Lending Library

Small business loans are one of the most popular ways for entrepreneurs to get the money they need to start a business and keep it running. Yet, despite the importance of accessing capital, some small business owners struggle to qualify for funding. In 2021, just 31% of business applicants received all of the funding they applied for according to a report by the Federal Reserve. 

On a positive note, there are many possibilities to consider where small business financing is concerned, and there’s a good chance you’ll be able to find a lender that’s willing to approve your business for some type of financing solution. 

If you’re wondering how hard it is to get a business loan, the answer depends in large part on the type of business loan you hope to take out. Your business details also play a significant role in the type of financing your company may be eligible to receive. Read on to learn more about business loan approval factors that lenders may consider.  This guide also includes details about approval odds for different types of business loans and how to discover whether a loan offer is an affordable financing solution for your company.

Business loan approval factors.

When you apply for a business loan, a lender may evaluate various factors to determine whether to approve or deny your application. After a loan approval, the factors below may also influence your loan’s interest rate, loan amount, and repayment term. 

Credit score and credit history (business and personal)

Lenders will review your personal and business credit score when evaluating a business loan application. A higher credit score will make it easier to qualify for a loan, especially if you have a consistent credit history. Minimum credit score requirements vary by loan type and lender. Equipment financing minimum requirements start in the 500s with SBA loans starting at 650.

Business revenue

Lenders will want to see a steady stream of revenue, so they know you will have the ability to repay the loan. Just like credit scores, the minimum revenue requirement will vary, but a minimum of $8,000 in monthly revenue is a good rule of thumb.

Time in business

Lenders inherently take on risk when loaning money to a business, so they want to ensure your business will still be around to pay off a loan. For larger, long-term loans, such as an SBA loan, lenders will want to see a minimum time in business of two years. For smaller, short-term loans, such as a business cash advance, funders will want to see a time in business of at least six months.

Collateral

Collateral acts as a guarantee for the lender that if you default on the loan, the lender will be able to recoup their assets by claiming an asset such as equipment or property. 

Industry

Certain industries can be seen as riskier than others depending on the nature of the industry and external factors such as the economy and government restrictions.

More established businesses with good credit, higher revenues, and lower overall risk profiles can typically borrow more money and qualify for better loan terms. Startups and businesses with bad credit—or other types of high-risk borrowing profiles—may face higher interest rates and lower loan amounts and struggle to qualify for certain types of financing.

Approval odds by type of business loan.

Getting approved for a business also depends on the type of loan you need. Below are several popular business financing products, along with your basic odds of getting financed. 

Accounts receivable financing

Sell your outstanding invoices to get cash flowing now. This is a great option for businesses with large accounts receivable.

Time in business

Any

Minimum credit score

N/A

Minimum monthly revenue

$8,333

Collateral requirements

Invoices act as collateral

Equipment financing

Finance your purchase of business equipment, vehicles, and electronics. Pay your loan back in regular monthly payments over a set term plus interest.

Time in business

0-1 Year

Minimum credit score

520

Minimum monthly revenue

$0 – $8,333

Collateral requirements

The equipment acts as collateral for a lease and a portion of collateral for a loan.

Business credit card

A business credit card helps you track expenses, build a strong business credit history, and increase your working capital so you can reap the literal rewards.

Time in business

0-2 Years

Minimum credit score

650

Minimum monthly revenue

Varies

Collateral requirements

None

Business cash advance

Get an advance on your future sales earnings to get fast financing, and pay it back with a fixed daily percentage.

Time in business

6 Months

Minimum credit score

500

Minimum monthly revenue

$8,333

Collateral requirements

None

Business line of credit

Get a revolving amount of funds to borrow from when you need to and pay back later. Great for working capital and regular short-term expenses.

Time in business

6 Months

Minimum credit score

600

Minimum monthly revenue

$6,000

Collateral requirements

Varies

Business term loan

A term loan provides a lump sum that gets repaid in regular intervals over a set amount of time, also known as the loan term.

Time in business

1 Year

Minimum credit score

600

Minimum monthly revenue

$8,000

Collateral requirements

Usually required

SBA loan

Invest in longer-term small business growth or even refinance existing debt with a loan that is partially government-backed. An SBA loan has stricter requirements and is usually paid back over a longer term with lower rates than other loans.

Time in business

2 Years

Minimum credit score

640

Minimum monthly revenue

$8,000

Collateral requirements

Required for loans greater than $50,000

Are you a skilled mechanic looking to open your own auto repair shop? Or, maybe you're passionate about cars and interested in starting a business in the automotive industry. Whatever your motivation may be, opening an auto repair shop can be both rewarding and challenging.

To help you get started on the right foot, we've put together a comprehensive guide on how to start an auto repair shop. From creating a business plan to hiring mechanics and building your brand, we'll cover all the essential steps you need to take to make your dream of owning an auto repair shop a reality.

1. Choose the type of mechanic shop to open.

Before you delve further into the process, it's imperative to decide on the type of auto repair shop you wish to open. This choice should reflect your personal skills, interests, and the market demand in your area. You could opt for a general mechanic shop that caters to a wide range of vehicle issues or specialize in certain services like engine repair, bodywork, or oil changes. Alternatively, you may want to focus on a specific type of vehicle, such as luxury cars, trucks, or electric vehicles.

Consider the competition in your area and identify any gaps in the market that your shop could fill. For instance, if there aren't many shops offering specialized services for hybrid or electric cars, you might consider tapping into this niche market. Research potential customer needs, review competitor offerings, and then decide on the type of services your shop will provide. This decision will play a key role when you secure financing for your business and determine what equipment you'll need to purchase.

2. Create a business plan.

Like any other business, starting an auto repair shop requires careful planning. A well-structured and detailed business plan will serve as the roadmap for your business and help you make informed decisions along the way. Include the following items in your auto repair shop business plan.

• Target market - Clearly define your target market and provide detailed information about their demographics, needs, and preferences.
• Competition - Analyze your competitors and highlight their strengths and weaknesses. Identify your unique selling points and how you differentiate yourself from the competition.
• Services offered - Describe the range of services you offer and explain how they address the needs of your target market. Highlight any unique features or benefits of your services.
• Marketing strategies - Outline your marketing strategies—including online and offline tactics—to reach and attract your target market. Include details on advertising, social media, content marketing, and any other promotional activities.
• Financial projections - Provide detailed financial projections, including revenue forecasts, expense estimates, and projected profitability. Include any assumptions or factors that may impact your financial projections.
• Location - Choosing a location for your auto repair shop is a crucial step in your business plan. Consider factors like accessibility, visibility, competition in the area, and the proximity to your target market. If possible, choose a location on a heavily trafficked road to increase visibility and attract more customers. The premises should be large enough to accommodate multiple vehicles at a time, have a comfortable waiting area for customers, and space for storage. Ensure the location complies with zoning laws for auto repair businesses. Check the local city or county government's website or office for more information.

If you're not sure where to start with creating a business plan, there are plenty of resources available online to guide you through the process. Additionally, you can seek professional help from business consultants or attend workshops and seminars to gain a better understanding of creating a business plan.

3. Plan for upfront costs.

Starting an auto repair shop comes with significant upfront costs. These costs can be broadly categorized into startup costs, ongoing expenses, and unexpected costs. Understanding these expenses is crucial as it will influence your budgeting decisions, your pricing strategy, and the amount of financing you need to secure.

• Startup costs - These are the one-time costs associated with setting up your auto repair shop. They include the cost of acquiring or leasing a business premises, purchasing necessary equipment and tools, construction or modification costs to make your premises suitable for auto repair work, and initial inventory of parts and supplies. Additionally, you need to factor in costs for business registration, permits, and licenses.
• Ongoing expenses - These are the recurring costs of running your auto repair shop. They include rent or mortgage payments, utilities, salaries of employees, cost of auto parts and supplies, marketing and advertising, insurance, and maintenance costs.
• Unexpected costs - It's crucial to have a buffer for unforeseen expenses. Equipment may break down, there might be unanticipated repair works, or you may face slow business periods. Having a contingency fund can help cover these unexpected costs and keep your business running smoothly.

Some common costs for starting a mechanic shop include:

• Premises - The cost of premises for your auto repair shop can vary widely depending on location and if you decide to purchase, lease, or rent your property. If you choose to rent or lease a property, you can expect to pay between $1,500 and $15,000 per month, depending on the location and size of the property.
• Equipment - The cost of equipment can vary greatly depending on the services you offer. Basic equipment like car lifts, air compressors, wheel balancers, and diagnostic machines can cost between $5,000 to $10,000 each.
• Business registration, permits, and licenses - The fees for business registration, permits, and licenses can range from a few hundred to a few thousand dollars, depending on your location and the specific requirements of your city or state.
• Insurance - The cost of business insurance can range from $1,000 to $3,000 per year, depending on factors such as the size of your business, number of employees, and risk factors.

Keep in mind that these are average costs and actual costs may vary. It's important to do your own research and get quotes based on your specific needs and circumstances.

4. Choose a business structure.

Before officially starting your auto repair shop, you'll need to decide on the business structure that best suits your needs.

Sole proprietorship

This is the simplest and most common form of business ownership. You are the sole owner, responsible for all profits and losses, and personally liable for all debts and legal obligations.

• Advantages - Simplicity, full control, and direct profit.
• Disadvantages - Unlimited personal liability, difficult to raise capital.

Partnership

A partnership is an arrangement in which two or more people own and run a business together.

• Advantages - Shared responsibility, shared profits, potential for diverse skill sets.
• Disadvantages - Joint liability and risk of conflicts among partners.

Corporation

A corporation is a separate legal entity from its owners. It offers limited liability protection to its shareholders, meaning they are not personally liable for the company's debts and obligations.

• Advantages - Limited liability, ability to raise capital through selling stocks, perpetual existence.
• Disadvantages - Complex setup and management, double taxation.

LLC (Limited Liability Company)

An LLC combines the legal protection of a corporation with the flexibility and tax benefits of a partnership. It offers limited liability protection to its owners, known as members.

• Advantages - Limited liability, flexible management structure, pass-through taxation.
• Disadvantages - More paperwork, potential for self-employment taxes.

