How to Calculate How Much To Borrow as a Small Business Loan?
Among many small business owners, it’s often seen that they take small business loans to finance their company’s goals. Secondly, a business loan often turns out to be a lifesaver during dry seasons, and also takes the business to the subsequent level by enhancing its steady growth.
The amount of loan, however, to be taken is a most crucial issue because both over loaning or under loaning lead to disaster mostly. How then do you calculate the exact amount of loan to be taken?
In the current economic scenario, finding the right lender as also the correct loan type is a tedious and often confusing process. That’s why before you begin, ask yourself the following critical questions: How much is required? Why is the money required? How quickly is it needed? How long would it take to pay back? What has been you tenure in the business? What is your business’s financial status currently? What is the collateral you can offer if any is required to get the loan?
The following 5 steps will help you figure out how much to borrow by way of a typical and small business loan:
Disbursement of Funds
In other words, it’s all about how the money you will get will be spent. This will give you a basic idea about how much to ask for to a prospective lender.
You are obviously wanting the funds to get a cash-positive situation for your business and to grow at a steady and healthy rate. However, the vital point to be considered is: Towards which direction would you be channelizing these borrowed funds? Are you hiring new talent, buying more inventory or opening new locations? In simple terms, your future game plan indicates how much you will ask for as a loan.
This is more so as a potential lender favors any borrower who has a clear direction in mind for disbursing the borrowed cash and which in turn will yield longer lasting value for his business. Therefore, to know beforehand how the borrowed money will be spent certainly helps in determining how much needs to be borrowed to achieve your tangible goals. That’s why being realistic about growth opportunities and tackling only those that will yield both short and long-term benefits is essential.
Researching different loan options also have varying limits on the total amount of money that can be borrowed as also the terms on which the funds are to be repaid. That’s why matching the desired loan amount with its source as also with all repayment terms with the businesses overall financial plan is mandatory. Certain loan options enable you to borrow more funds than you require. So it’s important that you don’t get starry-eyed when you can borrow $500k when you actually need $150k only.
The Right Source of Funding
Sources for taking loans usually differ among small businesses. Moreover, these depend on numerous factors such as business credit, collateral as also cash flow. It’s often seen that one particular small business owner does best with a simple SBA loan, while others may seek alternative routes of financing because of bad credit or lack of collateral.
By researching loan options, you get to figure out the most appropriate loan source based on your business’s financials and your abilities to repay the loan while functioning within the lender’s terms and conditions. When you borrow from the most appropriate source, you are not only borrowing money but more importantly, repaying it on terms that work favorably for your business, no matter what those terms may be.
Knowing Your Limits is Paramount
Once you have worked out how to utilize the borrowed amount, stick to a borrowing limit that is reasonable. Remember, biting off more than you can chew could be disastrous for your business. Say, if you need only $75,000 to shift to the next phase of growth, borrow only that much. This is applicable even if you qualify for a $200,000 loan.
That extra $50,000 if taken, will certainly increase your monthly installments and unnecessarily prolong the repayment period. The principal objective of taking the loan is to shift the business to the very next level and not to the next 20 levels in one go. Remember, neither is a loan a substitute for income generation nor a perpetual crutch. Small businessmen who view it in that way tend to land in hot waters more often than not.
As a small business owner, when you flip the switch for a loan, you’re actually taking a big step. So before inking the deal, step back to carefully analyze whether the loan could be utilized to generate enough income to be able to comfortably repay the borrowed amount over time and whether you very clearly understand such financing options. Take an objective view of your immediate goals over the next one year because you stand to tie up too much cash if you over borrow.
Consider the Thumb Rule
Your expected profits generated by deploying the business loan should exceed the total cost of the loan. Moreover, the business should be able to generate ample cash flow to cover the monthly repayment easily. In order to calculate the APR, total cost of interest and monthly payment use an online calculator. Enter the loan amount, the lender’s interest rate, loan repayment period, monthly service and upfront fees and you will get the desired figure.
In the case of SBA 7(a) loans, the APR includes also a guaranty fee for that part of a loan that is agency guaranteed and this fee ranges from .25% to 3.75%, depending on the loan size as also its date of maturity. Repayment terms also vary from lender to lender and depends on the reason for taking the loan.
For instance, a short-term loan for buying inventory may carry a 3- 12-month repayment term, while a loan for heavy equipment may come with a repayment term that stretches to the expected lifespan of the said equipment spanning anything between 5 years or longer. Loans for commercial real estate on the other hand, come with repayment terms that may go up to 25 years.
Once you’ve got the above mentioned points in order and have had your questions answered satisfactorily, it’s time to put in for a loan application.
Anne is a Senior Author for SBL. She began her career as an independent consultant for local businesses after graduating with a BA in Management. Since that time, she’s expanded to writing as well as consulting to spread helpful knowledge to small business owners across the country.