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What To Know Before Taking Out a Small Business Loan

What To Know Before Taking Out a Small Business Loan

ssguy / Shutterstock.com

ssguy / Shutterstock.com

Financing is critical for nearly all businesses, particularly small ones. After you secure the financing to initially launch your business, you’ll likely need additional funding at some point as your company grows. But before you take the step to take out a small business loan, you’ll have to be sure your company is positioned to do so. Taking out too large of a loan or the wrong type could cause serious financial damage to your company, perhaps even to the point of threatening its existence. But don’t let that stop you from acquiring the financing you need. With the right loans in place, a small business can grow exponentially.

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Here are some things to know In order to optimize your business financing strategy.

Know Where Your Money Will Be Deployed

Just like a home budget is important for keeping your personal finances in line, you’ll need to know where your loan proceeds will be deployed before you start the borrowing process. This is where a good business plan comes in, as it should outline your company’s plan for growth and the financing that will be required to get there. If you don’t have a solid business plan, it’s critical to chart out your intended uses for your financing before you get it. Otherwise, you may end up with excess cash in your accounts that is just begging to be misused. In this scenario, it’s highly likely that your capital will get deployed in an inefficient manner, leading to overspending or investing in areas that don’t provide a sufficient return for your business.

Explore All Options

The traditional, fixed-rate loan is one of the most commonly used tools for business financing, and it may be appropriate for your company as well. However, there are lots of additional options that may provide an even better way for your company to raise money. For example, many companies use invoice factoring or merchant cash advances to get money fast. For others, secured or collateralized loans are a way to get the money they need. Small businesses in particular often rely on credit card financing, particularly if they can obtain promotional rates of 0% on purchases and/or balance transfers. When it comes to business financing, you should know all of your available options before you commit to a financing option that may be less than optimal for your particular company.

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Check Your Credit

When taking out a small business loan, you’ll want to get the lowest-rate financing available. An important factor in this equation is your credit score. If you’re a sole proprietor, your own personal credit score will likely be used for your business, so make sure everything is in order before you apply. Verify that the information in your report is accurate and avoid any activity that is likely to ding your score, from making late payments to opening too many accounts over a short period of time. Even if your business is set up as an LLC or another type of corporate structure, your lender may still look at your personal score if your business is small and/or new, as it won’t be able to use your company’s multi-year earnings and cash flow history to make a credit determination.

Understand the Current Interest Rate Environment

You’re not expected to be an expert on market interest rates just because you run a small business. However, it’s important to be aware of the current interest rate environment if you’re looking to take out a small business loan. If rates are rising, for example, you’ll likely want to avoid taking out any adjustable-rate loans, because your payments will likely rise over the short term as well. Conversely, if rates are falling, you might want to avoid locking in a long-term loan because you’ll be stuck paying an above-average interest rate. Unless you’re also a professional economist, it can be a good idea to talk with a loan specialist about how to best finance your business in various interest-rate scenarios.

Verify Your Cash Flow Is Sufficient

The payments for your loan will have to come directly out of your working cash flow. Not only do you have to verify that your cash flow is sufficient to make these payments, your business will have to survive on the cash flow that remains. If it can’t, your operations could ground to a standstill. Even worse, if you can’t make your loan payments, you will default on your loan, and you’ll lose whatever collateral you posted for the loan and could even be forced into bankruptcy.

When reviewing your cash flow and payment obligations, remember that few companies have consistent revenue streams. In some months, your business will no doubt earn more than in other months, and you have to make sure that you can cover your loan payments even in those leaner months.

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This article originally appeared on GOBankingRates.com: What To Know Before Taking Out a Small Business Loan