3 Essential Financing Tips For Small Business Owners
Small business owners face several choices when researching financing options. The average small business owner is financially adept, as the Vcita financial literacy survey 2022 indicates. According to the survey, 80% of SMB owners go at their finances alone, and 60% understand their cash flow.
Despite the high degree of financial literacy amongst SMB owners, mistakes can occur. Here are 3 important points to remember if you’re seeking financing as a small business owner.
Understand what you need
Some SMB owners apply for financing before understanding how much money they need. Not all cash is good. Cash from financing comes at a price. Interest costs could erase your margins in the long run if you’re not careful. Thus, the first step you must take is to project how much cash you need and plan accordingly.
Review your cash flow projections to determine how much cash you’ll have coming in. compare these amounts to your projected expenses. Remember to account for one-time expenses. These tend to be paid in a lump sum and can throw your budgets awry.
Typically, large upcoming expenses such as inventory purchases or capital investments, need financing. Depending on the type of expense, evaluate whether paying interest to fund it is worthwhile. For instance, if a capital expense will generate cash flow greater than the interest on the financing, seeking financing is a good option.
However, if you need financing to pay rent and daily expenses, you have bigger issues to worry about. Using a loan to finance these expenses will only put you in a deeper hole. Once you’ve calculated how much you need, evaluate the types of funding you can access.
Depending on how much you need, some lenders might reject your application. For instance, short-term lenders do not fund large loan amounts. Make a list of the options available to you.
Prepare for the application
Preparing ahead of time for your application is the best way to reduce approval times. Gather all necessary documents such as your accounting statements, business tax returns, invoices, and even collection history reports. Evaluate your credit score to check whether you’ll qualify with a lender.
Traditional lenders such as banks tend to impose rigorous financing conditions on business owners. If your credit history is not up to scratch or if you have been in business for less than 5 years, these lenders will not be a good option for you.
Your business’ credit score is extremely important to the application process. Some lenders weigh it more than others, but everyone takes notice of it. If your credit score is below-par, consider improving it before seeking financing. Improving your credit score will save you significant amounts of money in interest expenses.
Online lenders tend to incorporate alternative data when evaluating applications. For instance, if you have a steady history of collections and a stable client base, these lenders might ignore your below-par credit score. While there are no guarantees, applying with an online lender might be a good choice if your business is young.
If your business is unprofitable, your lending options are severely limited, unfortunately. In such cases, it’s best to evaluate your business and get it profitable before choosing a lender. Some lenders might offer to finance high-risk businesses such as unprofitable ones but will charge stiff interest. Needless to say, those interest rates will push you further into a cash flow hole.
It’s best to ask lenders how long the application and approval process takes. Some lenders offer approval in as little as 48 hours, while others spend a month evaluating your application. Match these timelines with how quickly you need funds and choose the right funding option.
Lending agreements come loaded with fine print, and you must understand them thoroughly before arriving at a decision. Some examples of fine print that sabotage your cash flow are balloon payments and variable interest rates.
Lenders assume risk when offering you financing, and they hedge this risk through these tactics. Terms such as early repayment fees, origination fees, and maintenance fees can add significant costs over the lifetime of the loan.
Watch out for promotional rates. These offers give you a low interest rate for a fixed period before increasing interest significantly. The increased rates are usually tied to benchmarks such as the Fed funds rate or Euribor. Some business owners try to time these interest rates using macroeconomic predictions.
Despite high financial literacy, predicting interest rates is a risky task. Risking your business’ margins is not worth the effort. Stick to fixed interest rates or variable rates you’re comfortable with. Note that some lenders might offer interest-only loans with a balloon payment at the end.
These loans might suit your needs if you’re funding an asset that will produce guaranteed cash flow. However, make sure you can cover the balloon payment at all costs. Fail to do so and you might risk your business.
Several options and different considerations
SMB owners have a multitude of options when choosing between financing venues. Make sure you follow the tips in this article to choose the right option for your business.