Businesses often think they need to borrow money when they shouldn’t. Still, there are times when it’s a good move to get working capital financing, especially when it contributes to growing the business.
A bank approving an application for a loan isn’t a sign that a business needs it. All it indicates is that the bank believes the business can pay back the line of credit or loan. That’s their main goal regardless of how it affects your business.
How to decide if your small business needs a loan
So how do you know if you need funding? In CEO Blog: Signs Your Business Should Borrow, Brian Hamilton advises asking two questions. If you answer yes to both, then your business may need financing.
Questions to ask to determine if your business needs financing:
- Is your business actually profitable?
- Can you easily service the debt?
Answering the first one is easy for most. The second one not so much. The article explains how to calculate the debt-service ratio. Your accountant knows how to do this.
Did you say yes to both questions? Don’t start calling banks or private lenders just yet. Hamilton suggests getting working capital only if it increases profit. He gives a useful example of a business replacing a truck. Replacing a truck lets the company maintain business, but it won’t likely affect profit. Adding a truck, on the other hand, to service more customers is more likely to boost profit.
When people say they need working capital to grow the business, many times they mean they need cash flow to stay in business.
How to prepare for a loan
Start gathering your financing information now rather than waiting until your business needs funding. You may need to do a few tasks to make your business more viable to a bank or private lender. And, these aren’t quick.
Are your business accounting and personal financial records updated? These provide a snapshot of your company’s financial health and personal finance status. Why personal? Banks typically want to see a personal financial statement from a small business owner. You’ll also need updated accounting records for creating an income statement — also known as profit and loss (P&L) statement — or creating reports like a cash flow statement.
Be ready to answer the following questions when requesting a loan:
- How much money does your business need?
- How will your business use the money?
- How will your business repay the loan?
- What will you do if your business can’t repay the loan?
- What other debt does your business have?
Here’s a checklist of documents you’ll want to gather before applying for a loan:
- Business plan.
- Executives’ resumes. (Shows leaders’ ability to manage the business and its money.)
- Personal background information such as previous addresses, names used, educational background, criminal record and so on.
- Personal credit report.
- Business credit report.
- Bank statements.
- Financial statements.
- Income tax return.
- Legal documents, such as licenses, registrations, articles of incorporation, agreements, commercial leases and contracts with third parties.
Request a credit report
Check your credit report and your credit score for both business and personal accounts. (You can get this done at AnnualCreditReport.com — the only authorized source for free annual credit reports. This report includes Experian, Equifax and TransUnion.)
When you receive your credit report, look for outdated or wrong information on the following items:
- Accounts that aren’t yours.
- Closed accounts with a balance.
- Wrong balance for an account.
- Late payment that occurred more than seven years ago.
- Incorrect dates for open credit accounts.
- Credit line limits that don’t match your billing statement.
- Wrong category for listed accounts.
- Collection and charge-off activities that occurred more than seven years ago.
Correct any mistakes you find. Here’s help from the FTC on how to dispute credit report errors.
If you don’t have a business credit record, start by setting up a business entity and opening a checking account in the company’s name. Besides, it’s important to separate your business and personal bank accounts. SBA.gov provides five steps to manage your business credit.
What else would you do to prepare for a loan? What other options do you have for getting working capital or financing? Share your thoughts in comments.