You know that your company needs a business loan, but how much should you borrow? Should you base the amount on the needs of a project? On your revenue? Your profits? Financial projections? It’s important to take a variety of factors into account when looking for financing for your business. Here are a few.
1. How much money your business needs
It’s very important to determine the correct amount of money that your business needs, because if you ask for too much, lenders will question your ability to repay them, and if you do not ask for enough, you will have trouble funding your business. To find out how much money your business needs, you should create detailed costs projections for the use of borrowed funds. You should also prepare financial projections, including profit & loss and cash flow statements to estimate the revenue that you will generate by taking out a loan, and your costs. Doing this will not only help you determine the amount of money that you need, it will also show lenders that you are responsible and informed.
2. How much your business can afford
Making sure that you can make payments on the business loan is paramount. Lenders evaluate a company’s available cash to pay back a loan in a given year, which they call debt service coverage ratio (DSCR). To calculate your DSCR, you need to know your cash flow (how much money comes in and how much goes out), and the amount of money you’ll have left to make debt payments.
Many lenders also look at the borrowers’ personal finances, using a term called DTI (debt to income ratio), which calculates your total monthly income and monthly debt, including car payments, mortgage payments, credit cards, and other debts. Most lenders prefer that borrowers’ personal debt makes up no more than 36% of monthly income.
3. The costs of your business loan
What closing costs are there? What is your interest rate? What is the total amount that you will pay back? These questions all factor into how much you can and should borrow. Knowing the total costs of a loan can help inform you about the type and amount of financing that you should pursue.
4. The impact of your loan on your projections
How will the influx of money influence your future revenue projections? How much profit can you expect to make by taking out a loan after factoring in the loan’s costs? If you borrow more, will you make more as well? Calculating this can help you determine the optimal amount to borrow.
5. Future financing needs
Does your business plan call for future expansion that will require financing? If so, will taking out a smaller loan now and repaying it help you build your credit to secure a larger loan in the future? Is it necessary to take out a loan now to reach the point where you can meet your plans for future expansion? Or, if you borrow too much now will your debt from that loan get in the way of securing financing at a later date? By planning ahead, you can make informed decisions about financing your business now, and into the future.
Lendio’s small business loan calculators can help you gauge the level of financing that you need and compare loan types from many lenders.