1. Understand why you need a loan
It may seem obvious – you either need a loan to start or run your business. But it’s important to have a clear idea about exactly why you need to borrow money. ‘What is the purpose of the loan?’ is one of the first questions a lender is likely to ask. They want to see that you know the specific reason for getting the loan and how it will grow your business in the short and long term. For example, do you need help managing your cash flow or are you looking to expand your business? Perhaps you need some funds for new equipment, renovations, staff costs or training new employees. The more specific you can be, the better. Knowing the purpose of the loan will help you and your lender to find a loan that best meets your needs.
2. Work out how much you need to borrow and when you need the funds
Knowing exactly how much money you need and when you need it, shows that you have a clear spending plan. It is easy to work out the amount if you need a loan for an asset. However, it’s a bit more complicated if you need funds to help cover a cash shortfall. Closely monitoring your operating expenses, overheads, stock levels, debt collections and profits can help you work out how much money you need to help you with cash flow. It’s also a good idea to prepare monthly, quarterly and annual cash flow projections and engage an accountant to review your cash flow.
3. Know how much you can afford to repay
It’s essential that you know how much you can afford to repay because defaulting on a business loan will lower your business credit score or worse, throw you into a debt spiral that proves impossible to get out of. So, make sure you know how much you can afford to repay each month. To work this out, you can look at your business’s past financial records and prepare cash flow forecasts.
4. Have a strong business plan
Having a solid business plan in place will show lenders that you’ve carefully considered your growth and operations strategy. Make sure that your business plan includes a profit and loss budget and a cash flow forecast. Presenting a detailed business plan will help the lender determine when you’ll be in a position to repay the loan, and it will also help them to advise you on which loan would be most suitable for you.
5. Know what type of loan you need
There are many types of loans for businesses. Being clear about the type of loan that will best meet your business’s needs is an essential step in the process of applying for a loan. Here are the main types of business loans:
Upfront loan: With this type of loan, you receive the full amount all at once as a lump sum. The amount of money lent to you and the amount of time you have to pay back the loan, known as the loan term, both vary, as do the interest rate on repayments, type of interest rate (fixed or variable), fees and security. An upfront loan is a good option if you need funds to start a new business or buy equipment so that you can expand your current business.
Business overdraft facility/line of credit: This is a revolving line of credit that allows you to draw on additional funds when your account balance reaches zero. The overdraft facility is usually linked to your business transaction account, and you can only access funds up to an approved limit. You reduce the overdraft by depositing money back into your account when you can. You might consider accessing this type of finance when you need some extra help with your cash flow while you wait to get paid by customers. It can be useful to have an overdraft for when you just need a little extra money to purchase stock or pay invoices and wages.
Commercial hire purchase: This allows you to buy assets over an agreed period of time. The lender purchases the assets and then hires them to you. You make regular repayments over a set period and once you pay the total price of the assets, plus interest charges in full, you take ownership of the assets. One benefit is that both the interest on the finance and depreciation of the asset may be tax-deductible.
Chattel mortgage: Also known as a goods loan or car and equipment loan, this is a popular type of finance for buying vehicles and equipment. Similar to a fixed-rate home loan or mortgage, you buy and own the asset from the start of the loan term, and you make regular repayments until you pay off the loan in full. The finance provider uses the asset as security for the loan. Interest rates are generally lower than an unsecured loan, and another benefit is that you own the asset straight away.
Invoice finance: This allows you to access cash quickly to pay outstanding invoices. It is sometimes called accounts receivable finance. Lenders advance you around 80 to 85% of the value of your unpaid invoices and when your customers pay, the lender sends you the remaining money minus their fees. Invoice finance helps to improve your cash flow, keep your business running and reinvest in operations and growth earlier than you could if you waited for your customers to pay the invoices in full.
6. Decide whether a fixed or variable rate is better for you
These two interest rate options both have pros and cons, so it’s important to decide which one would work better for you.
Fixed: You lock in one interest rate over the term of the loan, so your repayments stay the same each month.
Pros
- Easier to budget: Knowing exactly how much your repayments will be makes budgeting and forecasting easier.
- Less risk: You’re not exposed to the risk of interest rate fluctuations, so it’s a good option if your business doesn’t have a lot of available cash after you’ve paid all your expenses.
Cons
- Higher repayment costs: If you decide you want to pay off your loan sooner, it’s likely that you’ll be charged an early repayment fee.
- Miss out on future rate reductions: It’s important to bear in mind that if interest rates go down, you will not benefit from the lower interest rate.
Variable/floating: The interest rate may go up or down during the loan term.
Pros
- Lower repayment costs: You can make earlier or additional repayments, and often you can pay back the whole loan early without any penalty.
- More flexibility: Some loans may offer features like offset accounts or redraw facilities. These reduce the loan balance that you pay interest on, while allowing you to access surplus funds.
Cons
- Less certainty: If interest rates increase, so too will your repayments. So, variable interest loans do not provide as much certainty as fixed rate interest loans.
7. Choose between a secured and unsecured loan
You can normally choose whether you want your loan to be secured or unsecured, so it’s important to know the difference between these two options and decide which one would work best for you.
Secured: You offer an asset, such as a property, inventory or accounts receivables, as security against your loan. If you are unable to repay the loan, the lender may sell your asset. The advantages are that you can usually borrow more, and the interest rate is usually lower than for an unsecured loan. However, the approval process is usually longer, as you may need to have value assessments done and provide additional proof and documentation regarding your assets.
Unsecured: You do not offer any asset as security. An advantage is that the loan is usually approved more quickly, as an asset does not need to be considered. However, the interest rate is usually higher, and it can be more difficult to get approval for an unsecured loan.
8. Gather the necessary documents
Finally, before you approach a lender to apply for a loan, it’s worth spending some time making sure that you have all the documents that they will ask you to provide. This will help them to decide about your loan application quicker. The requirements vary somewhat from one lender to another, but here are the documents that lenders generally want to see:
- financial statements, including profit and loss and projections – it’s a good idea to have these prepared by an accountant
- proof of individual income
- bank statements
- business as well as personal credit scores
- personal identification documents
- information about related entities, including trusts and self-managed super funds (SMSFs)
- copies of any relevant legal documents, such as articles of incorporation, contracts, leases and any licences and permits that you need to operate your business.