5. Register your business.

Registering your auto repair business is a crucial step in making your business official, compliant, and legally recognized. The process may differ slightly depending on the business structure you've chosen and the specific regulations of your state.

• Business name - Start by deciding on a name for your auto repair shop. Make sure the name is unique, easy to remember, and resonates with your target market. Check with your state's business registry to ensure the name is not already in use. You may also want to check if the domain name is available if you plan to create a website for your business. Once you've chosen a name, you can register it with your local government or state authorities.
• Employer Identification Number (EIN) - Next, you will need to apply for an Employer Identification Number (EIN) from the IRS. This is a unique nine-digit number that identifies your business for federal tax purposes. You can apply for an EIN online for free on the IRS website.
• State tax ID - In addition to the EIN, you may also need to apply for a state tax ID number, which is used to identify your business for state tax purposes. The process to apply for a state tax ID number varies by state.
• DBA (Doing Business As) - If you plan to operate your business under a different name than the one you registered, you will need to file a DBA (Doing Business As) or assumed name with your state or county. This allows the public to know who is doing business under a particular name.

Remember, it's important to consult with a business attorney or a professional business formation service to ensure you are meeting all legal requirements in your area. Not properly registering your business could lead to fines and legal issues down the line.

6. Secure financing.

Starting an auto repair shop requires a significant amount of capital. From renting or buying a space to purchasing equipment and inventory, you'll need enough funds to cover all the initial expenses. This is where securing financing comes into play.

• Traditional bank loans - A common option for funding your new business. These loans are provided by banks and typically require collateral and a good credit history.
• SBA loans - Small Business Administration loans that are guaranteed by the government. They offer favorable terms and lower interest rates but have stricter eligibility requirements.
• Equipment financing - This type of loan specifically covers the purchase of equipment for your business. The equipment itself serves as collateral for the loan.
• Business credit cards - A revolving line of credit that allows you to make purchases and access funds for your business. It's important to manage credit card usage responsibly to avoid high-interest rates and fees.

If you're not sure which option is right for you, Lendio can help. As the nation's largest small business loan marketplace, Lendio connects entrepreneurs with lenders and provides access to various loan options, including SBA loans, business lines of credit, and equipment financing. Learn more about auto repair business loans.

7. Acquire necessary permits and licenses.

Before opening your auto repair shop, you'll need to obtain the necessary permits and licenses. The requirements may vary depending on your location, so it's essential to research the local regulations and acquire all the necessary documents.

Some common permits and licenses for auto repair shops include:

• Business license - This is a general requirement for all businesses. It allows you to legally operate your business within a specific location.
• Sales tax permit - If you plan on selling products or parts, you'll need to obtain a sales tax permit from your state government.
• Environmental permits - These are required if your auto repair shop will be generating hazardous waste, such as oil and coolant.
• Occupational licenses - These are required for any technicians or mechanics working at your auto repair shop. The requirements may vary from state to state.

• Occupancy permit - This permit certifies that the building or property you're using for your auto repair shop meets the local building and fire codes. It's crucial to ensure the safety of your employees and customers.
• ASE certifications - The National Institute for Automotive Service Excellence (ASE) offers certifications for auto mechanics. While not always legally required, obtaining ASE certifications can greatly enhance your credibility and customer trust. These certifications demonstrate your knowledge and competency in different aspects of automotive repair and service. Consider encouraging your mechanics to get certified or hire those who already have ASE certifications.

Make sure to stay up-to-date on all permit and license renewals to avoid any unnecessary interruptions to your business operations. It's a good idea to consult with a business attorney or your local small business development center to ensure you're covering all your legal bases.

For a more comprehensive list of permits and licenses needed for an auto repair shop, check with your local government or consult with a business attorney.

8. Set up bookkeeping and a business bank account.

Proper bookkeeping is crucial for any business, and an auto repair shop is no exception. Keeping track of your income and expenses will help you make informed decisions and manage cash flow effectively. It's also essential to have a separate bank account for your business transactions to maintain accurate records.

You can choose to do bookkeeping yourself or hire a professional accountant. However, it's recommended to have a basic understanding of bookkeeping to ensure the financial success of your business.

9. Get business insurance.

As with any business, it's important to protect your auto repair shop from potential risks and liabilities. This is where insurance comes into play. Some key types of insurance that an auto repair shop should consider are:

• General liability insurance - Protects against property damage, bodily injury, and advertising injury claims.
• Property insurance - Covers damages to your business property due to theft, fire, or other disasters.
• Business interruption insurance - Provides financial support in case your shop is unable to operate due to a covered event.
• Workers' compensation insurance - Covers employees for work-related injuries or illnesses.
• Garagekeepers liability insurance - This type of insurance is particularly important for auto repair shops. It covers damages to a customer's vehicle while it's in your care, such as during a repair or maintenance service.

It's important to research different insurance options and consult with an insurance agent to determine the best coverage for your auto repair shop.

10. Hire mechanics.

Having a skilled and reliable team of mechanics is crucial for the success of your auto repair shop. When hiring mechanics, it's important to consider their experience, skills, and qualifications. Additionally, conducting background checks and calling references can help you make informed hiring decisions.

You should also have clear job descriptions and expectations for your mechanics, as well as provide ongoing training to keep their skills up-to-date.

11. Build your brand.

As with any business, building a strong brand is essential for attracting customers and standing out in the market. Some key aspects of building your auto repair shop's brand include:

• Creating a professional logo and visual identity - This will help customers recognize and remember your business.
• Establishing an online presence - In today's digital world, having a website and social media presence is crucial for promoting your auto repair shop and reaching potential customers.
• Offering exceptional customer service - Satisfied customers can be the best form of advertising for your business. Provide quality services and prioritize customer satisfaction to build a positive reputation.

Starting an auto repair shop requires careful planning and consideration of various factors. By creating a detailed business plan, choosing the right business structure, securing financing, obtaining necessary permits and licenses, managing bookkeeping and insurance, hiring skilled mechanics, and building your brand, you can set yourself up for success in this competitive industry.

Lendio is here to help you secure the funding you need to turn your dream of owning an auto repair shop into a reality. Apply for a small business loan today.

The holiday season is a golden opportunity for businesses to boost their sales and strengthen customer relationships. A well-planned and executed holiday marketing campaign can make a significant impact in getting your brand noticed and maximizing your revenue potential. This guide will provide insights into effective holiday marketing strategies and ideas to help your business shine brighter this season.

Holiday marketing strategies

1. Lean into local.

According to a survey from Bankrate, 72% of shoppers aim to shop with a small business this holiday season. These shoppers understand the challenges small businesses face and are eager to support their local community. Make it effortless for them to do so.

Shoppers want to feel good about their purchases, the recipients, and the places they buy from. Share your story to let customers know how much you value their patronage. Provide them with all the positive vibes they desire as they enter and exit your online or physical store.

Embrace the local spirit by taking steps to support small businesses in the community:

• Collaborate with neighboring businesses to offer special promotions.
• Whenever possible, work with local suppliers and manufacturers.
• Hire local talent for live events.
• Give back to charities and nonprofits in your community.

2. Nail your online strategy.

In today's digital era, nailing your online strategy is critical for a successful holiday marketing campaign. Customers are increasingly turning towards online shopping, and a well-executed online strategy can significantly boost your holiday sales.

Ensure your website is user-friendly and easy to navigate. Highlight your holiday deals on your homepage and consider creating specific landing pages for your holiday marketing campaigns. An efficient, attractive website design can make a big difference in customer experience and overall sales.

3. Update your holiday hours.

Keeping your customers informed about your operating hours during the holiday season is essential. Customers appreciate knowing when they can visit your store or reach out for customer service. It's crucial to update your holiday hours on both your website and your Google Business profile.

On your website, prominently display your holiday hours on the homepage and the Contact Us page. Make sure it's easily noticeable to avoid any confusion.

Updating your Google Business profile is equally important. Many customers turn to Google to find out if a business is open before they make a trip. To update your hours on Google, sign in to your Google My Business account. From there, click on the "Hours" tab, and then the pencil icon next to "Add special hours." You can add the dates and times your business will have altered hours due to the holiday season.

Remember, accurate information boosts customer trust and satisfaction, contributing to successful holiday marketing campaigns.

4. Prepare your staff.

Long waiting lines are hated by everyone and often result in customers abandoning their plans. So, how can you avoid this? One effective solution is to hire extra staff. This will ensure that your store remains well-staffed, even during peak shopping hours.

Training your staff to provide exceptional customer service and increase sales can also make a significant impact on your holiday marketing campaign's success.

5. Plan your holiday communications.

Now’s the time to overcommunicate rather than undercommunicate. Yes, your customers’ social media feeds and email inboxes will likely flood with messages—but they’d rather get up-to-date notifications on delivery expectations than silence.

Use your website, social media profiles, email program, and more to keep customers in the know:

• What deals can they expect this holiday season?
• Will there be any expected shipping delays?
• What’s the cutoff date for shipping by Christmas?
• Are there any products you anticipate will sell out quickly?
• Where can customers find your deals? Your website, Amazon, retailers?

Don’t leave it up to guesswork—give your customers all the FAQs and answers they need.

6. Brace for impact.

Anticipate demand upfront. Cash flow forecasts will help, but plan for the worst so you’re not caught off guard.

• Website: Make sure your website’s ready to handle a jump in traffic. The last thing you want is a site crash on Black Friday.
• Stock up on inventory: Don’t miss out on sales by understocking products—plan for adequate inventory.
• Hire extra help: Prioritizing online sales doesn’t mean you’ll need less help. There are still customers to serve, orders to fulfill, and sales to make—make sure you’re staffed appropriately.
• Budget for increased marketing: It takes money to make money. If you want more digital sales, plan on more digital spend. If money is tight, consider getting a business line of credit to expand your working capital.
• Upgrade your email account: Avoid unnecessary overages by estimating your email volume in advance. If your email volume (marketing emails, shipping notifications, support, etc.) is set to skyrocket this holiday season, consider upgrading your account in advance.

Promotion ideas

Strategies to boost sales and draw in holiday shoppers.

