Reasons to take out a small business loan
Many business owners wonder about the validity of taking out a small business loan. Small business owners worry because borrowing money is expensive for a company and raises its risk. In addition to the risk of whatever enterprise you are undertaking, borrowing money will introduce another level of risk to your company. Regardless, debt is one of the forms of financing small business operations. However there are several valid reason to take out a loan to help grow your small business.
Small businesses take out commercial bank loans for a variety of different reasons. It is important to understand that loans can come from many other sources as well banks. Credit unions make loans to small businesses and loans can be made using accounts receivable or inventory as collateral. Here are four reasons that companies often use debt financing-
- To purchase inventory-Without inventory companies would be hard pressed to make their goods or services. Banks will sometimes make loans to small businesses to purchase inventory. Some small businesses are seasonal in nature, particularly retail businesses and if a business makes most of its sales during the holiday season, they will want to purchase most of their inventory prior to the holiday season. Many of these types of businesses may need a bank loan prior to the holiday season to purchase a large amount of inventory to gear up for that time. Bank loans to purchase inventory are generally structured as short-term in nature and companies usually pay them off after the season is over with the proceeds of sales from their seasonal sales.
- To purchase real estate and to expand existing operations-Banks are more likely to loan money to existing firms that want to purchase real estate to expand their operations. This is because the bank feels that if a firm is expanding, then the firm is successful and it wants the company to keep on doing what it is already doing. Expansion generally only happens if the business is turning a profit and a positive cash flow and has positive forecasting numbers for the future. This the most likely scenario that makes a bank want to approve a loan. Bank loans for real estate are usually in the form of a mortgage. Long-term bank loans are usually 25-30 year term loans and the real estate is then used as collateral.
- To purchase equipment-Businesses are generally faced with a couple of different choices when determining how to acquisition equipment. Most businesses have to determine if the best choice is to lease or buy the equipment. There are some very good reasons to take out a loan to buy your equipment. Most businesses can take a substantial tax write-off during the first year you use the equipment and depreciate the rest of the equipment over its economic life. In addition the business can also use the equipment for its life and sell it for a salvage value. In order to know whether it is best to buy or lease equipment, a cost-benefit analysis should be done before you make the decision. When a bank makes a loan for equipment, it is usually an intermediate term loan. Intermediate term loans are generally 10-15 year term loans.
- To increase working capital-Working capital is defined as the money a business uses to manage their day-to-day operations. Small businesses sometimes need loans to meet their daily operations needs until their earning assets are sufficient to cover their working capital needs. Banks will sometimes loan short-term money to small businesses to enable them to get off the ground and grow. As the business grows and their own assets enable them to earn money, they can then repay the working capital loan to the bank. Working capital loans may have higher interest rates than, since banks generally consider them riskier.