Over the past month or so, the economy seems to finally be reopening – hooray! This is great news, especially for small and medium-sized enterprises (SMEs), which have been hit hard by the pandemic. But now that business is picking up, SMBs that had been in survival mode for two years face a new problem: how can they ramp up operations fast enough to take advantage of the fast-opening economy?
As someone who works for a lending company, I’m going to be 100% honest: loans can be a big help for businesses that are growing very quickly. Loans can help you serve more customers faster, negotiate better terms with your suppliers, and generally make managing cash flow easier. The big “but” here is this: but how do you know if a business growth opportunity is worth the cost of borrowing?
Today we’re going to share five simple questions that will help you understand if and when you might be ready for a business loan.
1. Are you turning down customers and sales because you lack cash?
As a general rule, you only want to borrow money when you can put it to use and make even more money – that’s how you can pay the interest while making a profit at the end. For growing businesses, this usually means you’ll use the money to take on a big project, get a high-value customer, or fill a big order.
If you find yourself turning down good business opportunities simply because you don’t have enough cash to fund the project or order, now is probably a good time to consider a business loan.
2. How much money do you expect to earn by taking the loan?
Once you have identified the business opportunity for which you will be using the loan, the next step is to understand exactly how much you expect. You can increase your profits directly through additional sales or indirectly by reducing costs, but the end goal is usually to increase profits.
You don’t need to predict your profit with 100% accuracy, but you should be able to come up with an estimate. If you can’t, be careful as it could be a sign that your identified business opportunity is not a good one. If you are unsure of your estimates, you can always lower your expected profit a bit to get a “safe” estimate.
3. How long will it take you to repay the loan?
Similar to estimating your expected profit, you need to have an estimate of how long it will take to repay the loan. This not only affects the total interest you will have to pay, but it also helps you plan for the required repayments. You can use this information along with the interest rate provided by your financing partner to see exactly how much the loan will cost you.
4. What are your loan options and how much do they cost?
Now that you have a good understanding of your financing needs, it’s time to start evaluating your options. Contact a few lenders and find out the cost of their loans based on interest rate, fees, potential lock-in period, and other terms. It can be overwhelming to calculate for this, but most lenders will be more than happy to help.
Just make sure you’re comparing offers on the same basis, as not all interest rates are used equally and other terms can have a big impact on your final cost. Getting the total peso value you’ll pay is usually a good way to make sure you’re comparing offers correctly.
It is also useful to take note of any non-monetary costs. For example, a loan offer may be cheaper in terms of interest, but you will have to pledge your house as collateral. This means you could lose your home if something goes wrong. Such risks have significant potential costs, so you need to factor them into your comparison.
5. Is your expected profit greater than the cost of your expected loan?
In a final step, compare the best loan offer to your expected profit. Will you have enough profit after paying off the loan to make it all worth it? If you don’t have much profit, are there any other benefits you might find useful?
For example, if you take out the loan to service a new client but only break even on that project, do you expect to get more profitable projects from that client in the future? What is the cost of not taking the loan? Will this cause a delay in delivery for your existing customers? Will it give you a bad name and hurt your future prospects? These are all important things to consider.
Like most things in business, no one can tell you the “right” or “wrong” answer. It’s always up to you, but I hope these questions have helped you better understand how you can make the best decision for your business.
Belli Caballeros is Head of Digital Marketing at First Circle. She has been helping digital-focused brands grow their business since 2014 and is passionate about improving the financial prospects of everyday Filipinos.