With the right strategies and creative holiday marketing ideas, your business can effectively attract holiday shoppers and significantly enhance sales, thereby making the most out of this festive season.

Offer gift cards.

Gift cards are often overlooked by small businesses. While they may seem expensive upfront at $1-$2 per card, the stats on gift cards may change your perspective. A whopping 54% of U.S. consumers buy gift cards as holiday gifts. On average, 61% of gift card recipients spend more than the card's value. So, despite the initial investment, your returns are likely to increase. If physical gift cards aren't your preference, consider offering digital ones. This is especially appealing to the younger demographic who prefer keeping gift cards on their phones.

Offer free shipping.

While it's true that not every business can implement this strategy, it remains a powerful method to attract customers. A 2023 Gartner survey found that 45% of holiday shoppers identified free shipping as one of the top drivers for a purchase decision. If it's feasible for your business to join in, it's advisable not to hesitate and seize the opportunity.

Hold a photo contest.

Humans have four fundamental needs: food, water, shelter, and the desire to see photos of themselves on the Internet. Take advantage of this by organizing a delightful holiday photo contest. Ugly sweater pictures are consistently well-received, but the theme options are limitless.

Add coupons to purchases.

During the holiday season, customers have come to expect and appreciate the presence of coupons. If you choose not to offer any, you may miss out on potential business. To reward your loyal customers and attract new ones, consider utilizing the tried-and-true method of offering a good old-fashioned coupon.

Partner with a charity.

Apart from spending money during the holidays, consumers also seek to make a meaningful impact with their purchases. When you support a worthy cause, the positive effects are felt by all.

Provide gift wrapping.

Offering a useful service at a fairly low cost is a great way to endear customers to your business. Whether you have a retail store or operate online, make it clear that you are happy to provide gift wrapping for your customers.

Use a window display.

If you have a physical store, why not borrow a tip from the good old days and create a captivating holiday window display? And if your business operates exclusively online, no worries! You can transform your website into a modern holiday window display that leaves a lasting impression.

Share the sample love.

If product samples are relevant to your business, consider giving them to potential customers during the holiday season. Additionally, try sending some samples to bloggers and product reviewers, as they can help spread the word through gift guides and articles. It's a great way to increase visibility and reach a wider audience.

Stand out from large competitors.

Ways to stand out from large competitors.

In the face of stiff competition from large corporations, small businesses can leverage their unique attributes and creative holiday marketing campaigns to stand out and secure their market share during the festive season.

Fight the fights you can win.

In the online marketplace, competition is fierce. Your local ecosystem may have a few direct and indirect competitors, but in the world of e-commerce, you'll be up against thousands of businesses, both big and small. To succeed during the holiday rush, focus on the battles you can win.

Don't waste your energy on pricing wars or trying to outdo big-box retailers like Target and Wal-Mart on delivery speed. Instead, choose the battles that truly matter and where you have an advantage.

Create connections.

No matter how low the prices at Wal-Mart's floral department, chances are you don't have a personal connection with them. However, when it comes to your local flower shop, it's a different story. The owner probably knows you by name, remembers your arrangement preferences, and even remembers your special someone. When it comes to building personal relationships, your larger competitors just can't compete.

Provide exceptional customer support.

The holidays are wild for everyone—not just your small business. Offer relief from the chaos by taking your customer support to the next level.

If you’ve traditionally relied on phone support, consider expanding your service channels to include social media, chat, video, and email. And if your schedule is jam-packed, consider hiring and training specific customer support help.

Holiday campaign examples

Holiday campaign examples from successful small businesses.

Several small businesses have conducted successful holiday marketing campaigns, setting a benchmark for others. These examples demonstrate creative strategies and effective execution.

1. Death Wish Coffee: This company initiated a "Golden Ticket" campaign during the holiday season. Each order shipped in November included a golden ticket offering a chance to win prizes. This lottery-style campaign not only boosted their sales but also solidified customer loyalty by making shopping a fun and rewarding experience.
2. BarkBox: BarkBox has always been skilled at creating holiday-themed boxes, but their "Home Alone"-themed box was a big hit. The company took the popular holiday movie and turned it into a unique and festive product offering, which drove customer engagement and sales.
3. Erin Condren: Renowned for personalized and custom products, Erin Condren, a stationery company, launched a "Gifts that Give Back" campaign during the holiday season. The company pledged to donate a portion of its holiday sales to a non-profit organization, thereby connecting with customers on an emotional level and promoting social responsibility.

Successful holiday marketing requires strategic planning, creative ideas, and a deep understanding of customer needs. With the right strategies and execution, your small business can navigate the holiday rush and achieve growth. Remember, the holidays are about connecting with customers, sharing the festive spirit, and showing appreciation for their loyalty and support.

Starting a home-based business takes a lot, and one has to invest a great deal of effort and time to see their business bloom. Conducting proper research before diving in is also essential, but many people skip this vital step. As a result, they face consequences, such as a penalty and even getting shut down.

One integral part of your research before starting your business should be finding out the licenses and permits that you need according to your state to make your business legal.

Below you will find the necessary licenses and permits for home-based businesses.

Specific licenses for home-based businesses.

Before we delve into the specifics, it's crucial to understand that the licensing requirements for home-based businesses can vary significantly, depending on the nature of your business and the state you reside in. As such, it's best to consult with your local authorities or a legal professional for more accurate and personalized information.

1. Home occupation permit

A home occupation permit is essential if you’re planning to operate your business from home. The permit shows that you will operate your business according to Homeowner Association (HOA) laws and that your property owner is aware of your business. These permits protect your neighbors’ rights and ensure your business will not create any trouble for them.

How to apply?

As with everything else, each state or city’s application process will be slightly different. However, the fundamental aspects will be the same:

• Review any restrictions that may apply in your residential zone.
• Contact your local authorities.
• Check with your local Sales Tax Division to see if you will also require a Sales Tax License.
• Fill out an application for a Home Occupation Permit in your area. As previously stated, you must find an application for your city, as each is unique.
• Pay an application fee.
• Contact your local government officials or homeowner association if you have further inquiries.

2. Signage permit

A sign in front of your house can be an excellent way to promote and advertise your home-based business. However, you will need to obtain a signage permit to do so. Almost every city has specific sign ordinances limiting the sign’s location, type, size, and lighting that you can use for your business.

Be sure to learn about the regulations you must adhere to and apply for a permit. If you place a sign without a permit, you will face penalties, and the proper authority will remove your sign.

How to apply?

Each city has its own set of sign permit regulations, which may include any or all of the following:

• A paper sign application is usually required.
• Complete elevations, a site plan, and fabrication plans for the sign are necessary for the application process.
• Proof of property ownership or written approval from the building owner is needed.
• You will need materials lists, structural calculations, and other engineering specifications for your one-of-a-kind design.
• The final fees are determined, and the city will complete the paperwork to approve the permit.
• After approval, the sign is ready to be constructed and installed.

3. Remote employee license

Running a home-based business often involves hiring remote employees or freelancers. In some states or regions, depending on the nature of your business, you may need a remote employee license. This license ensures that you're adhering to labor laws and maintaining fair and decent working conditions for your remote workforce. The necessity for this license varies, so it's crucial to check with your local business licensing office or legal advisor for guidance tailored to your specific situation.

How to apply?

The procedure to apply for a remote employee license can vary depending on your location and the nature of your business. However, the general steps involved can be summarized as follows:

• Research your local regulations - The first step is to understand the specific requirements and guidelines set by your local government or business licensing office. These regulations can vary widely based on the region or state, so it's essential to conduct thorough research.
• Gather necessary documentation - This typically includes business information, proof of home-based business license, employee details, and sometimes even employee contracts. The required documents may differ depending on the local regulations.
• Fill out the application form - The form for a remote employee license is usually available online through your local government or business licensing office's website. Fill it out with accurate and up-to-date information.

Zoning restrictions.

Operating a home-based business also often involves navigating through various zoning restrictions. These are laws that define how a piece of property in a specific geographic zone can be used. For home-based businesses, these zones often determine whether or not you can even operate a business from your own home. Zoning restrictions can also control things like parking, noise levels, and waste management.

It's crucial to understand these regulations to avoid any legal issues down the line. Consult with your local government or a legal advisor to understand how zoning laws apply to your business.

General business licenses and permits.

Besides the specific licenses for home-based businesses, there are also general licenses and permits that every business, regardless of its location, needs to operate legally. Let's explore them in the following section. 

1. General business license

Regardless of the kind of home-based business, most jurisdictions require new businesses to obtain a general business license. This license allows your home-based business to sell products and services both online and in person, as well as collect sales tax on any taxable goods.

How to apply?

You have three options for obtaining a business license:

• File on your own.
• Hire a third-party filing agency to assist you in preparing your licensing applications.
• Consult an attorney who can help you in obtaining your business license.

If you plan to file on your own, follow these general guidelines:

• Determine which business licenses you will require.
• If your city or county lacks a business licensing agency, you can find information on acquiring a basic business license from your local tax office.
• Gather the necessary business documentation for your application.
• Apply for a business license.
• Make sure you renew your license in a timely manner.

2. Sales tax license

Most states need business owners to collect sales tax when selling taxable items or providing taxable services. To collect sales tax on taxable transactions, a business must obtain a sales tax license, also known as a sales tax certificate of authority. 

Remember, executing a taxable transaction without a certificate of authority might lead to huge fines, depending on the situation.

How to apply?

Follow these steps to register with your state to collect sales tax:

• Gather important information such as your employer identification number (EIN) and other business identifying information.
• Go to your state’s Department of Revenue website.
• Search for or click on the “Sales and Use Tax” section.
• Click the link and follow the information given on the website to register your business.

Additional requirements for e-commerce businesses.

While conducting business online may seem devoid of many traditional business requirements, e-commerce businesses are not exempt from obtaining necessary permits and licenses. A notable requirement is the Sales Permit, also known as Seller's Permit or Resale Certificate. This permit allows e-commerce businesses to collect sales tax on goods sold to customers in states where they have 'nexus', which typically means a physical presence or a significant amount of sales. 

The rules and requirements for this permit can vary by state, and some states do not require one at all. Therefore, it is crucial for e-commerce business owners to consult with local authorities or a tax professional to understand their tax obligations correctly and avoid any legal complications.

