Before you go into debt with your business, you’re going to want to read this.
Today, we’re going to share with you the pros and cons of getting a loan or line of credit for your business.
Loan vs. Line of Credit vs. Credit Cards
There are two main ways that a business can get money from a lender: a loan or a line of credit.
A loan has a non-revolving credit limit. So you get a chunk of cash once and then you make interest and principal payments until it is paid off by a certain date. Because loans are more fixed, they often have better interest rates and terms, but that varies depending on your lender.
On the other hand, a line of credit has a set limit and the borrower has continuous and repeated access to that line of credit while it is active. You don’t have to use it all, and you make monthly payments on the interest and principal.
Credit cards, for example, are a common form of a line of credit. You have a base amount you have to pay each month to avoid penalties, you can charge up to a certain amount total, and you can use it again and again as long as you have the account and pay the debt down.
But while all credit cards are lines of credit, not all lines of credit are credit cards, so are directly from a bank. While terms vary depending on your lender, the APR – or percentage you pay in interest – is often lower with a line of credit at a bank and the limit is usually higher than that of a credit card.
That makes loans and lines of credit a better choice if you plan to borrow a large amount of money and pay it out over time than credit cards.
Credit cards often offer things like rewards and cash back, which can make them a better option for short term borrowing that you pay back at the end of each month, like regular operating expenses. Be sure to read our blog post and watch our YouTube video on credit card rewards first, though, to avoid scams.
Loans, lines of credit, and credit cards all can affect your credit score, both personally and as a business, so be sure to talk with your CFO if you want to see what’s best for you before choosing.
Instances Where You Might Want To Get a Loan
Here are some instances where a loan might not just be a beneficial, but also necessary:
- Expanding into a new physical location
- Buying major new equipment
- Making a mass purchase of inventory, especially if it would save you money to buy in bulk
Those instances are often easier to get a loan for as well, as you can show the direct benefit to the business itself to a banker.
There are other instances, however, where it might get a little trickier deciding whether it’s a good idea to take on debt in your business.
- Hiring new team members
- Starting a new venture or branching out in what you already do
- Expand into a new market you haven’t been in before
These can be harder to pinpoint the ROI, so a loan company might be more hesitant to lend to you and it might be harder for you to know if you’ll be able to pay it back.
Your CFO can help you run the numbers and determine what kind of loan and how much would be good for you and your business.
What To Consider Before Taking On a Loan
Here are some things to consider when deciding to take out a loan:
- Sales and revenue over the past 12 months.
- Current cash flow and cash flow and sales forecast for the next 12 months.
- Operational needs and long-term goals
- Economic conditions and how it might affect your business and the area of the market you’re in
- The terms of the loan or line of credit
And don’t forget to factor in interest rates! You’re not just paying back the loan, you’re paying it back and then some, so when you’re making calculations be sure to include that.
Your CFO can help you to run the numbers and look at any hidden costs that you wouldn’t know to include.
Alternative Ways to Get Capital
If you’re nervous about taking out a loan or your ability to pay it back, here are some alternative options you can do to help you raise the capital you need to expand your business.
- Raise your prices – especially if you haven’t adjusted for inflation and your loan is simply to cover the cost of rising prices
- Bring on a partner – this can include someone who works in your business and/or someone who invests money in it
- Crowdfund – this is a great way to get money now to develop a product and then deliver it later to the clients
- Grants – there are hundreds of thousands of dollars of grants offered to businesses each year, so start with a Google search of grants in your area
- Small Business Administration funds – this is a great way to get free coaching and low interest funding if you run a small business
- Rent or borrow community resources – instead of buying expensive equipment that you don’t’ need on a regular basis, think about short term rentals instead
- Meeting with a tax strategist regularly – one of the best ways to leverage capital in your business is understanding tax strategy and making sure you’re leveraging all the tax benefits available to you
When To Meet With a Professional
We here at Paragon Accountants always suggest that business owners meet with their CFO and tax strategist at least quarterly to make sure that they’re making the right payments and leveraging tax benefits as much as possible. If you’re thinking about taking out a loan or line of credit, you’ll definitely want to meet with your CFO beforehand to run the numbers and see what it would mean for your business and bottom line.
We’d love to hop on a call with you and help you figure out if a loan is right for you, so contact Paragon Accountants today to set up an appointment.