Top 5 Tips for Using Business Loans Responsibly

May 10, 2019 11:30 pm

It is pretty simple to find online advice describing how to use credit responsibly as a consumer. There are lots of articles talking about mortgage loans, car loans, and even how to use credit cards without overextending yourself. Yet the amount of information relating to business loans is comparably stark. That is not because business people do not know how to be financially responsible. It is because business finances are so much more complex.

You could make the case that it is entirely possible to live as a private individual without using credit of any sort. In fact, there are people who do it. You cannot make the same case for business. It is nearly impossible to take a business from the start-up stage to annual growth and expansion without making use of business loans or some other form of credit. Business loans are central to a thriving business in every sector.

The key to successful business funding is to use loans responsibly. Use them irresponsibly and they can be just as damaging as irresponsible consumer credit. Below are five tips explaining what responsible borrowing looks like for business owners.

1. Look for Ways to Not Borrow

While it is difficult to build a successful business without ever taking out a single business loan, there is another side to that coin. Business owners should not be quick to borrow whenever there is a financial need. Sometimes the best strategy is to look for ways to not borrow.

For example, short-term cash flow problems may be easily addressed simply by being more circumspect in dealing with customers slow to pay. Sometimes being just a bit more aggressive in the accounts receivables department can bring an end to cash flow problems.

2. Plan for Borrowing Before You Need It

Next, assuming that business loans are going to be a normal part of your business, do not wait until you are in desperate need to apply for financing. Otherwise, your financials may be such that no bank will lend to you. The time to start thinking about loans is when you don’t actually need them.

An example would be planning to borrow to fund a capital improvement project in the near-to-medium future. You may have sufficient cashflow to cover it but relying on cash may create a future problem. So plan on borrowing anyway. Then start working on obtaining financing in the months leading up to the project.

3. Develop Relationships with Lenders

As long as you are going to borrow, do not follow the same consumer practice of one-off banking. In other words, develop long-term relationships with lenders. Choose one or two lenders you can trust to be a long-term financing partner as your business grows and expands. This will lead to better deals for you and lower risk for your creditors. Everyone wins.

4. Always Be Cognizant of EBITDA

There is nothing worse for a company’s funding strategy than to apply for business loans only to discover that the financials do not line up. As such, it’s a wise idea for ownership to always be cognisant of EBITDA. The EBITDA acronym stands for ‘earnings before interest, tax, depreciation, and amortisation’. As a general rule, lenders look at it to determine company performance over a given period of time.

If your EBITDA is too low, your company might not be able to obtain affordable financing. Any business loans on the table may be too expensive to make borrowing worthwhile. Bear in mind that the lowest ratio most banks will look at is 1.25. Some banks want 1.5 or higher.

5. Save a Cash Reserve

Bank loans for some businesses are represented as continuing lines of credit. These lines of credit can be awfully tempting during periods of low cash flow. Likewise, they can easily become a credit trap that does more harm than good. One way to avoid this trap is to save a cash reserve.

Just like financial experts tell consumers to save at least one month of income to pay for unexpected expenses, businesses should build up a cash reserve of 4 to 6 months. In other words, there should be upwards of six months of cash stored away in a bank account to meet those unexpected expenses. Saving a cash reserve makes up for periods of low cash flow and alleviates the need to immediately borrow at the first sign of financial stress.

Business loans are almost a necessity for growing a company in this day and age. Used responsibly, they can be a financial engine that helps a business continually move forward.

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