3. Professional license

Professional licenses allow individuals who have satisfied specific education, work experience, and exam requirements to use their skills as their profession. The license demonstrates that you are qualified to execute a given profession. It includes ventures like attorneys, daycare centers, tattoo artists, hairstyling salons, architects, financial advisory services, etc. Each state has its list of licensed occupations.

How to apply?

• Conduct research and learn about the licensure process for your profession.
• Contact the appropriate state licensing board to obtain complete guidelines and visit their website. The U.S. Department of Education also created a resource that mentions over 50 regulated professions in the U.S. that need to be licensed.
• You will certainly be requested to demonstrate that you meet the licensing body’s academic standards. You should apply for a credential evaluation in this scenario.

4. Health and safety permits

This permit is commonly required if your clients or customers come to your home for business purposes. You may also need an inspection and a permit from the local fire department, but it is usually unnecessary if your home-based business provides service or goods online.

However, if you need to keep an inventory of potentially flammable products at your home for your online business, you will have to get a permit. If you are selling food and beverage, you will also need a permit from your health department.

How to apply?

• Visit the directory of local health departments from the National Association of City and County Health Officials (NACCHO).
• Contact your local county health department for details on the requirements for a health permit.

What are the risks of not getting licenses and permits for your home-based business?

Failing to get or renew a business license can be a costly mistake, and you can face significant penalties such as fines or lawsuits, and, in extreme cases, the business will get shut down. Because the consequences of operating a home-based business without a license can be far-reaching and have a long-term impact on you and your business, you must understand the risks of non-compliance.

Getting necessary permits for your home-based business can be time-consuming and complicated, but making this effort can save your business from facing the difficulties mentioned above. As a result, registering and obtaining the necessary permits and licenses should be one of the first steps to starting your home-based business.

_{The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. Any content provided by our bloggers or authors are of their opinion and are not intended to malign any religion, ethnic group, club, organization, company, individual or anyone or anything. The information provided in this post is not intended to constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.}

Many accounting classes start with the “lemonade stand” model of business management. You want to sell lemonade, so you work through the process of buying supplies and selling products.

However, running a business becomes more complicated when you leave the private sector to start a nonprofit. Instead of selling lemonade, you’re now trying to collect funds so others can have lemonade. Or you’re selling lemonade to donate funds. 

Nonprofits have their own accounting challenges and requirements, with specific documentation and legal guidelines for what they can accept and what they can do with their money. However, despite their complexity, the basic principles of accounting shine through. Nonprofits with clear records and organized financial categories have better odds of succeeding and bringing positive influence to whatever cause they support.

Learn more about nonprofit bookkeeping and its accounting process to better position your charity to apply for grants, win over big-money donors, and drive change.

What is nonprofit accounting?

Nonprofit accounting—also referred to as fund accounting—is a unique form of bookkeeping designed specifically for nonprofit organizations. Unlike profit-driven businesses, nonprofits aren't primarily focused on increasing wealth for shareholders. Instead, they're driven by a mission to serve a specific societal need, and their accounting practices reflect this difference.

Nonprofit accounting involves tracking donations, grants, and other forms of income, as well as ensuring these funds are used appropriately and efficiently towards the organization's mission. This form of accounting places a significant emphasis on transparency, accountability, and stewardship, making sure every dollar is accounted for and used responsibly.

Moreover, nonprofit accounting is regulated by a distinct set of legal and financial standards that require detailed reporting and compliance. Understanding these requirements is integral to the management and operation of any successful nonprofit organization.

How is nonprofit accounting different from for-profit accounting?

There are several key differences between nonprofit and for-profit accounting, primarily stemming from the distinct goals and operational structures of these two types of organizations. For-profit businesses aim to generate profits and increase shareholder value, whereas nonprofits exist to serve a specific social purpose and are tasked with demonstrating how they use their funds to further this mission.

In for-profit accounting, the focus is on revenues, expenses, and the resulting profits, with financial statements like the balance sheet and income statement detailing the company's financial health. On the other hand, nonprofit accounting centers around tracking and reporting on the use of funds, where financial statements such as the statement of financial position and statement of activities provide a transparent view of the organization's financial situation.

Moreover, nonprofits are held to a high degree of fiscal accountability and stewardship, requiring them to thoroughly document all income and expenditures. They are also subject to specific regulatory and reporting requirements, including filings like the IRS Form 990, which are not applicable to for-profit entities. These differences underscore the importance of understanding and effectively managing nonprofit accounting—it's not just about keeping the books, but ensuring the organization is taking the right steps towards fulfilling its mission.

How to navigate nonprofit accounting.

Navigating the world of nonprofit accounting can seem like a daunting task, with its unique regulatory guidelines, strict requirements for transparency, and the constant need for fiscal accountability. However, with the right knowledge and tools, it can be effectively managed to uphold your organization's mission and sustain its operations with confidence and ease.

Identify cash flow sources.

As your nonprofit grows, you may have multiple cash flow sources. Each source of income requires different levels of effort and spending. 

However, you’re responsible for tracking every dollar your nonprofit receives—and accounting for what you do with it. A few common examples of income sources for nonprofits include:

• Cash donations from benefactors and supporters
• Local, state, and federal grants
• Legacy gifts from donors who passed away
• Fundraising partnerships from local businesses 
• Ticket sales to events and your donor-facing locations

For example, an art museum or animal rehabilitation group can sell tickets to the general public. The art museum might also sell tickets for fundraising galas and summer camp activities for kids. Meanwhile, the animal rehabilitation center can fundraise through events like goat yoga, with the proceeds supporting the food and medication needed for their animals. 

Not every nonprofit has a donor-facing experience, however. Many homeless shelters and child advocacy groups rely instead on grants and donations from benefactors and businesses. While every nonprofit is different, most charities rely on individual donations to stay open. It’s estimated that over 80% of income for nonprofits comes from individual giving.  

Whenever you propose a new fundraising opportunity or activity, consider which category the development efforts fall under. This may determine how you can spend the money and the target ROI expected for your efforts. 

Quantify in-kind donations.

Beyond money, there’s a whole different kind of donation that nonprofit organizations need to track and build into their budgets. In-kind donations refer to gifts that aren’t monetary but have a monetary value. A few examples of in-kind donations include:

• A local restaurant donating a $100 gift card for part of a charity auction
• A marketing agency offering its services pro bono on a monthly retainer basis 
• Local high school students collecting soup cans or coats from their peers to donate 
• A few retired volunteers spending a couple of hours each week filing paperwork and performing other administrative tasks 

Each of these in-kind donations is specific and has value, but how can you track them in your accounting systems—and why do you need to?  

There are 2 main reasons why you need to track your in-kind donations. First, you’re required to for tax reporting purposes. In some cases, businesses and individuals can claim charitable donations on their taxes to receive deductions. The in-kind donation that a business provides might be part of its core values, but the company also wants a tax break. 

Next, you need to identify the sources of income and value to your business. For example, if a volunteer helps with administrative tasks for an average of 15 hours per week, they provide real monetary value to your business. If they suddenly stopped volunteering, how much would it cost to hire a temporary worker or part-time employee for those 15 hours of work? An administrative assistant earning $15 per hour for 15 hours per week over a year (50 weeks) earns $11,250. Just because that volunteer doesn’t give you cash doesn’t mean they aren’t one of your largest donors.  

Any person who donates time to your organization provides value and income. By tracking volunteer hours and activities (whether they offer highly skilled IT support or low-skilled help), you can estimate the cost savings to your organization.

Once you quantify your in-kind donations, set up a system to accept and process them. You’ll need to report on your in-kind support and volunteer hours at the end of each year, both in your annual report and in your budgeting meetings. Each donor also needs to receive a thank you letter that explicitly details what they gave and its monetary value. This record is used for their tax purposes.

Choose between cash- vs. accrual-based accounting.

As you develop the financial policies and procedures of your nonprofit, you need to consider whether you will use cash- vs. accrual-based accounting. Every business has to choose between these 2 accounting models—and keep in mind that it isn’t easy to switch from one to the other.

Cash-based accounting means that you only record income when you receive it and expenses when you pay for them. For example, you would record a donation from a benefactor once their check hits your account. 

The main benefit of cash-based accounting is that you always know what kind of money you have. There is less risk of overspending because you aren’t focused on future income that may or may not come. However, this format can make it hard to forecast upcoming expenses and future donations.

With accrual-based accounting, you record any income or expenses when they’re earned, not received. For example, if you call a plumber to fix your organization’s toilet, you will record the cost of the repair when the plumber completes the job—even if you don’t pay the invoice for another few weeks. 

Accrual-based accounting is viewed as more comprehensive than cash-based models. Nonprofits can understand more clearly the money they currently owe and will soon receive. 

So which model is best? In the nonprofit sector, most organizations use accrual-based systems. Yes, this process is more complex and time-consuming, but the system is believed to be more accurate and comprehensive.

In fact, some nonprofit types are legally required to use accrual-based reporting—for example, if you receive grants or have paid staff. This promotes financial transparency to organizational partners.

If you have a cash-based accounting system, you will need to create a disclaimer in your financial reports and year-end statements illustrating this and potentially explaining why.

Track the ROI of your fundraising efforts.

Nonprofit accounting doesn’t just provide transparency to donors and governing bodies—it also shines a spotlight on the efforts the organization works toward.

Over the past few years, there have been increased calls for nonprofits to serve as good stewards of the money they receive. Charity Navigator ranks nonprofits based on their transparency and their financial stewardship. If an organization mishandles money (e.g., through overinflated executive pay, overspending, and donation mismanagement), then donors are discouraged from contributing. 

Every nonprofit has its own operating costs and financial challenges. However, the team at Charity Watch estimates that a responsible expense ratio is 35% or less. For every $100 you bring into your organization, it is reasonable to spend $35 to solicit the donation. Other nonprofits shoot for a 25% expense ratio or a 4:1 ROI. 

Through your accounting processes, you should be able to track how much it costs each year to bring in donations to your organization. These expenses range from hiring a full-time donor coordinator to hosting fundraising events and galas each season.

