Business Loans: Potential, Perils, and Pitfalls
Everyone likes to have more money to spend in their business. Loans are a seemingly easy way to insert cash quickly, but there are pitfalls to consider before signing on the dotted line.
Loans (including a Line of Credit and credit cards) are just that – loans. Eventually, they must be paid back – with fees and interest. Before you take out a loan, consider how you’re going to pay it back and what you’re going to have when it’s paid off. Banks are often willing to lend money, but it is up to you to figure out how to pay it back.
When’s the right time to use a loan?
Loans are best used for one-time needs such as equipment, vehicles, buildings, or major software purchases. If the loan is tied to a physical item, you can often get a lower interest rate and have the chance to sell that item in the future to get a little cash out of it.
Covering day-to-day expenses such as payroll, utilities, rent, etc. with a loan points to a larger, underlying issue that needs to be managed. If your sales aren’t bringing in enough cash to cover related expenses, it’s time to address that first. Here are some possible items to look at:
Collection efforts need to ramp up.
Expenses need to be reduced.
Inventory needs to be sold, and new purchases made wisely.
Sales aren’t high enough to support the expenses.
Loans can easily provide a stopgap, but if the underlying issues aren’t resolved, you will probably end up in a deeper hole than you started in.
What about the CARES Act federal relief loans?
Many businesses have applied for the PPP and EIDL loans. Before spending the loans, think about how you will pay back any amount not forgiven. Even if in six months your business goes back to the level it was before, can you afford to pay these loans back? If you end up using the loans to pay down high-interest debt you were paying on previously, you will probably have the capacity to make the lower-interest loan payments when things stabilize. But how are you going to pay it back if your business doesn’t come back (either at all or in the short term)? What if you use the money for survival and your business never returns to profitability?
If you still see the need for a loan, begin with the issues above to minimize the loan needed. Setting aside the loan payment amount for a couple of months before you take the loan out could help you figure out if you can afford the payments. These funds set aside will also help you reduce what you need to borrow.
Loans have a role in business, but far too often businesses commit to way more than they can ever hope to pay back. Many owners have had sleepless nights and had to make even more difficult decisions down the road because a loan seemed like the easy answer.
If you need some guidance on how to effectively utilize business loans, or how to avoid them, schedule a time to chat with us! We’d love to offer some advice and assistance.