Meet Martha, a small business owner who had big dreams for her cafe and decided to get a business loan to make those dreams a reality. But as time went on, Martha found herself in a tough spot.
The money she had borrowed seemed to vanish into daily expenses. She found herself in a financial bind, struggling to make loan repayments. Relentless calls from lenders only added to her mounting stress.
In this article, we'll help you avoid the pitfalls Martha faced. We'll provide seven best practices to ensure that your business loan becomes a catalyst for growth rather than a source of stress.
Here we go!
Best Practice 1: Define Clear Objectives
Setting clear and objective goals for your business loan is crucial for ensuring its effective use and successful outcomes. Here's how you can set clear goals for your loan
- Identify your business needs: Start by pinpointing what your business needs most. Your needs include expansion, equipment, marketing, or cash flow management.
- Be specific: Instead of a vague goal like "increase revenue," specify "increase monthly online sales by 15% in the next three months.
- Measure success: Define metrics for success. For instance, if your goal is to expand, measure it by the number of new locations opened or the increase in market reach.
- Stay realistic: Set achievable goals considering your resources and capacity.
- Align with vision: Make sure your goals align with your long-term business vision.
- Set deadlines: Establish clear timeframes to create urgency and keep you on track.
- Review and adjust: Regularly check your progress and be ready to adapt your goals as needed.
Read Also: How to Set and Achieve Your Finacial Goals.
Best Practice 2: Only Borrow What You Need
Imagine you're at a buffet. Do you load your plate with more than you can eat, or do you take just enough to satisfy your hunger? Regarding business loans, it's often wise to follow the latter approach. Only borrow what you need.
- Only borrowing what your business requires means you pay less in interest. Every extra shilling borrowed is an extra shilling in interest payments over time.
- Keeping your loan amount in check makes it easier to manage and repay.
- Borrowing within your means minimizes the risk of default.
So, when considering a business loan, choose the plate that satisfies your business's appetite. Otherwise, it could lead to higher interest rates and financial strain.
Read Also: How to Avoid Regret After Taking Out a Loan.
Best Practice 3: Understand the Terms and Conditions
Reading and comprehending the fine print ensures you know what you're committing to financially and prevents surprises. It also ensures you only apply for a business loan that aligns with your business goal.
When reading the fine print, here are the key elements to look out for:
- Interest rates: Understand the interest rate structure and how it will impact your repayments over time.
- Repayment schedules: Know when and how you're expected to make repayments and the consequences of late payments.
- Fees: Be aware of any fees associated with the loan, including origination fees, prepayment penalties, or late payment charges.
- Collateral: If the loan requires collateral, understand what assets are at risk if you default on repayments.
- Terms for early repayment: Find out if penalties or restrictions exist on paying off the loan ahead of schedule.
It's wise to seek professional guidance to help you understand the terms and conditions. Engaging a lawyer or financial advisor can provide invaluable insights and help decipher any legal or financial intricacies within the agreement.
Additionally, it's a good practice to compare different lenders to find one with terms and conditions you are comfortable with. To simplify this process, you can use our business loan finder tool, which allows you to easily compare various lenders and their offerings, ensuring you make an informed financing decision.
Read Also: 6 Reasons to Have a Financial Advisor in Your 20s and 30s.
Best Practice 4: Create a Detailed Budget
To maximize your business loan, avoid using the money all in one go. Create a detailed budget and stick to it.
Here’s how to create a comprehensive budget for your business loan.
- Determine the loan purpose: Clearly define the purpose of your loan, whether it's for expanding inventory, marketing campaigns, or equipment purchases.
- Estimate expenses: Break down your expenses into categories and estimate the costs associated with each.
- Prioritise spending: Allocate funds based on priority, focusing more on areas directly contributing to business growth.
- Set a timeline: Create a timeline for expenditure to ensure funds are used when needed and not all at once.
- Track and adjust: Implement a tracking system to monitor expenses, and be ready to adjust your budget as circumstances evolve or new opportunities arise.
Read Also: 6 Simple Ways to Create a Working Budget.
Best Practice 5: Monitor Cash Flow
Your cash flow fluctuates every month. Some months have unexpected expenditures and slow revenue, while others may bring more income.
As such, monitoring your cash flow is essential. It ensures you can meet loan repayments and stay financially healthy throughout the loan term.
Here’s how to maintain a healthy cash flow.:
- Maintain clear bookkeeping records to track every incoming and expense.
- Review your cash flow regularly, ideally every month. This allows you to identify trends, anticipate lean months, and make informed financial decisions.
- Consider setting aside some of your revenue during good months as an emergency fund. This can act as a buffer for loan repayments during low-income months.
- If you encounter a bad month or financial challenges, be ready to make temporary expense cuts.
- If you anticipate difficulties meeting loan repayments, inform your lender. They may offer temporary solutions or loan modification options.
Read Also: 7 Signs that Your New Business is Destined to Fail.
Best Practice 6: Invest in Growth
When you get the funds, don’t just spend because you have the money. It's about ensuring every expenditure contributes to business growth.
Here are examples of growth initiatives you can adopt
- Inventory management: Allocate loan funds to replenish and expand your inventory to meet customer demands, keep up with trends, and increase sales potential.
- Marketing campaigns: Launching targeted marketing campaigns across various channels to reach a wider and more engaged audience.
- Hiring and training: Employ new staff and provide comprehensive training programs to enhance customer service, production efficiency, or product development.
- Equipment upgrades: Investing in modern equipment or machinery can boost productivity, reduce operational costs, and enhance product quality, contributing to business expansion.
- Debt Refinancing/Payment: Reducing financial obligations by refinancing or paying off existing debt can free up more working capital for growth initiatives.
Read Also: The 10 Golden Rules of Investing You Should Know.
Best Practice 7: Repay Promptly and Strategically
Promptly repaying your loan is crucial. Otherwise, you'll find yourself in a situation called loan delinquency.
Delinquency means you haven't fulfilled your agreed-upon payment obligations. The consequences can be significant:
- Your loan could accrue additional interest and penalties, increasing the overall cost of borrowing.
- If you used collateral to secure the loan, such as property or assets, the lender may seize these assets to recover their losses.
Create a concrete repayment plan and follow it diligently to avoid these pitfalls.
Here are some tips:
- Prioritise loan repayments in your budget, ensuring they are paid promptly.
- Set up automatic deductions from your business account to prevent missed payments and potential delinquency.
- Consider making early payments when possible. However, check for any penalties for early repayment before doing so.
- If you encounter financial difficulties, don't hesitate to communicate with your lender.
- Periodically assess your repayment plan and adjust if your financial situation changes or improves.
Read Also: How to Create a Debt Repayment Plan.
From what we've discussed, it's evident that business loans can be invaluable tools for growth and financial stability. However, their effective utilization relies on a strategic approach. By keeping these seven best practices in mind, you can harness the true potential of your business loan.