Additionally, you should be able to track what percent of your total donations actually support your nonprofit’s mission—which reflects your stewardship and respect for donors. 

These analyses can be performed on both a macro and micro level. While maintaining a high ROI for your fundraising efforts is important for your charity’s reputation, you may decide to prioritize some development efforts over others if they bring in higher donation amounts or cost less to implement. (If you come from the private sector, this is similar to adjusting your products to promote items with a higher gross margin.)

Know important nonprofit accounting documents.

Nonprofit accounting requires meticulous maintenance and management of numerous financial documents for transparency and compliance purposes. Here are several key documents that are integral to nonprofit accounting:

1. Nonprofit budget - This vital financial document outlines the organization's expected income and expenses for a certain period of time, typically a fiscal year. It serves as a roadmap for spending and revenue generation, playing a crucial role in guiding strategic decision-making and ensuring financial sustainability. Some things to remember when creating your budget include identifying your cash flow sources and quantifying in-kind donations.
2. Statement of financial position (SOP) - This document is the nonprofit equivalent of a balance sheet. It provides a snapshot of the organization's financial condition at a specific point in time, summarizing its assets, liabilities, and net assets. The assets are listed from most to least liquid—what could be spent the fastest—while the liabilities are listed in order of obligation. This document provides a high-level overview of the company’s finances and priorities.
3. Statement of activities - Analogous to an income statement in for-profit businesses, this document details revenue, expenses, and changes in net assets over a given period. It provides a clear picture of how funds are being sourced and utilized.
4. Statement of cash flows - This is a detailed record of the cash inflows and outflows experienced by the organization during a particular period, illustrating the liquidity and financial viability of the organization.
5. Statement of functional expenses - This statement provides a breakdown of expenses by both nature (what was purchased) and function (why it was purchased). It is unique to nonprofits and helps demonstrate how funds are allocated between program services and supporting activities.
6. IRS Form 990 - This is an annual reporting return that certain federally tax-exempt organizations must file with the IRS. It provides information on the filing organization's mission, programs, and finances.

Understanding and accurately maintaining these financial documents is crucial in nonprofit accounting, as they provide a comprehensive and transparent record of the organization's financial activities, ensuring compliance with regulatory requirements and fostering trust with donors, members, and the public.

Develop a clear operations budget.

Accounting serves two major purposes in business: looking back on past performance and planning for future income. While your nonprofit may use financial documents to report on the past quarter, you can also use this visibility to create fundraising goals and budget for future expenses.

For example, a nonprofit can review its operational expenses to predict how much it costs to run annually. The organization can then use this information to make cuts or take on new projects depending on whether they have a cash deficit or surplus.

On top of tracking operating expenses (OPEX), nonprofits often set goals to help the community and make an impact. These efforts come with their own version of cost of goods sold (COGS).

For example, if a nonprofit offers a mobile shower, shave, and haircut service to homeless individuals, the COGS required to offer that service might include towels, soap, the cost of hiring barbers, and care package items to give to those in need. A nonprofit that has a goal to offer 3,000 showers over the course of the year will have to budget for those items. 

The challenge for nonprofits: the funds for these operating expenses aren’t always guaranteed. Development teams will review the operational goals for the year and set fundraising goals to bring in more money so the organization can expand its efforts. 

While both the fundraising team and operations department might be on the same page during the year, both parties should meet quarterly to review their current finances to see if operations can get scaled up—or if they need to be pulled back. This is how a nonprofit balances its budget.

Set up a reporting system.

The world of finance and accounting can be stressful, especially for those who worry about recording every receipt and tracking numbers accurately—and there is some truth to this concern. If you let your sales receipts and donations pile up without recording them, then your accounting process will become beleaguered. You even risk creating inaccurate documents and making decisions based on outdated information because your books aren’t organized. 

The easiest way to prevent this backlog of unrecorded transactions is to set up a system where you can record income and expenses quickly. Invest in software tools that let you categorize costs and even auto-categorize repeating charges.

Train your team members to reconcile their expenses immediately and report any new donations. By spending a few minutes each day reviewing your transactions, you can keep up with your finances and prevent the dreaded backlog.  

Prepare to file taxes and submit annual reports.

All of your financial documents and accounting processes will help your nonprofit at the end of the year. Nonprofits still need to file taxes, even if they are tax-exempt (tax-exempt doesn’t mean you can skip filing, just that you won’t have to pay taxes).

One of the most important tax documents for a nonprofit is Form 990. This form covers the nonprofit’s mission, programs, and finances. There are multiple types of Form 990, with fields that vary based on your organization’s size and operations. For example:

• Nonprofits with less than $50,000 in gross receipts can fill out Form 990-N, an e-Postcard.  
• Nonprofits with more than $50,000 in gross receipts can fill out Form 990 or 990-EZ.
• Private foundations fill out form 990-PF. 

Some organizations are exempt from filling out Form 990. These include faith-based groups, government cooperatives, and subsidiaries of other nonprofits. 

Along with your taxes, your organization may need to submit an annual report to the state or federal government. These reports are typically made public each year by nonprofits and live on their websites for potential donors to access.

Use your nonprofit accounting system as a marketing tool.

Nonprofits are constantly fighting to win over new donors and prove they deserve support. As your accounting system falls into place, promote it within your development materials to show donors that you care about the money they give. 

• Highlight your target ROI and the steps you are taking to improve it.
• Share your impact goals for the year and the operating budget you need to hit them.
• Explain what your general fund does and why funding expenses like toilet paper and rent are important. 
• Showcase your stewardship and transparency to prove you respect their donations. 

You can’t talk about these aspects of your organization without clear proof. This proof comes in the form of financial documents and statistics highlighting your accounting efforts. You work so hard to serve your community and handle their money responsibly—it’s time you started bragging about it.

Create processes to manage your nonprofit accounts.

Establishing streamlined processes to manage your nonprofit accounts is essential for efficient and transparent operations. Begin by implementing a system that caters to your unique needs and ensures accurate record keeping. Regularly review your accounts to ensure compliance with regulations and maintain up-to-date records.

Opt for cloud-based accounting software tailored for nonprofits, as they can automate many tasks, improve accuracy, and save time. This includes generating financial reports, tracking donations, managing expenses, and even budgeting.

Develop an internal policy outlining how financial transactions should be handled, including approval processes for expenditures and proper documentation for all transactions. This can play a vital role in preventing misappropriation of funds and ensuring financial integrity.

Training staff and volunteers on the importance of financial management is crucial. Everyone involved should understand their role in maintaining the financial health of the organization. Regular training sessions can keep everyone up-to-date on best practices and changes in financial regulations.

By creating solid processes, you can manage your nonprofit accounts effectively, maintaining the trust of your donors, and ensuring the longevity of your organization.

Nonprofit accounting best practices.

Implementing best practices in nonprofit accounting can enhance your organization's operational efficiency, financial transparency, and overall accountability. Here are some key strategies to consider:

1. Implement robust internal controls - Internal controls are essential for safeguarding your organization's assets, ensuring the accuracy of your financial records, and preventing fraud. These can include separation of financial responsibilities to prevent a single person from handling all financial tasks, regular audits, and comprehensive financial policies and procedures.
2. Use nonprofit accounting software - Specialized nonprofit accounting software can simplify complex fund accounting, making it easier to track and report on different sources of income, categorize expenses, and ensure compliance with nonprofit-specific standards and regulations.
3. Regularly review financial reports - Regular reviews of your financial statements can help identify trends, foresee potential issues, and make informed, strategic decisions. This includes closely examining your statement of financial position, statement of activities, statement of cash flows, and statement of functional expenses.
4. Maintain a reserve fund - Having a reserve fund can provide financial stability in times of unexpected expenses or drops in funding. It also demonstrates to donors and stakeholders that your organization is financially responsible and prepared for unforeseen circumstances.
5. Provide transparency - Nonprofits are held to high standards of accountability. Regularly share your financial reports with board members, stakeholders, and the public to maintain trust and demonstrate responsible stewardship of funds.
6. Invest in financial training for non-finance staff - Everyone in your organization should have a basic understanding of your nonprofit's finances. Providing training can help staff understand the importance of their role in maintaining financial integrity and how their day-to-day actions impact the organization's overall financial health.
7. Stay current with regulations - As regulations and standards can update, it's important to regularly check in with the regulatory bodies or consult with an accounting professional to avoid non-compliance.
8. Plan overhead expenses carefully - Nonprofits, like any other organization, will have overhead costs, such as administrative expenses, salaries, utilities, and office supplies. It's important to budget and monitor these expenses carefully as they play a direct role in your organization's sustainability and efficiency. A well-planned overhead expense strategy ensures that the maximum amount of funding goes directly to your cause, enhancing trust among your donors and stakeholders.
9. Reference your budget often - Regularly referring back to your budget is key to maintaining financial discipline and ensuring the organization stays on track with its financial goals. This practice encourages proactive adjustments to spending habits and allows for timely reallocation of resources, if necessary, to meet the changing needs and priorities of the organization.

By following these best practices, your nonprofit can maintain strong financial health and continue effectively serving your mission.

