When it comes to taking on business debt, a common thread among small business owners is to avoid it at all costs unless absolutely necessary. While it makes sense that business owners or really anyone would want to avoid borrowing a penny more than what they need, it can be a different story when leveraging debt to grow. Not to mention the fact that circumstances often change and what you thought you needed today can and WILL change tomorrow.
Here are 3 of the most common signs that its time get your head on straight and consider a business loan:
- You found a business opportunity where your expected ROI (Return on Investment) outweighs the cost of debt.
Every now and then, an opportunity for growth and expansion comes along but you may not have the cash on hand needed to take action. Whether that means purchasing inventory in bulk to save on cost, finding a “steal” of a deal on expanding your physical location, or acquiring the latest equipment to take on that larger job. Whatever industry you’re in, it is imperative you calculate or forecast your expected ROI (return on investment) by weighing the cost of the loan versus the revenue you stand to make.
For example, lets say Bob, a contractor, won the bid for a mining excavation contract from Uncle Sam for $1,000,000. The problem is, Bob doesn’t have the necessary equipment such as a $200,000 medium-sized excavator required to complete the job. Let’s say Bob took out a 3-year loan to finance the equipment, paying a total of $75,000 in interest. Let’s say Bob also needs to hire more hands to complete the job on time, and it would cost him $200,000 to cover the cost of payroll. So in short, Bob’s total costs would be $475,000, and his profit would still be $525,000. This should be a no brainer.
It’s also important to note other benefits such as the fact that Bob now also has a new piece of equipment he can use for the next five years on other large jobs, and from doing a great job on time also gains a solid reference that can lead to even more opportunities.
- Your cash flow is in the red (Your business will not survive if this continues)
Running a business can be like eating glass while staring into the abyss, especially when the money coming in is less than the money going out. You’re not alone, as tough decisions have to be made with limited resources everyday by small business owners. Throw in something unexpected into the mix and you’ve got a recipe for disaster.
Here are a few questions to ask yourself honestly:
- Can you cover the next payroll?
- Has your sales decreased, but overhead costs remain unchanged or increased?
- Did you have an unexpected bill or emergency that has to be paid with capital you don’t have right no?
- Do you have late paying customers that are disrupting your cash flow or ability to run your business efficiently?
If you answered yes to any of these, then first off there are plenty of short-term options to help you bridge the gap in as little as 24 hours.
However, the reality here is the mantra of business owners acting only on what they “need” when they need it (reactive versus proactive) can backfire when applying for a loan, since lenders (even the ones who don’t require collateral or market themselves to look at non-credit related factors) will always make an offer based on any or all factors related to your credit, revenue, or assets. By waiting until the last minute to seek financing, you are effectively putting yourself in a weak position to negotiate.
- Your business is in great financial shape
This may seem counterintuitive, but the reality is lenders make offers based on assessing risk (underwriting). After all, their primary concern is that you, the borrower, can payback the loan. In other words, when your financials are strong, it is the best time to apply. Banks are notorious for this, creating the sentiment that banks only help those who don’t need the money. After all, 4 out of 5 applicants are typically denied, not to mention the stress that piles up in waiting often months for a decision, which may not align with your timeframe of seeking the money in the first place! The good news is that there are plenty of alternative sources of funding outside of a bank with less stringent requirements across the board.
Whether or not you’re dealing with a traditional bank, why should you consider borrowing money for your business if you think you don’t need it?
- When business is good it is also the best time to qualify for for a business loan.
As an entrepreneur you should never rest on your laurels or expect any hand-outs, and if you had more capital to buy out a competitor, increase your market share through advertising, or just wanted to know your options to plan strategically, wouldn’t you want to know your numbers?
- Avoid risking your own hard-earned capital that may be needed to cover ongoing expenses or kept on reserve for emergencies.
- Build Credit to improve terms on a larger loan for the future
This goes back to the importance of being proactive rather than reactive. The first loan you take out for your business will not be ideal if you haven’t built up your credit yet, and the higher interest rates will make any essential big purchase more costly. This is why it may be smarter to get your feet wet with a small, easy-to-repay loan before committing to a big one.
Let’s say for example you were approved for a revolving business line of credit with a limit of $50,000. Let’s also say you don’t even need to borrow a dollar at the moment as your cash flow is overflowing. In this scenario, you are not paying interest on money you don’t draw from the line of credit, you get a safety net (peace of mind) by having access to these funds that can be disbursed within 1-3 business days to address anything unexpected. You can also repay early and save on the cost on whatever you do use, which in turn replenishes you’re line for use again (hence the term revolving).
This can also have additional benefits such as building a better relationship with the lender to call upon later when needed, and building a stronger credit history so when the time comes to go big, you’ll be primed to qualify for better rates. Establishing a good payment history is in short critical to making you more appealing in terms of creditworthiness to lenders who either rely on or report your track record to the credit bureaus, which can eventually open the door to more lenders competing and thus lead to better rates as well. In other words, you are building up your credit when drawing from the line of credit and making payments on time, leveraging the line to use only when needed, and as a result being proactive to better position yourself in the future.
To be clear, no small business should take on debt that isn’t necessary, but hopefully this example highlights how you can leverage financing to your benefit and why its crucial to know your options earlier than later.
At Liquidus Funding, we put your best interests first. So whether you’re business is looking to expand or needed funding yesterday, there is a loan option that can help!
We hope this information helped you understand the importance of leveraging debt to grow along with why it’s important to stop waiting until the last minute to qualify.