Get a loan that won’t weigh down your business
By Pauline Muindi | June 23rd 2021
It is normal to experience cash flow problems when running a small business. Sadly, cash flow issues can lead to a downward spiral for your business finances. Poor cash flow affects your business in many ways, such as poor relationship with your suppliers, decreased employee morale, missed opportunities, failure to meet promises to customers, restricted growth, and ultimate insolvency of your business.
Taking out a loan is one of the best ways to solve your cash flow issues and ensure the survival of your small business. A short-term loan provides the funds you need to cover operational costs, build credit for the future, upgrade your equipment to boost production, purchase more inventory, and take advantage of opportunities that outweigh the potential debt.
That said, business loans are not to be taken without proper consideration. While loans can be highly beneficial for businesses, they also come with their fair share of disadvantages. For example, lenders will require you to put some form of security to obtain the loan. If you fail to pay the loan, you face the possibility of losing valuable business or personal assets. You will also have the added pressure of making monthly repayments and possibly have certain restrictions placed on your business decisions. For instance, the bank may require that you keep your business’ debt-to-equity ratio.
With this in mind, smart business owners analyse carefully before deciding to take loans. Here are several factors you should always consider before signing on the dotted line for a business loan:
Is the Loan Necessary?
As we’ve noted, while taking a loan can help you secure the funding you need to advance your business goals, it is not free money. Consider the purpose of taking the loan. Is it absolutely necessary? Loans should never be used for frivolous expenses – such as paying for a team treat or buying a new office carpet. Loans should only be for essential business expenses such as purchasing new inventory, buying necessary equipment, or expanding your business.
In addition, you should also consider whether there are other financing options that you could explore. For example, you can ask family and friends for soft loans, take advantage or business credit cards, ask for merchant cash advances, try crowdfunding, or look for venture capital.
How Much Do You Require?
Once you have established that a loan is, indeed, necessary, the next step is to have a grasp of exactly how much money you need. If you take a loan that is too small, you will be tempted to use the money for different expenses – meaning that the original goal will not be accomplished.
That doesn’t mean you should ask for more money than you need – the interest will be costly and you might be tempted to misuse it. Moreover, taking large loans will also have a negative effect on your income-to-debt ratio.
Don’t forget to factor origination fees in the equation. These are the costs of processing, underwriting and administering the loan. Before taking a loan, make sure that you understand the fees that you have to pay. The bank might charge a flat rate or a percentage of the loan amount.
What is Your Credit History?
Your credit history is a major determining factor on your probability of getting a business loan. It tells lenders the level of risk in lending to a specific borrower. Needless to say, having good credit history or score improves the chances of acquiring a business loan.
Since Kenya doesn’t have a reliable business credit scoring system, lenders will look at your personal credit score. If this isn’t your first business loan, the lender will also be interested in finding out if you paid it in time. However, don’t worry if you don’t have a perfect credit history or score. Many lenders have specific products for business owners with less-than-stellar credit.
While at it, lenders will also scrutinise your overall business financial health, especially if you’re taking a loan with a long repayment period. Therefore, you will need to have comprehensive and accurate bookkeeping, which gives lenders a snapshot of how your business is doing and your ability to repay the loan. Get your books organised before approaching a bank for a loan.
What is Your Collateral?
What do you have to put up as collateral for the business loan? Longer-term business loans will require you to put down some kind of collateral. Collateral assures the lender that even if you default, they can recoup their money by liquidating an asset that you own.
Therefore, you need to decide which assets, whether personal or business, you are willing to use to secure the loan and how much they are worth. Lenders accept log books, title deeds, inventory, cash savings or deposits, equipment, or any other valuable asset as collateral. Bear in mind that if you default on the loan, you are likely to lose the asset you used as collateral.
Beware, banks are notoriously conservative about valuing a borrower’s assets for collateral. On the other hand, most borrowers overestimate the monetary value of their assets. This is because they consider what they paid for it instead of its current market value. Find an independent appraiser to give you a fair market value of the asset in question. It is also a good idea to keep detailed records of your assets on your balance sheet – this will help in getting you a fair valuation.
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