Timing is everything — especially when it comes to getting a loan for your small business. Wait too long, and you could run into cash flow problems (the number one reason why small businesses fail). Take a loan too early and you may not be able to make payments, jeopardizing your business credit. It’s not always clear whether or not you need a loan for your SMB, but here are some signs to start exploring your options.
Get one before you need it
Most experts recommend applying for a loan before you run into any problems. “[T]ake it out when you have good credit and aren’t desperate for the money, when cash flow is strong. The better you can meet lenders’ eligibility requirements, the lower interest rates you’ll qualify for and the more loan options you’ll have,” said Nav.
Lenders will look at things like your spending history, business credit, and financial statements to make sure your business is ready for more funding. While getting a loan before you need it is the best-case scenario, new businesses may not have the financial history to qualify for certain loans. In this case, you need to do some business readiness assessments to see whether you can take out a loan. Answer these questions to see if your venture is loan-ready.
How old is your business?
A loan may not be the best option if your business is less than two years old. Lenders typically want to see that your business has a proven track record and is stable. Fortunately, there are other sources of funding for startups and new businesses. Consider looking for an investor, applying for a grant, kickstarting your funding need, or exploring seed funding. These resources can give you the push you need to take your venture to the next level.
Is the funding need loan-worthy?
There are plenty of good uses for loan funding, such as expanding your inventory to meet increased demand, covering a staff shortage, upgrading your work environment, or updating your equipment, according to Experian. Business activities that will build sustainable growth are prime for getting a loan.
A loan may not be the best option if your business is less than two years old.
However, there are instances when a loan can do more harm than good. It’s unwise to use a short-term loan as a solution to a bigger problem. “For example, think twice before taking out a business loan if you’ve already maxed out your current lines of credit. Build a plan for managing your current debts first,” wrote Experian.
Loans should be used to cover expenses you know you can afford with time. If you’re simply struggling with financial mismanagement, it’s better to resolve that problem with a different approach.
[Read more: 4 Mistakes to Avoid When Applying for a Small Business Loan]
Is your business financially prepared?
Loans are a big financial commitment. “Before you apply for a business loan, you need to find out if you can carry the debt (and for how long), when you could realistically pay your loan off, and to what degree a loan would help advance your operation,” wrote Funding Circle.
Check a few key metrics to make sure your business is financially prepared to use and repay the loan (plus interest). Consider your sales and revenue over the last 12 months, your cash flow and cash flow forecast, your 12-month financial projections, and your business and personal credit scores.
[Read more: Small Business Funding: A Breakdown of Business Loan Types]
Some business owners decide to take out a loan simply to build business credit. Consider taking out smaller loans to manage seasonal sales dips or to staff up during your busy season. Repaying these loans in full and on time shows you’re a responsible borrower and can help you get larger loans when you need to expand or make a big purchase. Ultimately, loans are simply another tool in your business arsenal that should be used strategically to fuel growth.
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