Putting up a small business is no little thing to deal with. No matter how competent and knowledgeable you are on the kind of business, having cash on hand helps.
No matter how big or small your business is, you will need financial assistance. That is where business loans come in.
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What Are Business Loans?
Business loans are financial assistance or loans specifically intended for business purposes. Usually this is done through a bank and they will give you a payment schedule.
There are many types of business loans. I suggest you know the types of financial assistance in order for you to consider the tax obligations and cash flow carefully as well.
Things to consider before asking for a business loan:
Consider your business and if you even need a loan. There are a lot of ways to get the funds for your business. If you are in the beginning stages, it’s important to think about how you want to grow.
- Determine the cost of the business loan that you need
- Create a feasible business plan
- Identify the timeframe when paying the business loan
- Assess yourself and the business’s capacity to repay the business loan
It is highly recommended to have an accountant who could provide you a bit of advice on the business’s financial status and future goals.
Types of Business Loans
There are a lot of o types of business loans you can get. Nonetheless, it depends on the types of business you own and what it needs funding for.
SBA Loan
Small Business Administration Loans (SBA Loans) offers various loan programs that come with competitive rates for business owners who’ve struggled to qualify for financing in the past.
Short-Term Business Loans
Business Term loans are generally ideal for protecting a one time expense. This type of loan is not a specific type of loan.
Short-term business loans involve invoice factoring, invoice financing, and merchant cash advances typically. Businesses that need emergency funds will go with this type of loan.
Even though short term loans are easier to qualify for, they’re more expensive than the other types mentioned. Make sure to check the repayment schedule.
Collateral Loans
Equipment and vehicle financing works like term loans, but with collateral of the equipment or vehicle, your business is purchasing.
The rates may be lower than with the unsecured equivalent, but you may also have the possibility of risking to lose your asset if you miss a payment on this loan.
Read: Owner Financing 101
Lines of Credit
Lines of credit are similar to a credit card. You will receive a credit line that you work from as needed by the business that you may need to pay for it on fixed installment over a set term or on minimum monthly repayments.
Features Of A Business Loan
Getting a loan is not for free. Loans are charged with interest as the price is paid for borrowing money.
Thus, it is essential to understand the loan terms if it is in a fixed or variable interest.
Fixed Interest Rate refers to the rate remains the same for the duration of the loan and its payback period.
Variable Interest Rate refers to the rate that can vary based on the variety of factors determining the rates.
The payback period refers to the months or years that the lender will use as collateral if the business cannot pay the loan back promptly.
Distinguishing Characteristics of Business Loans:
Time to maturity refers to the length of the loan contract. Business loans are classified according to their maturity into the following:
- short-term debt,
- intermediate-term debt,
- long-term debt
Revolving Credit
Revolving credit is turning over the credit line by paying it down and reborrowing the funds when needed. A perfect example of this is the banks that provide revolving credit by extending a line of credit.
Perpetual Debt
Perpetual Debt requires only regular interest payments. In this case, the borrower issuing debt through a registered offering determines the debt retirement timing.
Repayment Schedule
Repayment Schedule refers to payments that either be necessary to be paid at the end of the contract or set intervals. It is commonly paid on a weekly, monthly, quarterly, or semi-annual basis.
The payment is generally comprised of two parts: Outstanding Principal and Interest.
Outstanding Principal’s Portion
The outstanding principal’s portion – the principal amount of the loan is repaid gradually until it is completely paid. As the principal balance diminishes, the interest on the remaining balance also declines.
Interest Expenses
The interest costs – the interest loans do not pay all of the principal loans. The interest is paid on the principal loan amount. It is expected to be completed by the end of the contract.
Interest refers to the cost of borrowing money. The interest rate charged must be sufficient to cover operating costs, administrative costs, and an acceptable return rate.
Interest rates may either be adjusted according to market conditions or fixed for the term of the loan.
Credit contracts may adjust rates daily, annually, or at intervals of 3, 5, and 10 years.
