Whether you're a small entrepreneur or a farmer, the word "financing" can give you headaches. When you've decided to take the next step, to move your business to another level, you need to rethink your financial flows as well.
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Responsible financing, what you need to pay attention to
Things to consider before taking out a loan
Responsible financing, what you need to pay attention to
A correct approach to the question "how do I finance my business?" and "where do I get resources for financing" can be vital to your business's success. A preliminary assessment can help you identify the right financing source, which can be internal financing (self-financing) or external financing, meaning taking out a loan from a financial institution such as a banking or non-banking financial institution. Each of the above has its own advantages and disadvantages.
If the preliminary assessment shows you that you can't finance yourself from your own sources, then you need to finance yourself from external sources — but not before making sure you can actually afford external financing! We know this might sound strange to read: "what do you mean, afford external financing, how could I not afford a loan?" These aspects, along with other important points about responsible financing, are what we'll discuss in the article below.
Before taking out a loan, you need to do an analysis of your business. Most of the time, you'll also be helped by a representative of the financial institution you want to borrow from. Together with a loan officer, you'll go through all the key aspects of your business, identifying all the risks as well as the opportunities related to a loan. After analyzing your business, the representative of the financial institution will tell you what the appropriate financing amount is for your business. This amount will be closely tied to your business's debt level — meaning the other debts you have — as well as your payment capacity, since you need to be able to repay the loan safely. So, you'll be helped to avoid over-indebting yourself, which could "freeze" your business.
Another important aspect to consider is the purpose of the loan. A loan can have several purposes: a working capital loan, an investment loan, and a mixed-purpose loan.
Which type of loan suits you?
A working capital loan helps you replenish your merchandise stock, pay your suppliers, pay salaries or state taxes — so this type of loan helps you get out of a financial bottleneck and propel your business forward. It's a useful type of loan especially for merchants who want to increase their merchandise stock during periods of the year when sales are going well and existing stock wouldn't be sufficient. It's also suitable for businesses that, due to other unforeseen expenses/investments, have accumulated debts to the state or to suppliers — this type of loan is a solution for that financial impasse.
An investment loan helps you especially if you're a small producer or farmer. These are meant for purchasing vehicles, equipment, real estate, land, or setting up work points. This type of loan is granted over a longer term than a working capital loan and is useful especially for entrepreneurs who want to invest in equipment, land, spaces, etc., which will lead to business development and, in turn, higher income in the future.
A mixed-purpose loan is a combination of a working capital loan and an investment loan. This type of loan is intended for entrepreneurs who want to grow their business. For example, an entrepreneur has a small shop in a commercial space. He finds out that the adjacent space will soon become available and that he could rent and fit it out to expand his shop/business. So, this entrepreneur will need financial resources both for fitting out the space and for replenishing merchandise stock. In this case, a mixed-purpose loan represents the perfect financing solution.
Things to consider before taking out a loan
If you've decided to take out a loan to develop your business, you need to keep 4 vital aspects in mind:
- Debt level
Don't over-indebt yourself — before taking out a loan, think carefully about what other debts you have. It's possible you also have loans from individuals that aren't officially declared and that the financial analyst won't be able to take into account before approving your loan application. If you over-indebt your business, there's a risk of going bankrupt, and that's not something we want for you. Every financial institution wants to support entrepreneurs so that they can grow and develop together, step by step.
- Purpose of the loan
It's very important to choose the correct purpose for the loan. If, for example, you want to replenish your merchandise stock, you need to take out a working capital loan and not an investment loan. The difference between the two types of loan lies in the total repayment period of the loan. It's advisable to do a calculation and determine how much time you'll need to sell the merchandise stock you purchased, and match that sale timeline to the number of installments.
For example, you bought 100 mobile phones and estimate selling them within 9 months — then a working capital loan with 9–12 installments would suit you. If, for example, you took out a 5-year investment loan to pay for that merchandise stock, you could end up in a situation where you sell the phones within the first 9 months, pay the first installments, and then use the rest of the money obtained from selling the phones for other things that don't generate income. This way, you risk reaching a point where you can no longer pay the remaining 60 installments.
- Number of installments
As you could see above, calculating the number of installments is a very important aspect. You should avoid loans whose terms far exceed the terms of the transaction they were taken out for. In other words, if you estimate that a transaction will take 6 months, try to take out a loan for a period of 6–8 months so you can repay the money on time. If the transaction takes 6 months but you set up installments over 24 months, for example, you risk running out of financial means and not being able to pay all the remaining installments, or ending up paying off a loan over a longer period than the one in which you actually earned income from the money spent.
- The institution you borrow from
After you've made all your calculations and plans, it's time to decide who to take out the loan with! The most important aspects to pay attention to are: the total interest — which represents the cost of the loan, or in other words, how much you'll pay for the money you use. Likewise, the flexibility of the repayment schedule and what the conditions are for an irregular repayment schedule. And last but not least, the institution you borrow from.
Lending conditions differ from one institution to another; in some cases you may receive very attractive and tempting offers, but you need to keep one thing in mind: the costs associated with loans are important, but even more important is the relationship with the institution you're borrowing from. You should also take into account the institution's willingness to help you and support you with all the necessary information, and to have effective communication with the institution so that you can resolve any misunderstanding that may arise during the course of the loan.
Likewise, avoid taking loans from unauthorized individuals — if banks and other financial institutions can't help you with a loan, it would be advisable to wait a little longer until you resolve all your issues and then submit another loan application, or negotiate once more with financial institutions. Loans from unauthorized individuals, or "loan sharks" as they're commonly called, can have serious consequences. Keep in mind that there are financial institutions that are very flexible in evaluating loan applications — even if banks can't grant you a loan, there's a good chance a non-banking financial institution will approve your application!
If you've read this article, then you know how to finance your business responsibly. Share this information with your friends too.
Best of luck growing your business!
Warm regards,
Everyone at MK Kredit