How to Make Smart Borrowing Decisions

Not all businesses are at a point where borrowing money is the best course of action for them. Consider all the options that are available including what kind of loan is right for your business and how to ensure that your loan is helping you grow and not weighing you down.

Alternative Options to Consider

Before you consider borrowing, look into other options. Look for every possible way to not take out a loan. This should be your last resort. A simple option to avoid taking out a loan and make sure your business keeps running smoothly is work with your vendors.

If you decide to borrow money, it is important to think about how much debt you can afford. Responsible borrowing relies on figuring out what your debt coverage ratio is. Take how much money you earn from your operations each month before paying back any debt and divide that number by your expected debt payments each month. That ratio should be between 1.25 and 1.50 at the lowest. The absolute maximum amount you could decide to borrow should be dictated by that ratio. It is absolutely crucial that you have a forecast of whether or not you can handle the loan.

How Much to Ask for and When to Ask

When you are ready, know exactly how much you need and when you are going to need it. The key to borrowing money is having a business plan for the next two years. If you do not have a business plan, it is time to create one. Figure out what the money you will receive from you loan is needed for, and how much of each of these things will cost. Get estimates from contractors or equipment dealers, and if you are a startup think about what expenses you might incur before you open. Some things to consider are deposits, hiring, and more.

When you are creating your business plan, consider if there is any lag between when you provide goods or services and when you get paid. If you can build a budget that forecasts the next two years, and approximate the timing of your sales and expenses, you should calculate an estimated net income to guide your responsible borrowing.

You will know exactly how much you need to borrow to cover any future cash shortfalls with the financial plan in place. The amount you borrow should be less than the maximum amount we described earlier. Finally, you will want to apply for a loan several months before the money is actually needed.

Having six months of working capital saved in case your business falls is recommended. It is also important to remember the seasonality for your trade. Ask what you are going to use the cash cushion for and what six months of working capital is.

If your business starts to go south fast, you could be declined for a pre-existing line of credit as you will be asked for updated financial statements.

Which Lender Do You Choose?

After you decide the amount you need to borrow and when you need to do it, explore your options beyond traditional banking. Large banks have restricted their lending which is why many people turn to alternative lenders. Alternative lenders are institutions other than banks and credit unions that offer financing such as loans, lines of credit and cash advances.

Alternative financing is more expensive because there is more risk however, they are more lenient on lending terms. Often, banks can take weeks to review financial statements, business plans and tax histories, and generally require solid credit scores, business collateral and a serious company track record. Alternative lenders may use more creative ways to determine how creditworthy you are, like checking your customer reviews, social media, and more. Alternative lenders can now approve loans in under a week, making them a great option for businesses that either cannot or do not want to get a loan from a bank.

Which Loans Should You Consider?

Your business needs to study the terms of each type of loan to decide which is the best fit. The three main things that affect your loan is total borrowed, interest rate and terms, and the total time you’re borrowing. Changing any of those three affects your payment.

To be a responsible borrower, it is recommended breaking out short-term expenditures from long-term expenditures and advises that business owners match the kind of money to the kind of asset they are trying to buy.