Implementing best practices in nonprofit accounting can enhance your organization's operational efficiency, financial transparency, and overall accountability. Here are some key strategies to consider:

1. Implement robust internal controls - Internal controls are essential for safeguarding your organization's assets, ensuring the accuracy of your financial records, and preventing fraud. These can include separation of financial responsibilities to prevent a single person from handling all financial tasks, regular audits, and comprehensive financial policies and procedures.
2. Use nonprofit accounting software - Specialized nonprofit accounting software can simplify complex fund accounting, making it easier to track and report on different sources of income, categorize expenses, and ensure compliance with nonprofit-specific standards and regulations.
3. Regularly review financial reports - Regular reviews of your financial statements can help identify trends, foresee potential issues, and make informed, strategic decisions. This includes closely examining your statement of financial position, statement of activities, statement of cash flows, and statement of functional expenses.
4. Maintain a reserve fund - Having a reserve fund can provide financial stability in times of unexpected expenses or drops in funding. It also demonstrates to donors and stakeholders that your organization is financially responsible and prepared for unforeseen circumstances.
5. Provide transparency - Nonprofits are held to high standards of accountability. Regularly share your financial reports with board members, stakeholders, and the public to maintain trust and demonstrate responsible stewardship of funds.
6. Invest in financial training for non-finance staff - Everyone in your organization should have a basic understanding of your nonprofit's finances. Providing training can help staff understand the importance of their role in maintaining financial integrity and how their day-to-day actions impact the organization's overall financial health.
7. Stay current with regulations - As regulations and standards can update, it's important to regularly check in with the regulatory bodies or consult with an accounting professional to avoid non-compliance.
8. Plan overhead expenses carefully - Nonprofits, like any other organization, will have overhead costs, such as administrative expenses, salaries, utilities, and office supplies. It's important to budget and monitor these expenses carefully as they play a direct role in your organization's sustainability and efficiency. A well-planned overhead expense strategy ensures that the maximum amount of funding goes directly to your cause, enhancing trust among your donors and stakeholders.
9. Reference your budget often - Regularly referring back to your budget is key to maintaining financial discipline and ensuring the organization stays on track with its financial goals. This practice encourages proactive adjustments to spending habits and allows for timely reallocation of resources, if necessary, to meet the changing needs and priorities of the organization.

By following these best practices, your nonprofit can maintain strong financial health and continue effectively serving your mission.

Effective accounting is the backbone of any nonprofit's success. It not only ensures financial transparency and accountability, but also enables strategic planning for future growth.

By leveraging modern tools, establishing robust processes, and continually educating team members, a nonprofit can effectively manage its finances. As a result, it can prove its fiscal responsibility to its donors and governing bodies, ultimately helping to sustain its operations and further its mission. Remember, accounting is not just about crunching numbers—it's about telling a story of your nonprofit's stewardship, impact, and commitment to its cause.

Real estate agents deal with hundreds of tasks throughout the property buying and selling process. They have costs to market themselves, improve properties, pay a variety of fees, and split the commission.

By the time a property closes, there are dozens of transactions related to the realtor and their clients. This can be an accounting nightmare if you don’t have a clear system in place. 

Fortunately, you don’t need an accounting background to be successful in real estate—but you should have a general understanding to help you make the best strategic decisions for your real estate business.

Keep reading to learn more about real estate accounting. Even if you’re just starting out, you can create processes that help you to scale—and to keep as much commission as you can.

What is real estate accounting?

Real estate accounting is a specialized branch of accounting that focuses on managing the financial transactions related to a real estate business. This includes tracking income from property sales or rentals, expenses such as maintenance costs, commission payouts, and property improvements, and any other transactions related to real estate activities. 

A comprehensive real estate accounting system not only ensures compliance with tax and financial regulations, but also helps realtors make informed decisions to improve their profitability and growth. Whether you're a solo agent, a property manager, or a large real estate firm, understanding the basics of real estate accounting is integral to your financial success.

Why real estate accounting is important.

Understanding the importance of real estate accounting is crucial if you want to maintain financial health and propel your business forward. It not only helps track performance, but also aids in strategic planning and decision-making.

• Transparency - Real estate accounting gives a clear and transparent view of your financial situation, allowing you to understand your income, expenses, and profitability at a glance.
• Compliance - Real estate accounting ensures compliance with tax laws and financial regulations, preventing you from facing penalties or legal issues.
• Decision making - Real estate accounting aids in strategic decision making by providing vital financial data, facilitating operational improvements and expansion plans.
• Cash flow management - Real estate accounting helps in effective cash flow management, which is critical for the smooth operation of any real estate business.
• Cost management - With proper real estate accounting, you can identify areas of excessive spending and implement cost-saving measures.
• Investor confidence - Accurate and up-to-date accounting can increase investor confidence, which can be crucial if you're seeking external funding or partnerships.
• Profit maximization - Real estate accounting enables you to track and control your expenses, allowing for better budgeting and ultimately maximizing your profits.

Real estate accounting is an invaluable tool for anyone involved in the real estate industry. Its ability to provide a clear financial picture facilitates strategic planning, regulatory compliance, and ultimately, business growth. Ignoring its importance can lead to disorganization, legal issues, and missed opportunities for profit maximization.

Elements of real estate accounting.

Real estate accounting comprises several key elements that work together to provide a full picture of your business’ financial health.

1. Revenue tracking - This includes all income generated from property sales, rentals, or other services offered. It's crucial to accurately record all revenue transactions to have a clear view of your business’ profitability.
2. Expense management - These are costs incurred in the running of the business. They include maintenance costs, commission payouts, marketing expenses, and property improvements. Proper management of expenses helps to identify areas where costs can be reduced to increase profitability.
3. Financial reporting - Regular financial reports help realtors monitor the business’ financial performance over a specific period. These reports include profit and loss statements, balance sheets, and cash flow statements.
4. Tax preparation - A substantial part of real estate accounting involves managing tax-related matters. This includes determining taxable income, identifying tax deductions, and ensuring timely tax payments to avoid penalties.
5. Budgeting and forecasting - This involves making financial projections for the future, based on past and current financial data. Budgeting and forecasting are essential for strategic planning and decision-making.

Understanding these elements of real estate accounting can help you navigate the financial landscape of your business, ensuring that you are making informed decisions to drive growth and profitability.

Real estate accounting basic steps.

The financial backbone of a real estate business revolves around effective accounting practices. These practices maintain the flow of funds, enabling the business to thrive even in fluctuating markets. Even though real estate accounting might seem intricate, a clear understanding of the basic steps can simplify the process dramatically. 

Let's delve into the core steps of real estate accounting that can effectively manage your financial transactions and provide a clear picture of your business' financial health, regardless of the size of your real estate portfolio.

1. Choose an accounting method.

You can choose between cash-based and accrual-based accounting to track your expenses and income. 

With cash-based accounting, you record income only when the cash hits your account. You also only record expenses when your business is billed for them. With this model, you can see clearly how much money you have within your organization.

With accrual-based accounting, you record income and expenses when they occur, not when money exchanges hands. For example, you can record the costs to stage a home, even if you don’t pay the stager until the following month. Accrual-based accounting is a better option if you want more visibility into the finances of your business, including future expenses and revenue streams. 

However, many realtors prefer to use cash-based accounting for their firms. First, most expenses related to real estate are immediate. If you need to hire a photographer, you can cut a check for their services or request an invoice immediately. Because there isn’t a delay between the service and payment, the cash-based model works. 

Many realtors also prefer the cash model because of their income sources. Sales fall through, contracts are renegotiated, and renters cancel their leases. All of these changes can harm your cash flow, especially if you already recorded the income through your accrual-based system. With a cash model, you can record the income when the sale closes or when the renter’s check hits your account. The payment is a sure thing—and the money is yours to spend. 

Every business model is different, so consider your specific needs before selecting an accounting process.

2. Separate personal and business funds.

Blurring the lines between personal and business funds can lead to complicated tax issues and potential financial confusion. For transparency and accuracy, it is essential to set up separate bank accounts for your personal finances and your business transactions. This allows you to clearly track your real estate-related income and expenses separately from your personal expenses. Remember, mingling personal and business funds can raise red flags during audits and may impact your ability to accurately analyze your business’ financial performance. Keeping these funds separate is a best practice in real estate accounting that contributes to the overall financial health and integrity of your business.

3. Categorize your expenses and income.

Clear organization is the foundation of good bookkeeping. As your real estate business grows, you’ll need healthy bookkeeping habits to forecast growth and understand your financial opportunities. Consider a few of the different types of expenses that come with operating a real estate business, along with the different sources of income you can expect. 

Expenses

• Realtor association fees
• Commission fees
• Marketing costs
• Administrative assistant services
• Staging expenses
• Photography and video costs for homes
• Gas and wear on your car

Income

• Commissions earned
• Commissions from realtors you add to your team
• Rental income or sales income from investment properties
• Property management fees (if applicable)

With growth comes complexity. You may bring on an assistant or purchase an investment property to flip for a profit. To prevent confusion, establish clear accounting codes related to your business. Each purchase will have a category and a code number associated with it.

If your real estate business has multiple arms (like an agent arm and an investment property arm), you may want to consider establishing multiple LLCs or keeping the books for each business channel separate. This delineation can prevent confusion, while helping you to manage each aspect of your business individually.

4. Understand your commission model.

If you’re working with a real estate brokerage to build up your business and brand name, make sure you have a clear idea of your commission fees and opportunities. Each brokerage charges its own commission structure and creates opportunities for real estate agents to negotiate their percentages, signing bonuses, and other earnings.

Consider the commission systems of a few of the largest real estate brokerages in the country:

• Keller Williams - This brokerage offers a 70/30 split with agents, where the brokerage takes a 30% cut of your commission. However, agents also pay a 6% franchise fee on their sales (up to $3,000). This means you actually have a 64/30/6 split until you pay $3,000 in fees. Additionally, each Keller Williams office has its own commission cap (typically around $28,000). Once you hit that cap in commission fees, you take home 100% of your commissions.
• RE/MAX - This company has multiple commission plans that you can choose from. First, they have a 95/5 plan where realtors take home 95% of their commissions, but pay a 5% desk fee each month. With this option, there’s no commission cap. Realtors at RE/MAX can also opt for a commission split range of 60/40 to 80/20 depending on their previous sales. Once they hit their commission cap, they move up to the 95/5 model. 

If you’re still deciding which brokerage to work for, consider their commission structure and their brand name in your area. You may be able to earn more money by working for a specific firm—even if you pay them more commission than with another option.

A large part of real estate accounting is tracking what you earn in commissions and the fees you’re expected to pay over the course of the year. These numbers determine your take-home pay and your budget for marketing expenses and other investments.

5. Establish your operating costs.

The finances of a real estate professional can fluctuate significantly over the course of a year. You may experience a high number of expenses at the start of the year and then close multiple sales within a few weeks. This means that realtors need to balance their expenses so that they always have enough funds in the bank to cover basic expenses, regardless of the market. 

As you establish your accounting systems, start with your operating costs. Operating expenses (OPEX) are costs that aren’t directly tied to your services. They differ from your cost of goods sold (COGS), which are costs directly related to your services. 

