Every SME has to make the decision how to finance itself, either through debt or equity. It must also decide whether short-term or long-term financing is what it requires. If choosing to finance the company through debt, the most common way to do it is through a business loan. The alternative is to do it through equity, i.e. by injecting money into the company through an investment or by doing it with the company’s own cash flow. Below we go through some considerations for small business owners when financing their business with a business loan.
Business loans – starting with comparing offers
To begin with, before choosing to finance your company through a business loan you need to know what options you have as the terms tend to vary quite a lot depending on your business. The reason is that lenders evaluate every company differently and will adapt their offers based on the risk assessment of your particular company.
When comparing business loans you should start with contacting an online broker. Brokers will allow you to compare concrete offers from multiple lenders and banks quickly. In Sweden, the leading business loan broker is called Kompar företagslån (if you are based in other markets, a quick google search allows you to find the right service for you).
A business loan broker will help you to get an overview of what options you have in terms of lending amount, duration, interest rates, required securities, etc.
Are the loan options I have good for me?
Once you have a clear overview of the different options, you need to evaluate if these are good options depending on your situation. The process should look somewhat like the following:
1. What do I need the financing for and what impact will it have on my company?
Make it very clear what you need the money for and how it will make a difference in your particular business. If you need the money to renovate your restaurant, then how much do you really need to renovate and how much additional sales do you estimate that it will generate?
When doing so, it is important that you look at the gross margin of the additional sale (i.e. the revenues minus the costs associated with providing the service/the cost you have of buying the products that you are selling). The gross margin is what you will need to compare to the cost of the loan.
2. Comparing gross margin with the cost of the loan
Next step is to see how the impact from the additional funds stands against the costs associated with getting the financing. In concrete terms, what you need to do is to look at it from a cost and a cash flow point of view.
From a cost point of view, you simply compare the cost of the financing to the gross margin that you think that it will generate. Is the gross margin enough to cover the cost of the financing and generate a substantial enough profit in order for it to be worth it? Good, then proceed with the cash flow.
From a cash flow perspective, it is important that you ensure that you company will generate enough free cash flow to repay the loan and the financing charges that it will generate. In general, the longer the duration the better as it will allow you to pay back the loan over a longer period of time and thus your monthly instalment becomes smaller. However, the longer the loan is the more expensive it will be for you. Thus, it is important to look into the loan’s instalment plan, i.e. how much you need to repay per month, and see if this is doable for you.
In case you know Swedish and what to learn more about the subject, Kompar has published an interesting article about it comparing business loans.
Last step, what are your options?
Before moving forward with a business loan you need to ask yourself what your options are. Can you finance the need with the cash flow that the company is currently generating? Is there an alternative to put in more money yourself? Or the option to not do anything at all. These are all important questions to be asking yourself before getting additional debt.
Interesting related article: “What is Business Finance?”