Why it’s Crucial to Understand if Your Business can Afford a Business Loan

If your business is running low on cash, or if you’re keen to expand but don’t have the capital, a business loan can seem like the perfect answer.

Business loan

It’s true that a business loan can provide a valuable boost to working capital, especially if your income fluctuates. It can also enable you to pursue exciting growth opportunities.

And these days, getting a small business loan is much easier than it used to be. There is a booming alternative finance market in Australia, with a huge range of lenders eager to lend to small businesses. In fact, about half of Australia’s two million small businesses have a business loan facility other than a credit card.

Business loans: Can vs. should

Just because you can access finance, that doesn’t mean you should. Taking out a business loan isn’t always the right decision. Here’s why.

1. Growth doesn’t always pay

When you borrow money to invest in growth, you commit yourself to regular repayments that can put a real strain on your working capital.

Meanwhile, it can take a long time to see tangible results from an up-front investment in the labour, equipment or materials you need to service extra customers – and it may be that benefits never outweigh the additional costs. All too often, extra turnover simply doesn’t translate into more cash in the bank.

If you use your borrowings to buy extra inventory (to increase your capacity or take advantage of bulk discounts) you run the risk of stock obsolescence if you aren’t able to sell it as quickly as you anticipate. You’ll also need to pay for storage of your extra inventory, and the costs can quickly outweigh any discount.

If you’re planning to grow by acquisition, you need to be wary of the many things that can go wrong when you buy another business, from deserting customers to disgruntled staff. You may have to invest a lot more time and money than you expect to integrate your new purchase into your business, all while servicing your new debt.

2. Borrowing always comes at a cost

Obviously, you’ll have to pay interest on your business loan, which can add up to a surprising amount over time. There may also be a whole raft of other, hidden costs – such as set-up or ongoing administration fees, charges per transaction or transfer, penalties for late payments and even break fees if you wish to repay your loan early.

When you’re weighing up the financial benefits of borrowing, remember that the cost of your loan could rise considerably if interest rates go up. You may be able to avoid this by fixing the rate on some or all of your business loan for a period of time, but you can expect to pay more for that security. What’s more, fixed rate loans generally come with hefty fees for early termination, and no flexibility to make extra repayments to reduce your interest burden.

Unsecured business loans usually come with a higher interest rate than a secured loan. Make sure you review all your options as there are many types of unsecured business loans in addition to the loans you can get from your traditional high street banks.

Business loan

Can my business afford a business loan?

If you’ve prepared a solid business case and you’re confident that a loan will benefit your business, you still need to pay close attention to the numbers. Focus on your cash flow projections because lack of cash is the number one reason businesses fail – and that includes household name businesses like Dick Smith.

Your new loan repayments will have to be paid on the agreed schedule, regardless of whether your sales fluctuate with the seasons, your customers fail pay on time, or your anticipated growth doesn’t come at the speed you expect. If you’re forced to miss repayments because of working capital deficit you could face substantial fees or other penalties – not to mention getting a black mark on your credit rating.

When you’re preparing your cash flow projections, be sure to include variances for increases in interest rates – even a small rise could have a very substantial impact on the amount of your monthly repayments. Make sure you use a calculator to help you understand the repayments.

How lenders will assess your business loan application

The most important criterion that any business lender (including risk-tolerant alternative lenders) will use to evaluate your application is CAPACITY.

They will use their own formula to assess whether you are generating enough free cash to service your loan, which may be more or less conservative than your own.

If your application is rejected because you don’t meet the capacity test, you’ll earn a notation on your credit rating which could impact your ability to borrow in future.

If you are unsure whether you are likely to have your application approved, seek advice from a business loan broker or independent financial advisor, or delay your borrowings until you are better able to meet the costs of a business loan.

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