Expanding or growing a business usually means paying for the increasing accounts receivable balances, buying new equipment, and paying for more manpower. However, businesses that don’t have enough funds often need to consider applying for a business loan.
The trouble is, although you may have a credit score that’s fairly good, if you don’t understand your available loan options — and what lenders will need from you, then it will be very difficult to get the appropriate business financing you need.
With that in mind, here are the some crucial things you’ll need to know:
Purpose of the Loan
Why do you need a business loan? It’s important for every borrower to acknowledge this question because articulating a loan purpose will set the tone for other questions you might need to answer along the process. The purpose of your loan will help determine whether you’re trying to fill a long-term or short-term need.
For example, the funds needed for purchasing a new location for a restaurant or an expensive piece of heavy equipment are different from buying quick-turnaround inventory. It will not make sense, for instance, to borrow with a five- or six-year term to finance an inventory that will be sold in less than a year.
The general rule of thumb is, short-term loans have high periodic payments, but low total-dollar costs. Long-term loans, on the other hand, have lower periodic payments, but the total cost is higher.
The Amount of Money Needed
How much money do you need to borrow? The purpose of your loan should be the foundation to answer this question. Unfortunately, a common misconception has it that borrowing a lot of money will solve a business owner’s problems. It’s important to ward off the idea that you should borrow as much as you can whenever you have the chance because you never know when you can borrow again.
If the money you borrow will add value to your business or improve its ROI (return on investment), then a small business loan makes sense. If not, it’s better not to borrow at all. Borrow only what’s needed to fund your business, but no more.
A Feasible Business Plan
It’s important to have a sound business plan if you want to convince a lender to grant you a loan. Lenders want to know that you’re armed with the required knowledge and skills to grow your business into something great, and that you are running a credible one.
To convince them that you’re a capable borrower, you’ll need to draft an irresistible business plan that includes:
- your goals
- market analysis
- management team experience
- past and projected revenue and expenses
- how you intend to grow your company
You’ll also want to write an executive summary to draw the lender into your vision for your business.
Your Credit Profile Status
If you want to get approved for a business loan, be sure to create and maintain a strong business credit profile. Your personal credit score might not be a direct factor to gauge your business’ capacity to meet its obligations, but the majority of lenders will assess it when reviewing a business loan application.
Lenders have different approaches when it comes to evaluating personal credit scores. Some lenders set 680 as a qualifying score for a business loan. Others accept lower scores, provided that a business is showing healthy metrics such as income and a high volume of customers.
Your Capacity to Pay
The most crucial factor that every lender considers is you; yes, you and your capacity to pay. Only by looking at your monthly and annual budgets and expenditures will you understand just how much you can afford to make to pay for a loan. This will also help you decide on the amount of money to borrow.
As a borrower, you need to show that you’re capable of repaying the loan through the company’s cash flow. The lender will analyze your company’s free cash flow and its debt-to-income ratio. Lenders will then use these ratios as a cushion in case the business isn’t able to generate enough income.
The Bottom Line
It’s common for companies to seek out fresh funds to get them out of a rough patch or, in better cases, grow the business. Applying for a business loan is one way to make it happen. Don’t miss your chance of getting approved.
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