Article Summary: Answering the question, "Does a business loan make sense for my business?" really requires that you answer a few more questions first.
With that in mind, here are four questions you should ask before you start looking for a small business loan:
- What do I need to borrow extra capital?
- Will my cash flow support the periodic payments?
- What does my credit profile look like?
- Will borrowing positively impact my bottom line?
Once you answer these questions, it will be easier to determine whether or not a business loan makes sense for your business. Keep reading to learn more.
Popular media would have us believe that the answer to every small business problem can be solved with money—I call it the myth of the Shark Tank. Although access to capital can help business owners resolve a lot of small business challenges, borrowing at the wrong time, or for the wrong reasons, can put profits in jeopardy and potentially put a lot of stress on a business. Answering the question, “Does a business loan make sense for my business?” requires asking and answering a few more.
Question #1: Why do I need to borrow extra capital?
This question is really less about the reason and more about whether or not you have a specific specific loan purpose. Asking yourself this question first, will help you determine if the rewards of borrowing are worth the expense and help you determine how much you need to borrow, what kind of term makes sense to meet your business need, and even where to look for a loan. This should always be the first question. If you can’t give yourself a definitive answer of how you’ll use borrowed capital to push your business forward, it might not be a good idea to borrow.
Question #2: Will your cash flow support the periodic payments?
Regardless of where you borrow, there are costs associated with a small business loan that will impact your cash flow. Many lenders today offer daily, weekly, or monthly periodic payment options. Depending upon how cash flows through your business, you may need to evaluate your ability to service the debt depending upon the way cash flows through your business. For example, daily or weekly periodic payments are very effective at distributing the cash flow burden across the entire month, but if your cash flow all happens at the end of the month, this type of periodic payment might not be the right choice. Additionally, you’ll also want to consider the average monthly payment obligation, regardless of whether the payments are daily, weekly, or monthly. There are times when a daily repayment frequency can result in a lower average monthly payment obligation compared to a monthly payment.
Question #3: What does your credit profile look like?
For most small businesses, the owner’s personal credit, as well as their business credit, will be part of any creditworthiness evaluation. Different lenders have different accepted thresholds when they evaluate a business owner’s personal credit score. Traditional lenders like banks and credit unions will want to see a score of 700 or better (although in some cases they will drop that threshold to 680). The SBA will go as low as 650, and many online lenders will go below that if there are other metrics in place that demonstrate a healthy business and the cash flow to service the debt. Along with other metrics like time in business and annual revenues, your business credit profile and your personal credit score will be part of the equation. Fortunately, if you have a less-than-perfect credit profile, with time and effort, you can improve your credit profile—both your personal credit score and your business profile.
Question #4: Will borrowing positively impact my bottom line?
There are lots of legitimate reasons for seeking a small business loan. I’m not suggesting the only viable reason is to generate ROI, but that’s a good one. I’m of the opinion that generating additional profits or increasing the value of the business are at the top of the list. If the loan purpose isn’t going to do that, additional consideration should be made because of the cash flow impact.
The answers to these questions will help you determine if a small business loan makes sense for your business. Your answers likely won’t guarantee a loan approval, but could help you improve the odds when talking to a loan officer who is trying to evaluate your loan application, you, and your business compared to the others he or she is currently reviewing.
Does a business loan make sense for your business? You have the answers to that question.