Article Summary: Although there are many reasons why small businesses borrow capital, the costs associated with borrowing should be considered to determine when small business borrowing makes sense for your business.

Categorizing your business needs into three groups and asking these three questions will help you determine if leveraging a small business loan makes sense:

  1. Will borrowing help me improve the profitability of my business or provide increased ROI?
  2. Will borrowing help me improve the value of my business?
  3. Is there an operational need that needs to be addressed right away to keep my business running?

Keep reading to learn more.

Admittedly there are numerous and varied reasons why small businesses borrow. In many instances, borrowed capital can be the fuel that propels growth and keeps small businesses moving forward. Growing up in a small business and having spent nearly 40 years of my career either as an employee of a small business or a business owner myself, I’ve discovered that some reasons for borrowing are more beneficial to the business than others.

If your business has a healthy cash flow and the revenues to support debt, borrowing can be an invaluable tool to help your business leverage opportunities to grow and thrive. With that in mind, I group (at least what I consider) good reasons to borrow into three categories which will help you determine if borrowing is a good idea for your business.

Category Number 1: To Increase Profits

Of all the reasons to borrow this is at the top of my list because any tool that has the potential to add profits or additional ROI shouldn’t be ignored. In fact, many of the most successful small businesses I’ve observed over the years have leveraged small business debt to fuel growth within their respective businesses by increasing ROI. They also look at borrowing differently than those businesses that seem to struggle with debt.

They consider the total costs of borrowing (interest rates, fees, etc.) as part of the cost of goods sold. Looking at it this way helps them determine if the costs of borrowing will make the product or service their offering more profitable or will add too much to the cost of doing business. Here are a few examples of when small business borrowing to fuel grow—or increase profit or ROI could make sense:

  • Your business has an opportunity to purchase quick-turnaround inventory at a discount: It’s not uncommon for suppliers to offer discounts on special purchase inventory or annual bulk purchases of inventory a business could quickly turn around to make additional profit. Every additional five or 10 percent you can earn on business you’re already doing is additional ROI added to the bottom line making an inventory loan a viable option.
  • You want to purchase equipment that will generate additional income: For example, a restaurant owner may decide the addition of a new pizza oven could add additional revenue to his or her business. The same could be true for a contractor who determines a new backhoe or front-end loader would give him or her the ability to add an extra crew and generate more income. If this describes your business need, an equipment loan could be a good option.
  • You’re considering a new marketing campaign to increase your business’ footprint in the market: P.T. Barnum famously once said, “With out promotion something terrible happens. Nothing.” Many small businesses reach a point where they determine they need to do some marketing. Maybe it’s a direct mail campaign or a series of adds on local radio or some other marketing idea designed to bring more customers into their business generating additional revenue and profits.

One of the few times my father thought borrowing made sense was when there was a reasonable assumption that doing so would somehow increase profits. He considered borrowing for anything that didn’t increase profits to be too expensive, so that was always a litmus test for him. I tend to agree that this is one of the best reasons for borrowing.

Category Number 2: To Increase Business Value

Increasing the value of your small business is a little different than improving the ROI of a particular product or initiative. These initiatives will likely be longer-term investments than purchasing inventory or equipment, but can also be good reasons to consider borrowing. A couple examples of borrowing with this objective in mind include:

  • A need to expand into a new location: Small business owners generally understand the important role growth plays to the long-term viability of their businesses. If growth includes the need to expand into an additional location to better serve your customers or to increase your position in the market, this could be a good reason to seek small business financing (provided your business has the ability to service the additional debt).
  • Your business needs more space: Whether your business needs to expand into a larger warehouse to accommodate more inventory or is a restaurant with a goal to add an outdoor dining area to accommodate customers who want to take a meal outside, this type of investment in your business could be another good reason to seek borrowed capital.
  • Your business’ physical facilities need an update: If you’ve been in business for a few years and the exterior of your building, the machinery you use (if you’re a manufacturer), or your HVAC needs to be updated, these investments not only increase the value of your business, but they are also potentially good reasons to consider borrowing.

For some businesses, making investments like these are more important than they might be for others, but asking yourself, before you borrow, if the funds will improve the value of your business is a good idea.

Category Number 3: To Keep Operations Running

Sometimes the unforeseen happens. When a critical piece of equipment needs to be repaired or replaced, it’s often not practical to wait for cash flow to become available to make repairs or replace the failed equipment. These types of expenses, whether unforeseen or anticipated, could be good reasons for some kind of temporary cash flow loan, and could look like this:

  • A business-critical piece of equipment needs to be repaired or replaced: This would equally apply to a restaurant’s pizza oven as it would to the milling machine in a machine shop or small manufacturer. When the opportunity costs of a down piece of equipment exceed the costs associated with borrowing to fix or replace, borrowing could make sense.
  • Plumbing, HVAC, or other Utility Issues Arise: I’ve personally felt the sting of a plumbing line failure in an older building that required a contractor to dig up the parking lot to the street to make repairs. Expense? Yes. A good reason to borrow or access a credit line? Yes, again.

Additional capital, or small business borrowing, isn’t the answer to every challenge a business owner faces, but in the right circumstances can be a great tool to help your business grow and thrive. I admit, my views on this topic are conservative. There are costs associated with borrowing, regardless of how low or high the interest rate might be, and those costs can’t be ignored. To insure that borrowed capital benefits your business, rather than weigh it down, ask yourself these three questions before  you apply for a loan:

  1. Will borrowing help me improve the profitability of my business or provide increased ROI?
  2. Will borrowing help me improve the value of my business?
  3. Is there an operational need that needs to be addressed right away to keep my business running?

The answers to these questions will help you determine if the reasons you are considering a small business loan make sense and will help your business grow and thrive.

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