Lesson 5: How to Manage Business Loans

Securing and managing business loans is often a crucial step for growth and sustainability. Whether you’re a startup seeking initial capital or an established company looking to expand, understanding how to effectively manage business loans can make the difference between financial success and struggle. 

Important to note: You should consult with a mentor, business advisor, accountant, etc. before getting a business loan. Getting into larger debt with a business comes at a big risk since most business loans require a personal guarantee and if the business fails, the owner is still liable.

Managing Business Loans

Should I Take Out A Business Loan?

There are only a few instances where someone should take out a business loan. These include:

1. To purchase an asset that the business doesn’t have the cash flow, and this asset will create more cash flow
2. To consolidate high interest debt (be very cautious with this scenario, since it is only a bandaid)
3. To bridge the cash flow gap (e.g. you pay your vendors or employees weekly, but you get paid by your vendors every 30-90 days from your vendors)
4. You are experiencing aggressive growth, such as hiring, developing software, etc.(this also comes with significant risk).

As mentioned, you should only consider taking out a loan if you have been advised to do so by a mentor, accountant, business advisor, etc.

Understanding Business Loans

Types of Business Loans

1. Term Loans: These are traditional loans with fixed or variable interest rates and set repayment terms.
2. SBA Loans: Backed by the Small Business Administration, these loans often offer favorable terms for small businesses.
3. Lines of Credit: Flexible borrowing options that allow you to draw funds as needed.
4. Equipment Financing: Loans specifically for purchasing business equipment.
5. Invoice Financing: Borrowing against unpaid invoices to improve cash flow.

Key Terms to Know

• Principal: The original amount borrowed
• Interest Rate: The cost of borrowing, expressed as a percentage
• APR (Annual Percentage Rate): The yearly cost of the loan, including fees
• Collateral: Assets pledged to secure the loan
• Loan Term: The period over which the loan must be repaid

Preparing for a Business Loan

Proper preparation is crucial for both securing a loan and managing it effectively.

Assess Your Financial Need

Before applying for a loan, carefully evaluate:

• The exact amount you need
• How you plan to use the funds
• Your ability to repay the loan

This assessment will help you choose the right type and amount of loan, reducing the risk of over-borrowing.

Improve Your Credit Score

A higher credit score can lead to better loan terms. To improve your score:

• Pay bills on time
• Reduce credit utilization
• Correct any errors on your credit report

If you don’t have a business credit card yet, read our previous lessons on getting a business credit card and best practices for using it.

Organize Your Financial Documents

Lenders will require various financial documents. Have these ready:

• Business and personal tax returns
• Financial statements (balance sheet, income statement, cash flow statement)
• Business plan
• Bank statements
• Legal documents (licenses, registrations, contracts)

Choosing the Right Loan

Selecting the appropriate loan is crucial for effective management.

Compare Loan Options

Don’t settle for the first offer. Compare:

• Interest rates and APR
• Repayment terms
• Fees and penalties
• Collateral requirements

Consider Alternative Lenders

While traditional banks are common sources for loans, also explore:

• Online lenders
• Credit unions
• Peer-to-peer lending platforms

These may offer more flexible terms or specialized loans for your industry.

Related: How hard is it to get a business loan?

Managing Your Business Loan

Once you’ve secured a loan, proper management is key to maintaining financial health.

Create a Repayment Plan

Develop a detailed plan that outlines:

• Monthly payment amounts
• Due dates
• Sources of funds for repayment

Incorporate this plan into your overall business budget to ensure you can meet obligations without straining your cash flow.

Set Up Automatic Payments

Automatic payments can help you:

• Avoid late fees
• Maintain a good relationship with your lender
• Potentially qualify for interest rate reductions

Monitor Your Cash Flow

Regular cash flow monitoring is crucial. It helps you:

• Anticipate potential repayment challenges
• Identify opportunities to make extra payments
• Ensure loan repayments don’t hinder business operations

Use Loan Funds Wisely

Stick to your original plan for the loan funds. Avoid the temptation to use the money for unplanned expenses or non-essential purchases.

Strategies for Successful Loan Management

Implementing these strategies can help you manage your loan more effectively and potentially save money.

Make Extra Payments When Possible

If your cash flow allows, making extra payments can:

• Reduce the overall interest paid
• Shorten the loan term
• Improve your credit score

Check if your loan terms allow for prepayment without penalties.

Communicate with Your Lender

Open communication with your lender is vital, especially if you encounter financial difficulties. Many lenders are willing to work with borrowers to:

• Adjust payment schedules
• Temporarily defer payments
• Restructure the loan

Early communication can help you avoid defaulting on the loan.

Refinance When Appropriate

Keep an eye on market conditions and your business’s financial health. Refinancing can be beneficial if:

• Interest rates have dropped significantly
• Your credit score has improved substantially
• You need to adjust the loan term

However, carefully consider refinancing costs to ensure it’s truly advantageous.

Leverage Tax Deductions

Many business loan expenses are tax-deductible, including:

• Interest payments
• Origination fees
• Some closing costs

Consult with a tax professional to maximize your deductions and improve your overall financial position.

Avoiding Common Pitfalls

Being aware of potential pitfalls can help you navigate loan management more successfully.

Don’t Overborrow

Borrowing more than you need can lead to:

• Higher interest costs
• Strain on cash flow
• Increased financial stress

Stick to borrowing only what’s necessary for your business goals.

Beware of Predatory Lenders

Some lenders may offer loans with unfavorable terms. Watch out for:

• Extremely high interest rates
• Hidden fees
• Pressure to borrow more than you need
• Lack of transparency in loan terms

Avoid Using Personal Funds for Business Loan Payments

Mixing personal and business finances can:

• Complicate accounting
• Create tax issues
• Potentially impact your personal credit

Maintain a clear separation between personal and business finances.

Final Thoughts

Managing business loans effectively is a crucial skill for any entrepreneur or business owner. By understanding loan types, preparing thoroughly, choosing the right loan, and implementing sound management strategies, you can leverage borrowed funds to grow your business while maintaining financial stability. 

If you have further questions on how to acquire or manage business loans, contact us!