For a start-up, having a reasonable amount of debt can be an operative way of doing business. Some new business owners are often proud of the fact that they have never had a reason to borrow but we all know that path is not always realistic. In order for your business to grow, you most times need huge capital which may lead to you getting a personal loan or other types of debt financing.
Many people do not have an idea of how much they need to borrow for their business. The amount of money you need to borrow to run your business will be determined from your cash flow after careful analysis.
Carefully study the below guidelines that will help you below will help you conclude whether taking a loan is a good idea for your business.
Recognize your reasons for borrowing:
There are a number of situations that may arise which might make you to take on a debt. Generally, taking a loan can be the right way to go if you need to increase or sustain your cash flow, or expand your business.
Here are some major reasons for getting a loan:
• Working capital – the working capital of a business is the true measurement of efficiency. You can get a loan when you’re considering increasing your company’s work force, boosting your stock or just to fund the general day to day bills of running your business.
• Expanding into new markets – when your business is about to enter into a new market, you will most times experience a longer cash collection cycle, so borrowed funds can be of massive help during this period. The expansion option will allow the firm to measure the economic situation in the future and conclude whether it will be profitable to continue developing a particular product.
• Making capital purchases – capital expenditure are funds used by a firm to acquire or improve their physical assets e.g. Equipment, property, etc. You may need to buy new equipment in order for your business to expand i.e. in most cases, to expand the product line.
• Building credit history with a lender – borrowing in this case is to establish a relationship with a financial institution in order to build a good repayment history which would be of great help in future when needing financing.
After concluding that you really need a loan, here are a few tips on what you should do:
Before you approach a Bank for a loan, carefully plan your capital needs. Do not rush to take a loan when in sudden financial crisis, e.g. the inability to pay salaries or other financial emergencies. A plan will allow you to predict your cash requirements, letting you to know what and when you will need it. This will offer you more time to explore all possible borrowing options. A plan should contain:
• A complete assessment of your balance sheet to help you examine cash flow, assets and liabilities.
• A document, which is an estimated balance sheet for the next 1-3 years.
SHORT-TERM V.S LONG-TERM DEBT
After planning, you must know the exact type of loan that you need, which can either be short-term or Long-term. Also identify the kind of need you have to service, it could also be long or short term. Have this in mind, if you take a short-term loan to service long-term needs, you will create financial problems which may result to you taking some drastic decisions e.g. selling a part of your business.
So in general, make use of short-term loans for short-terms needs and vice versa. This will prevent you from paying higher interest rate associated with longer-term borrowing.
Base new debt on current needs
Taking a loan can seem appealing when money is cheap with low interest rates. You might be tempted to take a loan for capital purchases. Base your borrowing decisions solely on current needs. Do not take a loan for something you do not really need for now which will leave you with debts that you will be obliged to pay off.