For example, if you keep a marketing agency on a monthly retainer to maintain your real estate website, you will factor this expense into your OPEX. It doesn’t matter whether you sell a dozen houses this quarter or none—you’ll still need to pay the flat marketing fee. Additional OPEX listings include rent, a lease on a work vehicle, and utilities like internet fees or your electric bill. 

Meanwhile, if you hire a photographer to help you market a house on a per-property basis, their services are part of your COGS. If 10 new listings are added within a month and you need to photograph each of their homes, then your photography expenses will be higher than if you have only two clients another month. 

With the uncertain nature of the real estate business, you can use your OPEX to identify predictable costs related to your company. Your electric bill might fluctuate and gas prices might drive up your monthly bills, but you can anticipate costs related to those operating expenses every single month, regardless of your business.

6. Track all of your business expenses.

Once you have your operating costs sorted in your accounting system, you can take steps to track all of your business expenses. 

Real estate agents have some of the most diverse expenses in business. They face costs ranging from landscaping services that improve curb appeal to lunches for clients and gifts for buyers. Realtors’ expenses can reach a few hundred dollars a month or into the thousands, depending on their listings, marketing strategies, and many other factors. Real estate agents also accrue these business expenses daily—which means you can easily get overwhelmed if you don’t have a system in place. 

There are a few ways to keep your expenses in order as your real estate business grows. The first step is to get a business credit card. This card will separate your business expenses from your personal charges, while keeping your monthly costs all in one place. You can also get a business bank account to isolate your business transactions. 

The next step is to look for software that can record your business expenses. With tools like BizXpense Tracker, you can upload receipts and track costs related to certain projects—even if you have to use your personal card. You can also download a gas mileage tracker to log how far your drive. This information will be essential when separating personal and professional gas costs, insurance payments, wear and tear, etc. 

If you set aside a few minutes each day (or an hour or two weekly) to evaluate your charges and business expenses, you can keep your accounts clearly organized. This practice prevents an end-of-month scramble to reconcile your business costs with your bank account balance.

7. Set up double-entry accounting.

Regardless of whether you choose the cash or accrual model for your real estate bookkeeping, you’ll want to establish a double-entry system for your accounting materials.

A double-entry system is based on the idea that every credit has an equal and opposite debit. In accounting, a debit increases the value of accounts (a positive number) while a credit decreases the value of accounts (a negative number). 

For example, let’s say you order business cards and other giveaways to market your business. These cost $500. With a double-entry bookkeeping system, you’ll credit your cash account $500, because that is how much you paid while debiting your marketing assets $500—because you now own cards, magnets, koozies, and other fun items.  

The purchase of marketing materials is a simple example, but double-entry accounting also becomes valuable when you start adding assets to your real estate firm. For example, you can purchase a house to flip for $200,000. You now have $200,000 less in cash, but a significant asset worth that amount. If you flip the house for $350,000, then you can track your profits using the expense accounts in your double-entry recordings.    

Double-entry bookkeeping also provides a series of checks to ensure that each entry is correct. If the two lines of credits and debits don’t align, then something was recorded incorrectly. While it might not seem like a big deal if you mistype your electric bill or are off a few dollars on your commission income, these errors can add up—and might affect your taxes and cash flow. Plus, you will have to return to your books and redo them to ensure that they’re error-free. 

If double-entry accounting seems intimidating, keep in mind that many online systems will fill in the backup entry for you. Your accounting system will ask for a copy of the invoice and the expense category, then do the rest.

8. Reconcile your accounts.

Reconciliation is a crucial part of accounting that ensures all the transactions in your books accurately reflect the transactions in your bank statement. The process involves comparing your internal financial records against the monthly statements issued by your banks and credit card companies to check for discrepancies.

To execute this process, you should start by making sure the beginning balance of your records matches the beginning balance on your bank statement. Now, compare each individual transaction: the date, the recipient, and the amount. If you detect any discrepancies, such as missing transactions, double entries, or discrepancies in amounts, flag them immediately and investigate.

Remember, reconciliation should be performed regularly, preferably on a monthly basis. This is not just a good practice for keeping your books clean, but it's also an effective way to detect any potential fraud or errors early.

If you opt for financial software, most modern systems have an automatic reconciliation feature that simplifies this process. However, it's essential to understand the process and check the reconciliation report to ensure accuracy.

Remember, accurate bookkeeping is not just about compliance—it also gives you a clear picture of your financial health, thus aiding strategic planning and decision making.

9. Evaluate your performance monthly.

The purpose of bookkeeping in real estate provides two benefits: improving your future performance and forecasting your upcoming costs and income. In both cases, you’ll want to evaluate your accounts monthly to make sure your business is operating at its best. 

First, review your expenses and income to understand your profit margins. For example, if you bought a property for $200,000 and sold it for $300,000, it looks like you made a nice profit. However, if you spent 12 months and $90,000 on renovations and marketing, then your $10,000 profit doesn’t seem as impressive. 

Evaluating your profit margins can help you to understand how much money you really make on the sale of homes and renovations of properties. You may decide to adjust your fees or focus more on investment rentals in order to grow your profits. 

Next, forecast your income and expenses for the future. This exercise isn’t always easy in the real estate field. Take your static expenses and OPEX estimates to get an idea of what you can expect to pay in the next few months. You can also use your pending listings to estimate your commissions and income. Depending on the market, you can also create forecasts for your COGS based on your average monthly leads.

Your forecast numbers aren’t meant to be exact figures. However, they serve as informed estimates on your future income and costs. These forecasts can help you understand whether the coming months will be ideal for making major investment purchases or if you’ll need to seek temporary funding sources to cover upcoming costs.

10. Organize your documents.

It's essential to maintain an organized record of your real estate business transactions, contracts, and other related documents. This includes documents related to property purchases, sales, rental agreements, and invoices for any expenses incurred. 

Digitizing your documents can be highly beneficial, as it provides easy access, reduces the risk of loss, and allows for efficient categorization. Utilize document management software or cloud storage solutions for an organized, searchable collection of your important business documents. Regularly backing up these digital files can help prevent data loss. 

Remember, a well-organized document system not only simplifies your business operations, but also streamlines the auditing process and ensures you comply with tax regulations.

11. Prepare early for tax season.

You can benefit from healthy accounting practices throughout the year, but one of the main time-savers for your real estate firm is having your books in order for tax season. There are multiple reasons why your taxes may be more complicated as a real estate professional:

• You will have to sort your business and personal expenses into two separate categories and may need to file taxes for both your business and personal arenas depending on your company’s structure. 
• You will have multiple sources of income as you diversify your revenue streams. You’ll need to account for your commissions, any rental fees, and any profits from the sale of renovated houses that you flipped. 
• You will need to record your deductions and relevant business expenses. 
• You may have to pay real estate taxes on any properties you own during the renovation process. Buying and selling homes as a business can make your taxes more complicated. 

If your business expenses aren’t clearly recorded and labeled, you may miss out on a significant amount of deductible income. If you lack clear balance sheets and P&L statements, it may take longer to file your business taxes. Good accounting habits can make the tax process easier and faster—while also optimizing your tax deductions.

If you want to streamline your tax filing, start reviewing your books in the fall. Make sure all expenses and sources of income are clearly recorded. Pull your receipts and relevant sales documents. Review your income statements. When your CPA or tax-prep service requests this information, you’ll already have it on hand. 

Real estate accounting best practices.

Embracing accounting best practices can streamline your operations and simplify the financial management of your real estate business. Here are a few strategies to consider:

• Utilize real estate specific accounting software - Investing in a real estate-specific accounting software can automate your bookkeeping, making it easier for you to monitor income, expenses, and cash flow. It can also simplify your tax preparation and ensure your financial reports are accurate and up to date.
• Hire a professional accountant - If your budget allows, consider hiring a professional accountant who specializes in real estate. They’ll be able to navigate the unique financial challenges of the industry and can offer expert advice to optimize your financial management.
• Keep personal and business expenses separate - Always maintain a clear separation between your personal and business expenses. This not only simplifies your bookkeeping, but also ensures compliance during tax season.
• Regularly monitor your cash flow - Cash flow is crucial in the real estate business. Regularly monitor your income and expenses to avoid cash flow issues. This will help you make informed decisions about your business and can prevent financial difficulties down the line.
• Maintain accurate and timely records - Be diligent about recording all income, expenses, and financial transactions as they occur. This makes it easier to prepare accurate financial reports and will be invaluable come tax season.

Remember, effective real estate accounting isn't just about keeping books for tax purposes—it's about using financial information as a tool for strategic planning and decision-making in your business.

Common real estate accounting mistakes.

While handling the accounting side of real estate business, it's quite common to make a few slip-ups. Being aware of these mistakes can better equip you to avoid them. Here's a brief outline of the most common ones:

• Neglecting regular bookkeeping - Delaying or neglecting to update your books regularly can lead to inaccuracies and missed deductions, which can significantly impact your bottom line. Try to develop a habit of regular bookkeeping to maintain accurate and up-to-date records.
• Mixing personal and business expenses - It's crucial to keep your personal and business expenses separate. Mixing these can create confusion, make your bookkeeping more complicated, and potentially result in inaccurate tax filings.
• Inadequate record-keeping - Not maintaining comprehensive and accurate records of all transactions can lead to serious issues during tax filing or an audit. These records should include receipts, invoices, and cash flow statements.
• Not utilizing real estate specific accounting software - Real estate-specific accounting software can streamline your accounting process and significantly reduce the chances of errors. Choosing to do everything manually or using non-specialized software can increase your workload and the likelihood of mistakes.
• Failing to plan for taxes - Real estate professionals often overlook the importance of planning for tax season. Not setting aside funds for tax payments or failing to prepare your books in advance can lead to a frantic scramble during tax season.
• Neglecting to reconcile books with bank statements - Failing to regularly compare your bookkeeping records with your bank statements can mean missed discrepancies, leading to potential errors or fraud going unnoticed.

Remember, avoiding these common mistakes can save you from future headaches and ensure your real estate business runs smoothly and efficiently.

