Everything You Need To Know Before Your Business Borrows Money

 

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Financing a business is very hard work as you constantly need money to fund your various plans and ideas. Successful businesses don’t have a lot to worry about as they can pump profits back into their business operations. In essence, they become a self-reliant machine, needing no one else’s help. This is the dream and aim for every business owner – to never need anyone else’s financial help ever again. Few can manage it, and even some of the biggest companies in the world still have to borrow money. 

As you can tell by the title, that’s what we’ll be talking about today: borrowing money. Your business may need to do it at various stages, but what should you know before you sign any contracts? It’s all about understanding why you may need the money, how you can get the money, and what you should do before applying. All of this will be discussed in the guide below!

Why do you need to borrow money?

This is a very important question as it can completely change everything. Asking yourself ‘why?’ is important to understand if you even need to borrow money or not. A good example of when borrowing money makes sense is during the startup phase. In truth, this is when most people are likely to take out a business loan or seek other finance options. Why? Because you’re at a point where you need a significant injection of cash to get your business up and running. If you can’t get the money from other means, borrowing it is the best thing to do. 

Similarly, borrowing money to expand your business makes a lot of sense. Again, you’re at a point where you need a boost of money to take your company to the next level. Expanding a business could mean hiring new employees, finding a bigger office, opening a new branch, and so on. All of these things are very costly, and you may be unable to finance them through your profits alone. So, borrowing some cash can help you go from a small business to a medium-sized one. 

It’s also very common to borrow money to purchase tools or equipment. However, this usually only happens when you have expensive things to buy. For example, construction companies often take out loans to buy diggers and other huge construction vehicles. All of these examples are perfectly reasonable situations where borrowing money makes financial sense for your business. You’ll notice they have something in common; you’re borrowing money with the aim of using it to improve your company in some way. 

With that in mind…

When shouldn’t your business borrow money?

It’s hard to give examples for this as there’s mainly an underlying factor to consider. Primarily, your business shouldn’t borrow money if you’re borrowing to cover up some financial pitfalls. Let’s say you hire loads of new employees. You need to pay them, but your finances don’t add up and you physically don’t have the money. You knew this before you hired them, yet still chose to bring them on-board as you’ll borrow money to pay them instead. 

Something like this is not a wise idea as you are depending on the loan too much. You’d probably need to keep borrowing more money every single month to pay your new employees, which is not a financially clever thing to do at all. You’ll end up in a terrible cycle where you have the money to pay your employees, but then need to use it to repay the loan, meaning you need to borrow more money to pay them. It’s a vicious cycle to be in, and one that can be avoided by not borrowing money, to begin with. 

So, think long and hard about the reasons for borrowing money before you do it. Ideally, it should help your business achieve more than it’s already achieving. Obviously, if you’re in a bad financial position and need a loan to help you out temporarily, that will also be okay. But, don’t start using loans and borrowing money all the time to keep your business afloat – it will only end in tears. 

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What types of business finance options are available?

Next, you have to consider how you will borrow the money. What types of finance options are available for you to use? A traditional business loan is the first one that springs to mind. This is a simple method of borrowing money, usually with your business secured against it. So, if you fail to repay the loan, the lender can technically take control of your business and sell your assets to get what they need. 

Then, you have things like a merchant cash advance. Here, money is borrowed then repaid via transactions. Long story short, you agree to pay a percentage of your transactions through credit cards to the lender. Eventually, you repay what you borrowed, and everything is settled. It’s a concept that’s become popular in recent times, particularly for retail businesses and other companies that primarily use card transactions to charge their customers. 

You’ve also got many other options when borrowing money for a business. One that piques a lot of companies’ interest is a revolving credit facility. Effectively, this lets you continuously borrow money as and when you need it. That doesn’t do it much justice, but it’s the simplest way of putting it. Following on from this, there’s also the idea of invoice financing. This is where you borrow money based on money owed through invoices. Let’s say you have $5000 unpaid in invoices, you can borrow that amount and then use the money from these unpaid invoices to repay the loan. It’s a way of letting you have access to cash that’s technically yours but hasn’t been paid yet. 

If you explore the various business finance options, you will come across many other nuances here and there. In most cases, you can find a lending option for almost any niche within the business world. The best approach is to revert back to the first question at the start of this guide: why do you need to borrow money? From here, you can start researching which option would make the most sense for you. 

What should be done before borrowing money?

Aside from working out why you need to borrow money and finding the correct lending option, what else do you need to do beforehand?

In all honesty, we can condense most of the things down under one heading: credit score. You need to work on improving your credit score before you apply for any credit. Why? Because it can be the difference between you being accepted or not. Also, what a lot of people don’t realise is that your credit score impacts things like interest rates and how much you can borrow. Someone with an excellent score will always be allowed to borrow more money at a more reasonable rate than someone with a poor one. 

However, things get slightly more complicated when a business is involved. When borrowing money for personal use, your personal credit score is checked. Now, this is sometimes still checked when you seek out business funding options. It will typically be checked in instances where your business has no credit history. For example, if you need a loan to start a business, then your personal credit is usually taken into consideration. But, lenders will also be interested in your business credit score. This is pretty much the same as a personal score, only it focuses on your business. The two scores aren’t impacted by one another as they are separate things. It’s entirely possible to have an awful personal credit score and a fantastic one for your business. 

So, you have to work on improving both credit scores to put your business in the best possible situation. This will include doing things like:

  • Making all your payments on time
  • Not applying for too many loans or borrowing too much money at once
  • Keeping credit card balances as low as possible
  • Make frequent payments instead of saving them all at once

The list obviously goes on, and you can do plenty of research into how you can improve both. For now, your best step is to get a credit check online. They’re usually free to do, and it will help you understand where you currently stand. Who knows, you may be in a fantastic financial position, meaning you can go ahead and start applying for money. But, if things are bad, you will need to spend a bit of time building your credit score back up. 

In conclusion, borrowing money can be a benefit and a hindrance to your business. It’s never ideal to owe money to anyone, but it can be very helpful in some situations. The key is understanding why you need to borrow money, then looking at any alternatives. If borrowing money is the best way to help improve your business, research the different lending options available. After finding one that suits your needs the best, you can apply for it. Hopefully, this guide has explained this topic in more detail, letting you know everything about borrowing money for your company.