To survive and thrive, businesses frequently have to seek credit from external sources. This credit is used to cover everyday operating expenses and make strategic investments for future growth.
Although the idea of getting a business loan may be appealing, it’s not always the best option. Some reasons for wanting a loan may not be enough to justify going into debt, but there are valid reasons that should be thoughtfully considered.
If your business is ready for a strategic leap and you do not have the working capital to make the right moves, here are five reasons why taking a loan may be an apt move.
1 Expanding your operations
Any business with the fortitude or mettle for growth will eventually outgrow its original base of operations, hence the need to set up shop at a much bigger base. A move of this nature is likely to prompt a prodding necessity to take a loan.
But this is good news. If your business has outgrown its current home, it means the business is doing well, even if you do not have all the funds needed to facilitate a move.
In that case, you may need a term loan to finance your big move. Whether it is expansion or picking up and moving, the up-front cost and change in overhead will be significant.
An Ogun State-based fish farmer, Olatunde Fagbuyiro, in a chat with our correspondent, described his decision to take a loan to expand his business as fitting because currently has the space to rear more fish and make a bigger profit.
Before you take the plunge, it is pertinent to critically evaluate the overall impact that this decision will have on your business in the short and long term. Could you cover your loan costs and still make a profit? Use a revenue forecast along with your existing balance sheet to see how the move would impact your bottom line. If you are talking about a second retail location, research the area you want to set up shop to make sure it’s a good fit for your target market.
- Building credit for the future
If you have plans to raise larger-scale financing for your business in the future, the wise decision would be to start with a smaller short-term loan to build your business credit history.
If you do not have a well-documented credit history capable of making a compelling argument before your potential creditor, the chances are that you will not be able to attract any large-scale financing when you need it. Taking out a smaller loan and making regular on-time payments will build your business’s credit history.
This strategy is also effective in helping you cultivate trust with specific lenders. It gives you leverage to go back to when you are ready for that bigger loan. However, you have to be careful and make sure that you do not take on an early loan you cannot afford. Even one late payment on your smaller loan could make your chances of qualifying for future funding worse than if you had never applied for the small loan at all.
- Equipment acquisition
There comes a time in the life of a business when the need to purchase equipment to boost production. Whether it is replacing outdated equipment or adding to your existing fleet, you will typically require an amount of money which you cannot shoulder from your income.
Nonetheless, before you take out an equipment loan, make sure you are separating the actual needs from the nice-to-haves when it comes to your bottom line. Yes, your employees probably would love a new coffee machine or the latest split unit air conditioner, but unless these wants are tied to improving productivity, that particular equipment may not be your business’ best investment.
- Purchasing more inventory
Inventory will inevitably constitute the biggest expenditure for your business. Just like equipment purchases, you need to keep up with the demand by replenishing your inventory with the most efficient ones. This could be a tall order, especially when you need to purchase large amounts of inputs before seeing a return on the investment.
If you have a seasonal business, there will be times when you need to make bulk inventory purchases without liquid cash to do so. In such a situation, taking a loan may not be a bad decision.
To measure whether this would be a wise financial move for your business, create a sales projection based on past years’ sales around that same time. Calculate the cost of the debt and compare that number to your total projected sales to determine whether taking an inventory loan is a wise financial move. Keep in mind that sales figures can vary widely from year to year, so be conservative and consider multiple years of sales figures in your projection.
- Taking advantage of opportunities
As you continue to navigate the labyrinths of doing business, promising new opportunities may show up now and again. It could be a chance to order inventory in bulk at a discount, or a contract to make large supplies above your current stock. When this happens, you should determine the return on investment of the opportunity, weighing the cost of the loan versus the revenue you stand to generate through the available opportunity.
For instance, if you run a business where you get a contract of N200,000 and you do not have the equipment to complete the job. Purchasing the necessary equipment would cost you about N50,000. If you took out a two-year loan on the equipment, paying a total of N10,000 in interest, your profits would still be N140,000. If the potential return on investment outweighs the debt, go for it! But be careful with your calculations. You should never allow your desperation for new business to get the better of you.
by Edidiong Ikpoto