Numerous banks and finance companies provide a range of loan options and other forms of financing for small businesses. Prior to borrowing money, it is important to consider the impact on your business and take into account both the positive and negative.
Is borrowing right for you?
If you plan to approach banks or finance companies for borrowing money, ensure that you have a solid case for the loan and can pay it back on time.
Most small business owners have borrowed money at some point.
Usually, borrowing money can be a good choice if you:
- will use the funds to grow your business or cover a short-term cash shortage, rather than as a last resort
- can make payments on time, consistently
- can pay off the loan early, but only if it will save you money (compare reduced interest to early repayment fees)
- comprehend the loan’s terms and conditions.
Case study
Buy what you can afford
When it comes to capital, Vicki Ha, the owner of Wellington’s House of Dumplings, believes in spending only what she has. “I still haven’t borrowed one cent from the bank and there’s not a lot of businesses like that,” she says. Ha thinks bank loans aren’t a safe business practice because she can’t prove how much income she’ll make.
“My approach is that you can’t predict sales,” she says. “That’s the problem with a lot of businesses. They go to the bank to borrow $40–50k based on their own predictions. But who decides that? It’s not the owner — it’s the customers.”
Ha avoids borrowing by only purchasing what she can afford and avoiding unnecessary or impulsive business expenses.
“When I started, I had $20,000 in my bank but I would only spend it very wisely. I’m still very cautious about spending money.”
While Ha consciously chooses not to take on debt, loans can be a viable option for those who carefully evaluate whether borrowed money can be repaid on time and used effectively.
Questions to ask yourself
When you’re considering whether or not to borrow money, think about these questions:
- Why do I need the money? The things you buy should provide a good return, such as an asset that’s necessary for growth.
- How can I cut costs? If you can reduce your spending, you may not need to borrow as much money — or any at all.
- Can I afford the repayments, even during slow months and at tax time? Make sure you can pay on time, every time. Banks and other lenders often charge extra for late or missed payments. Create a cash flow forecast and, if you’ve been in business for long enough, review your financial records from the past two years.
- How much interest will I pay? If you can manage it, choose a shorter loan term and/or higher repayments to keep interest charges low. Use an online tool to calculate repayments for different terms and interest rates — try the debt calculator on the Sorted website. Then include loan repayments in your cash flow forecast. Is it worthwhile to take on debt?
- What loans am I eligible for? The options for borrowing are quite different for new businesses compared to existing ones.
An accountant or bookkeeper can assist you in deciding whether taking out a loan is a good idea or not.
Tips on choosing types of funding
Tip
Be cautious of fast or unsecured financing offers.
Although these loans may be easier to obtain, they often come with higher interest rates.
Pitching for a loan
Securing a loan requires more than simply strolling into a bank and making a request.
To ensure you get the best deal, it’s important to explore your options and come prepared. Conduct thorough research on different loan types, lenders available, and assess your own financial situation.
Similar to investors, banks will want to ascertain the viability of your business. You will need to demonstrate your ability to repay the loan and cover the interest.
When approaching a bank for a business loan, remember to bring along the following documents:
- Financial records, such as profit and loss statements
- Cash flow forecast
- Business plan
If you’re new to the business world and lack financial data to support your application, your lending options may be more limited. In such cases, you might have to consider obtaining a personal loan or increasing your mortgage borrowing.
Introduction to business finance
Tip
If it’s within your financial means, you may want to consider bootstrapping as a startup strategy.
Bootstrapping involves using your personal funds and avoiding any debt. However, it may not be appropriate for all types of businesses. For more information on bootstrapping, refer to Choosing the right types of funding.
Your bank
Banks tend to provide better deals and lower interest rates to individuals they have established trust with. Building a strong relationship with your bank can be beneficial.
Even if you don’t have an immediate need for borrowing money, it’s advisable to start cultivating a positive rapport with someone at your bank. This individual could be the branch manager or a specialised advisor.
Several banks offer additional support for business owners, such as customised banking services and avenues to connect with potential investors.
Common mistakes
- Borrowing funds without forecasting your income or with an overly optimistic income forecast. It’s advisable to underestimate your earnings and overestimate your expenses.
- Failing to comprehend the loan’s terms and conditions, as well as the interest rate agreed upon.
- Receiving a loan and spending it extravagantly. While it may appear to be effortless money, it’s crucial to have a spending plan in place.
- Not developing a repayment strategy for your loan. It’s essential to budget for regular repayments.
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