Your motivation for taking the loan and your business’ financial position often determines whether you should or shouldn’t take on debt. Below we give an overview of indicators that can help guide your decision.
When to Get a Loan
"You can lose out on opportunities to grow your business if you don’t secure the funding you need to get there. Using debt strategically can help grow your business if the right motivations are there." - Eoghan, Funding Specialist
To Take On A Business Opportunity With a Positive Return
A business opportunity could come in various forms. It may be getting a contract from a big client or finding that you can barely meet the demand for your products. Either way, these are good signals that your business is ready to expand. A few examples of ways to use the additional funding to expand your business include:
- Renting a new location to seat more people at your restaurant.
- Purchasing inventory to keep up with seasonal demand.
- Hiring staff to help with daily tasks while you focus on your business’ bigger vision.
- Investing in equipment could help improve the efficiency of your operations.
However, when deciding to invest, you should take the steps to measure if the potential returns from the opportunity will outweigh the costs. It’s common for entrepreneurs to overestimate potential profits and underestimate the true costs of a project. This mistake is why it's important to have a quantitative assessment of the opportunity to guide your decision. A quantitative assessment could include using your historical financial records and creating a revenue forecast. Then you’ll have exact figures to know if the return on investment will be enough to justify the loan.
To Increase Working Capital
Working capital is the cash used to manage your daily operations. Sometimes it’s necessary for businesses to take out a working capital loan to cover their daily expenses until they are cash flow positive again. As your business becomes more profitable, you’ll be able to cover your loan payments and operational expenses.
To Build Future Credit
If you’re planning to apply for a large loan in the future, you’ll need a strong business credit to secure that funding. Without having a strong credit history report, your business may find it harder to qualify for a larger loan. We recommend that you build your business credit by taking out a smaller loan while making your payments on time. This tactic proves that you are financially responsible which will strengthen your business credit score. For this to work, you must be sure that you'll be able to repay the loan, otherwise, consistent late payments will hurt your business’ credit.
Different forms of business financing are more expensive than others. For example, credit cards are known to have much higher interest rates than short-term loans. However, many small business owners still rely on multiple credit cards or other costly financing options to support their business. Juggling these numerous obligations can become overwhelming and complicated.
If you’ve found yourself in this situation, you should consider consolidating your debt. There are many online lenders that can help you consolidate your debt at a lower rate, which will help save your money and time.
To Handle A Surprise
Every entrepreneur has run into a surprise they weren’t expecting. Surprises range from your equipment breaking, or an opportunity to get bulk pricing on inventory. In these situations, you can use a short-term loan to get the funding you need to handle the surprise as quickly as possible.
When Not to Get A Loan
You Want to Pursue A High-Risk Opportunity
Not everything that glitters is gold, and not every business opportunity is a profitable venture. Before you take on debt for a seemingly attractive prospect, you should evaluate if this is the best move for your company. Taking on a high-risk project without knowing if it will bring long-term value to your business, could do more harm than good.
You're Struggling to Meet Previous Obligations
When you apply for a loan, a lender will consider the existing debt you have before approving you for additional funding. This is to ensure that you’ll be able to be able to repay both your existing obligations and your new loan.
If your existing loans are maxed out and you’re having trouble meeting these payments, then taking out an additional loan is probably not the best solution. Consulting a financial advisor may help you identify why the debt you have isn’t bringing the returns you expected.
You should evaluate your situation carefully before you decide to get a business loan. It's important to know if the benefits of the opportunity will outweigh your costs. If you find that you're in a good position to get more funding and move your business forward, get a quote to see how much you're eligible for.
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About the Author
Lendified is Canada's premier online lender for small businesses. The company was founded by former bank executives dedicated to provide businesses with fast, easy, and affordable financing. The Lendified team regularly produces blogs and guides to help small business owners succeed.