We are debt averse in general. Borrowing money should be the choice of last resort, not first. But there are times where capital is needed and the business does not have sufficient time to generate the capital needed through its regular operations. In that case, borrowing might be useful.
But you’d better have a good reason to go down this road.
There are several reasons to borrow money:
Business expansion
There are two aspects to business expansion:
- Asset Acquisition: Sometimes when we expand the business we need to buy some assets like equipment, computers, etc.
- Working Capital needs: When your business grows, your working capital needs to grow with it. Typically, expenses will increase with expansion (especially payroll when you hire more people). If you sell on credit, your accounts receivable will increase. That happens when you sell to customers, but they take some time to pay, and your cash flow may take a hit.
Asset purchase or replacement
Yes, that equipment or technology needs occasional replacement because it wears out. Sometimes it becomes obsolete and must be replaced or upgraded to continue to work with your systems and processes.
Fund a loss
If your sales drop, or your expenses increase, you might find yourself in a position where your business is temporarily unprofitable. In that case you might need an infusion of cash to help you work through the challenge of becoming profitable once again.
Before you borrow there are several questions you should always ask:
- What will you spend it on? Is this purchase essential to your business, or is it a luxury item? Do you really need that new vehicle, or did you see it on the road and start drooling? There are only two reasons to spend money (especially borrowed money).
- It helps you save more money than you spend.
- It helps you make more money than you spend.
- Are you just putting a band-aid on an open wound? If your business is not generating enough cash to cover its expenses, then borrowing will not solve your problems. In fact, it might make them worse! You must first triage your business and stop the bleeding. In other words, you need a workout plan to find and treat the source that is causing the cash flow shortfall. Once you have a plan in place you “might” consider funding a “temporary deficit” with some outside financing. And make sure your plan will more than adequately cover the loan payback in addition to rebuilding your working capital.
- How and when will you pay it back? You need a cash flow plan to make sure you pay the loan back as payments come due. Sometimes there might be a delay between the time you receive the funds, and the profit starts coming in. In that case you need to make sure you can float the deficit until the situation flips around and you become cash positive.
- Why don’t I have the cash on hand to fund this? (Check out the article below on how you can become your own lender). This is actually an important question to ask yourself. If you had been thinking strategically, you might have been able to set up a separate account (a sinking fund) to store up cash for the purchase or fund the expansion. So you should ask yourself if there are any other surprises lurking in the shadows that you should start planning for.
Which Bank or Lending Institution Should You Use?
Believe it or not, not all banks are created equal. There are asset based lenders that require assets to secure a loan. There are also cash flow based lenders that insist on adequate income (cash flow) to fund the loan.
Additionally, different banks have different lending requirements. And they might like certain types of businesses over others.
So it makes sense to either do some homework about the different institutions, or work with a lending broker that knows how to navigate and find the right fit for you.
Banks need your financial info…
Banks require specific financial information. And it’s important that the info is accurate and presented cleanly. We can help you do that. Having well prepared financials will many times help expedite their approval process. We also know how to talk to lenders and answer questions they have.
We do this ALL THE TIME. So call us if you need help…
