Business owners sometimes shy away from borrowing money; a loan is considered a burden instead of an opportunity. When leveraged correctly, a loan can help propel your business towards success. The predominant mistaken assumption is that loans are only used to cover cash flow shortages. In fact, loans can be used in ways that add significant long-term value to your business. A few examples include
- Increasing inventory to meet demand,
- Purchasing equipment that is more efficient or that operates at a higher capacity, and
- Moving into a new location with more space or increased foot traffic.
A good business loan offers flexibility, allowing business owners to use it to meet their business goals. However, borrowing money is never without some risk. To maximize the positive impact of a business loan, there are three mistakes that you need to avoid.
1. Not borrowing enough money
This one sometimes confuses people. Isn’t it better to have a smaller loan amount to minimize the total cost? Not always. You need to borrow enough money to have an impact. Take the time to determine how you will use the additional funds and calculate the amount needed to achieve those business goals. Then, put together a cash flow forecast and include potential contingencies and delays. This can help you more accurately calculate how much money you need to turn the loan into profits. If you skip this step and don’t borrow enough, you risk getting caught with a loan repayment that didn’t generate additional revenue.
2. Not understanding the value of loan repayment terms
The first thing most people look at when taking on a loan is the interest rate. The interest rate is important because it affects the total cost of the loan, but it isn’t the only thing to be considered. Working together with your accountant and loan officer, look for ways to optimize aspects of the agreement like
- The repayment schedule,
- Loan length,
- Flexibility for seasonal payments,
- Interest-only options, and
- The guarantee terms.
3. Paying back the loan too quickly
Business owners love to get loans and debt off the balance sheet and often accelerate loan repayments to do so. Sometimes, paying it back too quickly doesn’t make financial sense. The first reason is that there may be a penalty for completing the loan repayment before the agreed-upon date. The second reason is that by doing so, you may expose your business to a cash flow shortfall in the event of low revenue or unexpected expenses. The third reason is that without access to the additional capital, you may miss out on the opportunity to take action that can help increase the business’s overall financial health.
Loans are a significant commitment for small businesses and should be treated accordingly. While a loan is considered a financial liability, it has the potential to add real value and improve the bottom line. If you think your business would benefit from a loan, start by talking to your accountant and a loan officer to learn more about your options and crunch the numbers.