When your small business needs money, there are so many options available to you it can be difficult to know where to start. In this introductory guide to borrowing, we’ll take a brief look at everything you need to know before you apply, so you can make the best choice for your business.
Which Loan is Right for Your Business?
Today’s business owner has an abundance of credit products to choose from. In addition to traditional bank loans and lines of credit, for example, you can take advantage of startup or short-term loans, invoice or equipment financing - even merchant cash advances.
The best way to figure out which type of loan is right for your business is to clearly define what you need funding for. Different loan categories service different business goals, any of which might include:
- Expanding your business
- Better managing your daily expenses or cash flow
- Financing the purchase of new equipment or inventory
- Taking advantage of unexpected business opportunities
You’ll find many sites online where you can compare the financial nuts and bolts of various business loans, as well as learn more about the purposes they serve.
Determining Loan Affordability
Once you’ve decided on the type of loan you want, you should nail down the amount you plan to borrow. You probably have a good idea of how much money you ideally need to accomplish your goal, but that figure may differ from what your business can actually afford.
There are a couple of easy ways to estimate how big a loan your company can comfortably carry. The first is by using an online business loan calculator to determine how a specific loan amount will impact your business financially.
The second thing you can do is perform a rough debt service coverage ratio (DSCR) analysis with the help of your company’s financial statements. The DSCR ratio will show you how much cash your business has available to service its debt. A simplified version of the formula looks like this:
Monthly or Annual Cash Flow (sales – expenses) ÷ Monthly or Annual Loan Payment = DSCR
Generally speaking, a debt service coverage ratio that’s greater than 1 implies your business is generating enough income to cover its new debt obligation.
How Important is Your Credit Score?
As a small business owner, both your personal and your business credit score are likely to play a role in determining your loan eligibility and the amount you can qualify to borrow. In general, the better your scores, the more affordable loan options you can expect to access.
You can easily check your credit scores online before applying for a loan (this is a good habit to get into regardless, since it can help keep you safe from identity theft). And as a frame of reference, you should know that most lenders will look for a personal credit score of 550+, but will ideally want to see 620 or higher before approving you for the best deals.
Understanding Loan Fees
It’s important to understand a loan’s cost, term, and repayment structure before you sign on the dotted line. In particular, you should be aware that the cost of a loan usually extends beyond just its interest rate alone. There are a wide range of potentially hidden fees you’ll need to watch out for and inquire about, including:
- Application and administration fees,
- Late payment fees,
- Early or pre-payment fees,
- Guarantee fees, and
- Check processing fees
Charges like these – along with the loan’s interest rate – form what’s known as its APR (Annual Percentage Rate). Looking for this term as you sift through your options will make it easier to compare one loan with another.
Getting Your Documents in Order
Ready to apply? Then it’s time to get your documents in order.
As a general rule of thumb, the longer a loan’s term – and the lower its cost – the more paperwork there’s likely to be. But while every lender has their requirements in terms of the forms you’ll need to present, here are a few of the most commonly requested business loan documents:
- Your most recent personal and business tax returns
- Your business bank statements
- Your company’s financial statements, which may include your balance sheet and profit & loss statement, along with a business debt schedule
Bear in mind that when it comes to advancing funds, lenders tend to favor companies that have been in business for two years or longer. You should also be prepared to have them to take a close look at your annual revenues.
Finally, to maximize the odds of qualifying for the small business loan you want, you should consider seeking help from your bookkeeping professional before you apply, to ensure all your accounts are up-to-date and in order.
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