DURING the last month or so the economy finally seems to be opening up again – hooray! This is great news, especially for small and medium-sized businesses (SMEs), which have been hit hard by the pandemic. But now that business is picking up again, SMEs that have been in survival mode for the last two years face a new problem – how to ramp up operations fast enough to take advantage of the rapid opening up of the economy.
As someone who works for a lending company, I’ll be 100 percent honest with you – loans can be a huge help for businesses that are growing very quickly. Credit can help you serve more customers faster, negotiate better terms with your suppliers, and generally make managing cash flows much easier. The big “but” here is: But how do you know when a business growth opportunity is worth the cost of borrowing?
Today we present five simple questions to help you understand if and when you might be ready to get a business loan.
1. Are you turning away customers and sales because you’re short on cash?
As a rule of thumb, you only want to borrow money if you can work with it and make more money – this way you can pay interest and still make a profit in the end. For growing businesses, this usually means using the money to tackle a big project, land a high-value client, or fill a large order.
If you find yourself turning down good business opportunities just because you don’t have enough money to fund the project or job, then it’s probably a good time to consider a business loan.
2. How much money do you expect to make by taking out the loan?
Once you have identified the business opportunity you will be using the loan for, the next step is to understand exactly how much you want out of it. You can increase profits directly through additional sales or indirectly through cost reduction, but more profit is usually the end goal.
You don’t have to be 100% accurate in predicting your win, but you should be able to make an estimate. If this is not possible, be careful as it could be a sign that your identified business opportunity is not a good one. If you are unsure about your estimates, you can always lower your expected profit slightly 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 pay off the loan. Not only does this affect the overall interest you have to pay, but it also helps you plan for the repayments you need to make. This information, along with the interest rate provided by your financing partner, allows you to see exactly how much the loan will cost you.
4. What are your credit options and how much do they cost?
Now that you have a good understanding of your financing needs, it is time to examine the options available to you. Contact some lenders and find out the cost of their loans based on the interest rate, fees, potential lock-up period, and other terms. It can be overwhelming to calculate this, but most lenders are happy to help.
Just make sure you’re comparing offers on the same basis, as not all interest rates are used in the same way and other conditions can have a big impact on your final cost. Finding out the total peso value you’ll be paying is usually a good way to make sure you’re comparing offers correctly.
It also helps to keep any non-monetary costs in mind. For example, a loan offer could have lower interest rates, but you would have to provide your house as security. That means you could lose your home if something goes wrong. Such risks have large potential costs, so you should consider them when making your comparison.
5. Is your expected profit higher than your expected cost of borrowing?
In the last step, compare the best loan offer with your expected profit. After paying off the loan, will you have enough profit left to make it all worthwhile? If you won’t have much profit, are there other benefits that could be valuable to you?
For example, if you take out the loan to service a new customer, but only break even on that project, do you expect to receive more profitable projects from that customer in the future? What does it cost not to take the loan? Will this cause delivery delays for your existing customers? Will it give you a bad name and hurt your future prospects? These are all important things to keep in mind.
As with most things in business, nobody can give you the “right” or “wrong” answer. It’s always up to you, but I hope these questions have helped you better understand how to make a decision that’s best for your business.
Belli Caballeros is Digital Marketing Manager at First Circle. She has been helping digital-first brands grow their businesses since 2014 and is passionate about improving the financial prospects of everyday Filipinos.