Loans are a common financial service used by businesses. Regardless of size and type, it’s not unusual for businesses to resort to loans to sustain their operations. Loans may also be used to fund expansion or a venture into a new product range.
Loans mean obligations but they don’t necessarily mean that a business is having problems. Small business loans, in particular, can help a business grow or survive. However, there are things businesses need to think about before getting a loan.
1. Be mindful of your credit score
Traditional lenders consider credit score as one of the most important factors they take into account when evaluating prospective borrowers. That’s why it’s essential to make sure that your credit score is something that will not reduce your chances of having your loan approved. You may need to have your business evaluated so you can prepare for what to do next. Check the report for accuracy. There may be incorrect details that lower your score such as payments you made on time but were reported as delayed. Contact the credit bureau to promptly address the corrections you want to make.
As much as possible, don’t just target a credit score that will get you a loan approval. Higher credit scores are always better as they can mean lower interest rates. Take note of the following factors that affect your credit score:
- Payment history. Bills and other financial obligations should be paid on time. Late payments can adversely impact credit score.
- Amount of current debts. Carrying high debt balances relative to the total credit limit is perceived to mean greater risk of defaulting and can, therefore, lower credit score.
- Credit history. This refers to the overall record of accessing credit. It does not take into account the length of time you have been using credit. It’s more on how you have dealt with your debt obligations.
- New credit applications. Applying for new credit while still having multiple outstanding obligations negatively impacts credit score.
- Types of current credit. Having different types of credit is considered better than using just the same type of credit, especially to address a common financial need.
2. Know and understand your options and make thorough comparisons
Once you are confident that your credit score will not hinder your access to credit lines, you need to make sure you are well-informed about your credit options. You can’t just get a loan from any financial services company. Find loan products with the best terms, the lowest interest rates, and most reasonable requirements. Don’t focus too much on the interest rate. It’s also important to consider other factors such as repayment flexibility, loan term, and the collateral sought. You can use the internet for this and ask for recommendations from others who have been using loans for their businesses.
Don’t limit your options to what most others are using. It doesn’t have to be with a bank or lending company in the same city or municipality. Focus on the advantages of the loan products available and not on the trivial conveniences like knowing someone in the bank or having good relationships with the manager of a lending company. Then, be sure to do careful comparisons of the different loan products you are qualified to get. Also, don’t forget to ascertain that the information you are comparing is accurate and verified.
3. Thoughtfully decide how much you need for your loan
You can’t just apply for a loan without discerning the amount to get. Remember the following points on how much to borrow:
- The amount should be just enough for what you need. Borrowing too much would mean higher amortization and interest, which you may not be able to pay.
- Similarly, borrowing too little may not be good especially if you are using the loan for a revenue-generating plan. Running out of funds without achieving profitability or momentum for your plan will make the plan worthless. The loan can’t be some minuscule amount that ends up only getting used to help finance day to day operations without creating palpable impact for the business.
- You should have a plan on how to pay for the monthly amortization of the loan. Calculate the monthly payments and examine if you can pay for them. It’s important to have a record and plan of cash flow so you can determine the right amount of loan to get.
- The loan amount should create a positive impact on your business. For example, it could be a loan to acquire new equipment to improve productivity and subsequently improve revenues. You can’t get a loan that is less than the amount you need for equipment acquisition because you would end up having to get another loan or acquiring the equipment partly on credit.
4. Smaller banks or financial services companies are usually more accommodating to small businesses
Often, smaller lending companies tend to be friendlier to smaller business borrowers. They tend to have financial products that are more tailored to address the needs of those who are looking for small business loans. This does not mean bigger financial institutions should be ignored. However, if you are looking for options, you may want to look at smaller lenders first.
5. Receivables can be used as collateral
This is one notable tip mentioned on Inc.com’s “8 Things You Need to Know about Small Business Loans.” Those operating in the business-to-business environment that have poor credit standing can use their receivables as collateral especially when dealing with alternative (but legitimate) lenders. However, they may mean higher interest rates. Also, you need to be very careful when dealing with alternative lenders. Many of them tend to have transparency issues and highly onerous terms.
6. Be serious and meticulous in making your pitch to a banker or lender
Your documents should be complete. You should have a clear plan on how to use the loan complete with projections of potential revenues, records of past business performance, a convincing presentation of competitive advantages, and a detailed plan on how you will pay the loan. It is very important to persuade the banker to provide financing for your business. Don’t treat the loan application process as a mere formality.
7. Rejection is not the end and you need to learn from it
Having your loan application rejected is not uncommon. Don’t be disheartened by it. What you need to do is to figure out why your loan was disapproved and learn from the experience. Address the problems or deficiencies that caused the rejection before you try applying for a loan with another lender.
8. Don’t think of paying the loan too early
If you are running a business, always bear in mind that the funds in your possession can be put to more important use to generate more revenues instead of being used to prematurely repay a loan. While it’s good to be free from loan obligations, using funds to prematurely pay debts is not wise for a business unless it means a considerable discount on the interest and fees.
Business loans are not comparable to personal loans in the same way that fund management for businesses is not similar to managing personal finances. It is important to be well-acquainted with the intricacies of business loans and to be wise in using them. Remember the points discussed above for guidance.