Floating rates depend on some market index and are adjusted regularly.
Security
Security is also known as collateral that may secure the loan agreement between the lender and the borrower. Collateral is defined as the assets pledged or promised as security to borrow money.
It is common knowledge in the business loan world that credits backed by collateral are more secured. Assets purchased by the loan often serve as the only collateral e.g., real estate, collateralized land mortgages, insurances, or vehicles.
Reasons That Keep You From Getting A Business Loan
Poor Credit History
One way to determine the credibility of the borrower is through credit reports.
If the credit reports show that a borrower of money indicates a lack of past diligence in paying back debts, this could lead to the rejection of your application for a business loan.
That is why it is crucial to build a robust personal credit score and pay any debt before applying for a business loan.
Limited Cash Flow
Lenders assess their borrowers through the cash flow of the business. Cash flow refers to how much cash you have on hand to pay back a loan. It is generally the first thing that lenders check during the assessment of the application of the loan.
A quick tip on how to figure out how large of a loan payment one can afford:
- Calculate the debt service coverage ratio by dividing the net operating income by the total annual debt.
- You are getting a ratio of 1 if your cash flow is equal to your monthly loan payments.
- A ratio of 1 is acceptable; however, lenders prefer a ratio of 1.35.
Lack of A Solid Business Plan
Creating a solid business plan and religiously following the plan will give you a better chance of getting a business loan.
Some businesses do not have a formal business plan. You will need to have a solid business plan whenever you plan to get a business loan.
A standard business plan comprises a summary of your company, market, products, and financials. If you do not know how to create a business plan, it is best to seek professional advice from a business planner expert.
Moreover, you have to prepare yourself to explain why you need a loan and how you plan to repay the loan.
Read: The Goal: How to Get to $10,000 Per Month
Multiple Loan Applications
Some business owners apply too many loan applications simultaneously, which they thought they could maximize the different options and offers.
Nonetheless, applying for too many loans at once can cause a red flag for credit bureaus.
Failed to Seek Expert Advice
Accountants are one of the essential sources of advice for small business owners. When you apply for a business loan, lenders want to see that you’ve sought guidance from knowledgeable advisors.
There are business networking groups that can provide advice to business owners regarding their financial capability.
Wrong Lender or Lending Scheme
Looking for a lender for your business loan can be stressful. Make sure to do your due diligence.
It is best to take the time to research various traditional and alternatives lenders that would be suitable for your business.
Non-Traditional Lenders
If you can’t get a traditional loan, look at sourcing funds from other areas. Build up relationships with people, and you will be able to find funds for your business.
- online lending platforms,
- peer-to-peer lending sites,
- own network of friends and relatives
When shopping around for a lender make sure to do your research. You can request from each lender to help you calculate the annual percentage rate of their loan offer.
What Is the Average Interest Rate On A Business Loan?
Getting a business loan may be a great idea, especially if the loan is essential to your business. Always keep in mind that a loan might still be the best option to keep your business running because you can repay it.
- Traditional bank loans: 2% to 13%
- Online business loans and financing: 7% to 100%
- SBA 7(a) loans: 5.5% to 11.25%
- Invoice financing: 13% to 60%
Nonetheless, I suggest you should always weigh the costs and benefits of the debts regarding the growth of your business.
Frequently Asked Questions
Why Business Loans Are A Good Idea?
Getting a business loan is a good idea if your planning to expand your business. You will have sufficient funds for what your business expansion needs.
Getting a business loan can also be an opportunity for your business in terms of exposure and partnership with other business industries. Thus, a good credit standing is one way of building a good credit history.
Should I Get Money From Friends and Family?
It is possible to get funds from friends and family. Try to source your business by yourself in the beginning. Once you need the actual funds, you can reach out to them as needed.
How Much Money Should I Borrow For My Business?
Be conservative. Whenever you look to borrow money, make sure you have a plan to pay it back.
Consider asking for a little bit more than you need. By asking for a little bit more, the lender can counter how much to lend you and you will still get the amount you want.
