Taking out business loans is common practice among small business owners, as it grants them access to more capital than they would otherwise be able to obtain through sales. Sometimes an influx of capital is just what a business needs to get off the ground, or to finance a new product line, marketing campaign, or expansion.
Business owners should bear in mind that while the use of business loans is widespread, the long-term effects of taking out a business loan may vary.
Because of this, it is a good idea to carefully consider the potential benefits, and the possible drawbacks of taking out a business loan. Weighing the pros and cons of business loans will help business owners to make smart, informed decisions when it comes to business financing.
Drafting a Blueprint for Success
If a business has been established for more than a few years, it is likely to have an easier time acquiring financing. However, startups that are seeking business loans will likely have a lot more convincing to do before they are approved for financing.
Part of what lenders want to see is a solid business plan. A good business plan should take stock of a company’s assets, its position in the marketplace, its competitive advantages, and the qualifications of its principals. It should also show earnings projections for best and worst case scenarios.
Whether or not a company is approved for a business loan on its first attempt, the act of putting together the business plan will have the effect of bringing key aspects of the business into sharp focus. True, this isn’t a direct effect of taking out a business loan. However, drafting a business plan during the loan application process can have a clarifying effect, thus contributing to the business’s long-term success.
Impact on Credit
If the terms of the loan are fulfilled and it is correctly reported to the credit bureaus, then taking out a loan can have a very favorable impact on a business’s credit. The credit boost from promptly paying off a business loan can pave the way for larger loans in the future, or for other types of financing.
However, if the payments are made late, or incorrectly reported, then taking out a business loan could have a damaging effect on the business’s credibility. Worse yet, if the business is unable to make the payments on the loan, those who have signed as personal guarantors could lose a substantial portion of their personal assets.
Using a Business Loan Effectively
When taking out business loans, it is important to consider how the loan should best be used.
Long-term loans (those lasting more than a year) are best used to finance specific, one-time business needs such as real estate, vehicles, or new equipment. When taking out a long-term loan, it is a good idea to make sure that the benefits of taking out the loan will offset (or ideally, outweigh) the cost of borrowing the money.
For example, if having a new piece of equipment will add enough to a business’s profits so that it more than pays for the cost of the loan, then it is likely a sound investment.
In contrast, using a long-term loan to purchase impulse or luxury items, which have no appreciable effect on the bottom line, is an unwise use of capital.
These are just a few of the factors that can impact the effects of business loans. As with any other type of financing, the long-term effects of business loans can go either way. Thus it is important for businesses to do their research, and to make sure to always use business loans in a fiscally prudent manner.