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Entrepreneurs Should do a Need Analysis Before Taking a Business Loan

An image of two business owners discussing their business loan

Starting a small business or running an existing one is difficult. It takes tremendous effort, time, patience and money to make a small business successful. Many surveys show that inadequate cash is the most common reason startups fail. While it is not advisable to invest all your savings in the business, a business loan needs consideration of all financial aspects, from current and future cash flows to expenses to existing debt.

When you are sure that the loan is essential in expanding your small business or kick-starting a new one, the next step is to ensure that the fund is optimally used.

In this article, we will discuss how, as a business owner, you should do a need analysis before taking a business loan.

Why Does Your Small Business Need the Funds?

Many entrepreneurs take a business loan to meet their growing financial needs as the business expands. If your accounts are updated, you might find that company has sufficient cash balance to meet the requirement. Identifying the objective of the loan will not only help avoid taking on unnecessary debt but also aid in deciding the period of the loan.

If you plan to buy an asset to improve or expand your business operations, you might need to take a long-term loan. But a short-term loan will suffice if you need the loan to meet your working capital needs.

How is the Credit Profile of Your Small Business?

Needing a loan is totally different from getting one. You might need a small business loan for various reasons, but will you get the loan? Your personal and business credit score will decide your eligibility for a loan, no matter how important it is for you to get a loan. A healthy personal and business credit score increases your chances of getting a small business loan at favourable terms. To maintain a healthy credit score, you can clear all your bills and other personal or business loans and ensure your company’s financial statements are clean and correct.

When and What Amount of Small Business Loan Do You Need?

Another factor that could be a game changer is how urgently you need the money. If you have an immediate requirement for funds to meet the demands of a new contract, then a business loan might not be a good idea. The application and approval process for a small business loan could take weeks.

Next, you need to decide the amount of your loan once you have identified the purpose of the small business loan. If you decide the amount in advance, the money can be utilized correctly and not wasted on unimportant things.

What is the Current Interest Rate on Small Business Loans?

Once you have decided on the amount of loan that you want, you need to find out the prevailing interest rates in the market. Interest rates vary depending on the existing economic environment, like rising inflation, unemployment, supply chain disruption and war. A fixed-interest rate loan is suitable in a rising interest rate scenario, and a floating rate loan is in a stable market.

Additionally, the duration of the small business loan will play an important role in deciding whether you should select a floating or fixed interest rate. The higher the loan term, the higher the interest cost and vice versa. Given the central bank’s hawkish stance on interest rates, the current environment is not conducive for a business loan.

How is the Financial Position of Your Small Business?

After answering the above questions, ask yourself whether your business is well-positioned to take the burden of a loan. No matter how small or large the cash inflow of your business, the interest and capital repayments take precedence over other payments. Large loan repayments could hinder the day-to-day operations of your small business. Hence, it is important to do the math and ensure that the small business loan fits into your long-term plan.

Exploring all financing options

But even before you go for a business loan, explore different funding options or a mix that reduces your overall cost of capital.

  • If the loan amount is not huge, you could seek monetary help from friends or family.
  • You can consider an overdraft facility or a business credit card for short-term money requirements.
  • If you need money to pay the supplier, you can work out a credit arrangement and buy some time from your suppliers.

Key Takeaway

Every small business needs to take a loan at some point in its lifetime. It could either be at the beginning to help start the business or at a later period to expand the business. Loans should be considered a means to grow rather than a burden.

A business loan adds liability and fixed monthly payments. Unless you are sure that the loan money will help generate cash flow sufficient to service the debt, a loan can put your business at risk. You need to carefully plan and consider all aspects of your business before deciding on the purpose, amount and duration of the small business loan.

Contact ESS CPAs LLP in Burlington to Help You Plan Your Business Loan

Talk to a professional business consultant to find answers to the above questions and explore various financing options. At ESS CPAs LLP, our consultants and accountants can provide services such as financial need analysis to help you develop an optimal capital structure. To learn more about how ESS CPAs LLP can provide you with business consultancy, contact us online or by telephone at 905-517-2297