Loans are a convenient way to grow your business and protect it during lean times. However, when you take out a loan you are obligated to meet certain repayment conditions that could negatively impact your small business if you aren’t careful. By following these eight tips for being a responsible business borrower, you can use loans to your advantage without hurting your business.
- Start by building a solid foundation with your vendors
Being a responsible borrower often begins before you ever go to a financial institution for a loan. Establishing good relationships with your vendors can be a huge help when money gets tight. You may even be able to avoid taking out loans entirely if you can secure better terms and negotiate repayment with each vendor.
- Use a loan calculator
There are plenty of free loan calculators out there. Use them first. They can help you see how much the loan will cost you overall as well as give you an estimate of monthly, weekly, or daily payments. With this information, you’ll have a better sense of how much you can afford to borrow.
- Know your debt-to-income ratio
Your debt-to-income ratio is a comparison of your annual profit to your annual debt. If your ratio is 1.0 or greater, you’re in a good position for a loan. Of course, the better the ratio, the better your chances of getting a loan and lowering your costs. Anything below 1.0 should be a warning sign that you are spreading your income too thin, and that you should reconsider taking on any additional debts.
- Give yourself a financial cushion
How much you should save will depend on the size of your business and the nature of your industry, but saving enough capital to cover six months of business expenses is ideal. Not only does this make you look like an ideal borrower to lenders, but it gives you the capacity to handle some emergency costs without having to borrow and lower your debt-to-income ratio.
- Draft a solid business plan
Smart borrowers and smart business owners know that a strong business plan is essential for a small business. Write a plan for the next two years that includes quarterly and monthly income projections and provides a breakdown of your expenses. With this information, you can easily identify how much you’ll need to borrow and how much you’ll have available for repayment.
- Don’t take the first offer
Shop around and compare small business loan products to make sure you’re getting the best possible terms on your loan. Read the fine print, and ask questions about interest rates, early payment penalties, and other fees and charges.
- Borrow only when you need to
Loans aren’t always the answer to your financial problems. If you need to free up cash, don’t forget to consider alternative solutions including cutting overhead, downsizing, or finding ways to increase your profit margin. Or you might want to consider advancing your invoices with a tool like Fundbox to help manage your cash flow.
- Make your payments on time
When you take out a loan, make repayments on time. If for some reason you are unable to make a timely payment, call your lender. It’s always best to maintain communication with the creditor. Not only is it the responsible thing to do, but it may also help to protect your credit rating.
Responsible borrowers are responsible business owners. And one of the most important advantages of following these tips is that they provide you with even better opportunities down the road to expand your business, borrow at better rates, or even sell.