When is the right time to get a business loan?

A business loan can help growing businesses in many ways. First, they augment your working capital, so you can meet your company's financial obligations and keep your cash flow sufficient. Second, having fresh capital for expansion can grow your inventory, help you serve more customers better, or even help you negotiate better terms with your suppliers.

However, a common misconception among business owners worldwide is that business loans are the answer to every cash flow gap or any other urgent financial problem. While these situations may be eased by funding for a short while, any financial issues that are caused by missed revenue and sales targets — or worse, a flaw in your business plan, organizational structure, or operations — can only escalate. This is especially if you took out funding, only to discover that you can't make repayments after using it all up.

So how do you know when your small business is ready for a loan? The short answer is when your business is growing too fast for your capital.

The long answer lies in the 5 simple questions we have below, which will help you understand if and when you might be ready to get a business loan — and what your business loan options may be.

1. Are you missing out on business opportunities due to lack of capital?

In general, you want to borrow money only when you can put it to work and make even more money. This way, you'll be able to afford the loan's interest rate and still come out with a profit at the end. For growing businesses, this usually means you have the opportunity to bid for a new project, get a new customer, or fill a big order.

If you're starting to turn away good business opportunities just because you don’t have enough working capital to fund the project or order, then it’s a good time to start considering a business loan.

2. How much profit do you expect to earn by taking this loan?

After identifying the business opportunities that you'll be using your funding for, the next step is to understand exactly how much value you expect to create. For business loans, the best measure of that value is usually profit.

You might be increasing profit directly through additional sales or indirectly through things like better operating efficiency, but increased profit is still probably your end goal.While you don’t need to predict your future profits with 100% accuracy, you should be able to come up with an estimate. If you can’t, proceed with caution: it might be a sign that your identified business opportunity isn’t a good one.

If you’re unsure about your estimates, you can always be conservative and lessen your expected profit to get a “safe” estimate. What’s important is that you get an idea of how much debt you can afford.

3. How long will it take you to pay back the loan?

Similar to estimating your expected profit, you need to have an idea of how long it will take you to pay your loan back.

If you’ve already estimated your profit in the second question, this should be fairly simple. Just compare when you expect to earn from your profit — for instance, your client's payment date — against the repayment plans offered by your loan provider. For example, if you are taking a business loan to fund a 12-month project, you can expect to pay back the loan after 12 months.

If you're not 100% sure when customers will pay you, there are specific types of business loans with features that can come in handy. For example, some revolving credit lines allow you to repay early with no early-repayment fees in case your profits came in earlier than expected.

What are your loan options and how much do they cost?

Now that you have a good understanding of your financing needs, it’s time to start assessing the options available to you.

A quick Google search can tell you the best loans in your area, but what it doesn't tell you is the type of business loan that fits your needs best. In the Philippines, where First Circle is located, there are 5 types of business loans: term loans vs. credit lines, secured vs. unsecured business loans, and startup loans. Between these five, you'll be able to narrow down your choices by asking yourself the following:

• Is your business need short-term (credit line) or long-term (term loan)?
• Do you need money in lump-sum (term loan) or in small increments that you can borrow whenever you need (credit line)?
• How much do you need, and how much interest rate are you willing to pay to get the money soon?
• If you can't find an affordable interest rate for the amount you need, are you willing to get a secured business loan, which requires you to put up collateral?

From here, contact a few lenders and find the cost of their loans based on their interest rate, fees, potential lock-in period and other terms. It can be overwhelming to compute and compare several factors, but most lenders will be more than happy to help. Remember that in many countries, sending in a business loan application can affect your credit score. So ask your financing agent how to get as much information as you can regarding a business loan without it having to impact your credit score.

When you start comparing offers, you'll notice that not all lenders use the same terms to describe their loan interest rate, fees, or repayment terms. Due to this, it's always a good idea to ask for a computation of how much you'll be paying per month until the completion of your loan term, and the total value of your repayments.

It also helps to take note of any non-monetary costs. For example, one loan offer might be cheaper in terms of interest, but you would have to put up your house as collateral. This means you could lose your house if something goes wrong. Risks like that have big potential costs, so you should consider them in your comparison.

Is your expected profit more than your expected loan cost?

As a final step, compare the best loan offer to your expected profit. Will you have enough profit left after paying for the loan to make everything worthwhile? If you won’t have much profit, are there any other benefits that might be valuable to you?

For example, if you take the loan to serve a new customer but only break even on the project, do you expect to get more profitable projects from that customer in the future? What is the cost of not taking the loan? Will it result in delayed delivery for your existing customers? Will it give you a bad reputation and harm your future prospects? These are all important things to consider.

Like most things in business, no one can tell you the “right” or “wrong” answer. It’s always up to you, but we hope this short article has given you a bit more clarity on which questions to consider and how you can make a decision that suits your business.