Borrowing is not uncommon when running a business.
From starting a business to funding your scaling efforts, there are several good reasons to borrow. However, business owners should always borrow with a degree of caution. When managed poorly, a line of credit can turn into a source of business debt that can become a potentially fatal threat.
Here, we’re going to look at some tips on how to make sure that you borrow responsibly, for the right reasons, with a structured, sensible approach.
When to borrow and when not to
First of all, it is worth addressing whether you should be borrowing money or not. As mentioned, getting the start-up funding for your business or scaling it to expand your services to a new market or develop new products are some of the most common reasons to borrow.
Borrowing in the event of emergency costs can be helpful, too. However, you should be careful not to borrow if you’re using a loan as a stopgap in the event of consistently poor cash flow.
Otherwise, you should also look into alternatives to borrowing, such as using a revolving line of credit, finding an angel investor, or launching a crowdfunding campaign.
Know how much you need and why you need it
Besides knowing when to seek funding, it’s important to know how much you’re going to need and why exactly you need it. Traditional loan providers, such as peer-to-peer platforms and banks will require evidence of how much you need and why you need it.
This means going beyond the surface level reason such as ‘to scale the business’. It means putting together a business plan that shows exactly how you plan on spending the money and how the funding is going to help you build a business model that can reliably pay it back.
Besides providing the proof that lenders need, you should put together this type of plan for your own sake, so you ensure you use the money you borrow responsibly.
Get your credit in good health
There are several options for borrowing and funding that do not require you to have your business credit in good health, which we will explain in more detail later.
However, for the vast majority of sources of funding, a good credit score is going to help. Building a good business credit is done much in the same way as you would build healthy personal credit.
Making responsible use of open lines of credit, such as business credit cards, will help. Managing long-term financial commitments, such as renting property or leasing equipment, can also improve it.
Ensure you check your business credit report for any potential incorrect records that can negatively affect it, as well. The better your credit, the more you are able to borrow, the lower your interest, and the more flexibility you have in terms of payment arrangements.
Don’t mix personal and business finances
When first starting, it is tempting for many small business owners to turn to their own personal lines of credit first and foremost.
However, mixing the business with the personal is never a good idea. It puts you at significantly more personal risk, first of all. It also makes it harder to effectively organise your finances and separate them when tax season calls.
What’s more, it may be easy to lose track of which money is for the business and which money is your own. If you’re borrowing for the sake of your business, then keep it confined to your business credit and well away from your personal bank accounts.
Ensure you can manage your cash flow
Before you borrow any money, you should be fully aware of your cash flow situation and know how to effectively manage it.
This means putting in place a system that tracks both the money that’s coming into the business as well as the overheads, expenses, and accounts payable.
If you’re not already effectively managing the money that the business has, you are much less likely to be able to make the most effective use of any cash you borrow, as well.
Accounting software can be helpful in making it easier to track all the aspects of your cash flow, to automate reports, and help you recognise problems such as expenses you’re spending too much on.
Borrow in a way that suits your payment model
There are plenty of different ways to get the funding you need, including different borrowing options that allow you to pay back in different methods.
With traditional bank and peer-to-peer loans, you actively pay it back by cash or transfer. However, you can automate the repayment process with a merchant cash advance.
This is a method that lends money based on how much you make through credit and debit card transactions. Instead of having to pay it back yourself, you pay it back automatically every time someone uses your card machine to make a payment to the business.
What’s more, it’s one of the methods of borrowing that doesn’t require good business credit. It can be much easier to manage repayments if its directly tied to the methods of payment the business is already using.
Use what’s already yours
Financing is a way of using assets that are already yours in order to free up cash that is currently tied down. Asset financing, for instance, is borrowing by using your assets, such as property and vehicles, as collateral.
Invoice financing, on the other hand, involves providing invoices that haven’t yet been paid. The lender lends you the amount you expect from the client or customer as stated on the overdraft.
Once the customer pays, you then pay the lender back with interest on top. You may not be able to borrow as much through invoice financing, but it can be an effective short-term solution for smaller costs.
Ensure you’re able to pay it back
To some, this point may be obvious, but it’s crucial to do your due diligence and ensure that you’re able to completely repay any money that you borrow.
First of all, most lenders are going to require proof of just that. This includes not just your plans on how you’re going to raise the money, but it might also include providing collateral or at least a statement of all the valuable assets under your possession.
If you want to pay business debt off more quickly, then finding ways to increase revenue, such as hosting a sale, can make sure you get ahead of the repayments.
Have an emergency plan
Even the most responsible borrowers can provide 100% certainty that they are able to manage their debt. After all, crises do happen, from supply chain issues to property damage as a result of severe weather or fire.
If that does happen, then it’s wise to have an emergency plan ready so you can raise the cash you need to pay off your debt. Otherwise, it can continue to grow to become a serious threat to the business.
This includes looking at all your current expenses and thinking about which you can reduce first and how to do so if essential. There are lot of ways to save money in your business operations to make it easier to pay off your creditors.
Credit can be a valuable tool for a business owner, so long as its wielded mindfully and with a plan in mind. The tips above should help you recognise how when and how to borrow, as well as how to ensure you can always pay it back.