Streamlining your real estate accounting process is crucial not just for tax compliance, but also for accurately gauging the financial health of your business and making informed strategic decisions. Regular bookkeeping, vigilant record-keeping, and the use of industry-specific accounting software can greatly simplify this process and minimize the likelihood of errors.

Consider professional help if your budget allows fo it, and always keep business and personal expenses distinct. Remember, good accounting practices are not just about keeping the IRS satisfied—they provide valuable insights into your business, helping you strategize and grow. Avoiding common mistakes and implementing best practices in your accounting can set your real estate business up for lasting success.

If you're considering purchasing commercial real estate, it's worth exploring the option of a commercial real estate loan, also known as a commercial mortgage. This type of loan can be a valuable tool for small business owners looking to expand their operations or acquire additional property.

But getting approved for a commercial real estate loan is not always easy. Lenders typically have stricter requirements compared to residential loans, and the process can be more complicated and time-consuming.

However, with proper planning and preparation, you can increase your chances of obtaining a commercial real estate loan. In this blog post, we'll discuss the steps you can take to secure financing for your commercial property.

What is a commercial real estate loan?

These small business loans have been precisely engineered for real estate projects. Here are some examples of relevant uses:

• Building a new office building
• Renovating your existing restaurant
• Opening a new retail space
• Purchasing an existing warehouse
• Getting out of a lease so you can become a property owner
• Refinancing for an extension of your payment term

As you can see, commercial real estate loans are more versatile than the name suggests. So if your project is real estate-related, there’s a good chance that it qualifies.

These loans are unique because they offer more generous interest rates than many other types of small business loans, largely because the real estate involved with the loan will actually be used as collateral.

When you secure a loan with such a valuable and readily accessible asset, you can expect rates that begin as low as 6.25%. As for the dollar amount, a commercial real estate loan can start at $250,000 and go as high as $5,000,000. Expect the repayment terms to fall somewhere between 10 and 25 years.

How to find the right commercial real estate loan.

Finding the right commercial real estate loan can be a complex decision, involving careful evaluation of your business needs, financial capacity, and long-term objectives. Let's dive into the key factors to consider in choosing the right loan for your business.

1. Determine your goals.

The first step of any loan process is identifying the financing option that best matches your purposes. To do this, you’ll need to decide exactly how much money your project will require and how soon you’ll need to get that money. These two factors help to narrow the list of viable options and save you valuable time.

After reviewing your loan amount and timeline, you may find that a commercial real estate loan is the ideal solution. You’ll then need to figure out the costs of various loans to separate the top contenders for your business. This process is done by lining up comparable elements between loans.

2. Compare lenders.

There are a plethora of lenders offering commercial real estate loans, each with their distinctive terms, conditions, and rates. It's crucial to take time and compare various lenders, considering factors such as interest rates, loan terms, additional costs (like origination fees), and customer reviews. Traditional banks, credit unions, and online lenders all have different merits and demerits.

Before proceeding with the loan application, check whether you meet the lender's minimum qualifications. These may encompass your credit score, annual revenue, and years in business. In addition, most lenders will require a down payment of 10% to 30% of the property's purchase price.

3. Apply for the loan.

Once you've determined your needs and compared lenders, the next step is to apply for a commercial real estate loan. The application process requires you to provide various documents and data.

• Financial records - Lenders will want to see your business' financial records to assess your ability to repay the loan. You will need to provide business and personal financial statements, income tax returns, and a credit report. If your business is new, you may be asked for a business plan or revenue projections.
• Property information - You’ll need to share details about the property you wish to purchase or renovate. This includes the property's address, purchase price, appraisal value, and blueprints (or renovation plans, if applicable).
• Legal documents - Lenders may also request legal documents such as incorporation documents, commercial leases, and contracts.

Remember, every lender has different requirements, so it's essential to understand what is needed before starting the application process. The sooner you can gather and provide this information, the smoother the application process will be.

The approval process can take anywhere from a few weeks to several months. Once you've been approved, you'll need to review the loan terms carefully before agreeing to them.

Requirements for a commercial real estate loan.

To secure a commercial real estate loan, you must meet certain requirements that prove your ability to repay the loan.

• Credit score - Most lenders require a personal credit score of at least 650. This gives them confidence in your ability to handle credit responsibly. Higher scores can lead to better interest rates.
• Business plan - Lenders want to see a well-crafted business plan that outlines your strategies for growth and income. This should include market analysis, competitive analysis, marketing strategies, and detailed financial projections.
• Debt service coverage ratio (DSCR) - The DSCR measures your business’ ability to service its debt. A ratio of 1.25 or higher is typically considered good.
• Property value - The property's appraisal value needs to be high enough to cover the loan amount. Lenders will conduct their own appraisal as part of the application process.
• Down payment - You’re typically required to put down 10% to 30% of the property's purchase price.
• Business financials - Lenders will want to see at least two years of financial statements for your business to evaluate its profitability.

Remember, every lender could have slightly different requirements, so make sure to check with your lender to know exactly what you need to apply.

Additional qualification criteria for a construction loan.

In addition to the general requirements for a commercial real estate loan, obtaining a construction loan often necessitates additional qualifications.

• Construction blueprints and detailed plans - Lenders will need to see a comprehensive set of construction plans and blueprints before they can accurately assess the risk associated with your project. These should be prepared by a qualified architect or engineer.
• Qualified builder - A legitimate, licensed, and insured builder is a requirement for most construction loans. The lender will need to validate the builder's qualifications and reputation before approving the loan.
• Cost estimate - A detailed cost breakdown is necessary. This estimate should include costs for labor, materials, permits, land development, and contingencies.
• Appraisal - The lender will want an appraisal of the future value of the building upon completion. This is sometimes called the after-repair value (ARV).
• On-site inspections - Lenders will conduct periodic on-site inspections to ensure the construction is proceeding as planned and the funds are being used appropriately.

Remember, the qualifications can vary based on the lender and the specifics of the construction project, so it's essential to have a thorough discussion with your lender about what is needed.

Interest rates and fees

Just like any other loan, a commercial real estate loan comes with its own set of interest rates and fees.

Interest rate

Your interest rate—often expressed as an Annual Percentage Rate (APR)—is the amount you'll be charged for borrowing money, represented as a percentage of your loan amount. Commercial real estate loans generally offer more competitive interest rates, sometimes as low as 6.25%, because the real estate you're purchasing will serve as collateral for the loan.

Fees

The fees associated with a commercial real estate loan can vary, but some common fees include application fees, origination fees, and appraisal fees. Application fees cover the cost of processing your loan application, while origination fees are charged by the lender for creating the loan. Appraisal fees are paid to a third party to assess the value of the property being purchased.

Prepayment penalties

In addition, some loans may include prepayment penalties, which are fees charged if you pay your loan off early. It's crucial to understand all the fees and interest associated with your loan so you can accurately calculate the total cost of borrowing and ensure it aligns with your business's budget and financial plan.

Comparing costs

As you evaluate your best loan options, here are four popular pricing metrics that will help you break down the cost into manageable views:

• Annual percentage rate (APR) - Anyone who has purchased a home or vehicle is familiar with this metric, which represents the cost of your loan on an annual basis.
• Total cost of capital (TCC) - Sometimes it helps to get a macro view. With the TCC, you’ll see an overall cost that takes into account interest—fees on loans that don’t charge interest, plus ancillary fees.
• Average monthly payment - Because budgets are often viewed on a monthly level, this metric is helpful. Even if your loan were to have daily or weekly payments, you could still calculate those payments on a monthly scale.
• Cents on the dollar - The simplest of all the pricing metrics, cents on the dollar breaks down the amount you’ll pay in fees and interest for every dollar you borrow.

While these metrics will give you a clearer view of your loan costs, they’re far from your only resource. Commercial mortgage calculators are readily available and are a simple way to crunch the numbers and improve your understanding of various costs.

Where to get a commercial real estate loan.

There are multiple sources from which you can secure a commercial real estate loan. Each has its own benefits and drawbacks, thus your choice depends on your specific needs and circumstances. Here are some of your main options:

• Banks - Banks are traditional sources of commercial real estate loans. They typically offer competitive interest rates and longer terms. However, they also have stringent approval criteria and require extensive documentation, which can be a challenge for some small businesses.
• Non-bank lenders - These include online lenders, credit unions, and private lenders. Non-bank lenders generally have less stringent approval criteria, faster approval times, and more flexible terms than banks. However, their interest rates can be higher.
• Commercial mortgage-backed securities (CMBS) lenders - Also known as conduit lenders, they pool and sell commercial mortgages on the secondary market. These loans have fixed, low-interest rates and longer terms and are typically nonrecourse, meaning the lender can only claim the collateral in case of default.
• Hard money lenders - These are mostly private investors who offer short-term, high-rate loans. The advantage here is speed and a less rigorous approval process, making them suitable for short-term investment opportunities or when a faster closing time is paramount.
• Real estate investment trusts (REITs) - These are companies that own, operate, or finance income-generating real estate. They provide loans for commercial real estate but usually require a higher return on their investment.
• SBA 504 loan - The SBA 504 loan is offered by the U.S. Small Business Administration (SBA) for purchasing fixed assets, such as land and buildings. The advantage here is that you can access lower interest rates with a longer term with a 10% down payment.
• SBA 7(a) loan - The SBA also offers the SBA 7(a) loan for any kind of business expense including purchasing real estate. 

Repaying a commercial real estate loan.

Repaying a commercial real estate loan typically involves a combination of regular interest payments and a final balloon payment at the end of the loan term. The specific repayment schedule will depend on the terms set by your lender and the type of loan you have obtained.

• Regular interest payments - Most commercial real estate loans require monthly interest payments for the duration of the loan term. These payments are calculated based on the loan's interest rate and the remaining principal balance. Interest rates can be either fixed or variable, depending on the terms of the loan.
• Principal amortization - Some loans include a principal amortization schedule, in which a portion of each payment is applied towards reducing the principal balance of the loan. This means that over the term of the loan, you'll gradually reduce the principal until the loan is fully repaid. However, some commercial real estate loans have a shorter amortization schedule than the loan term, leading to a balloon payment at the end.
• Balloon payment - If your loan has a balloon payment, this means that the remaining balance of the loan is due at the end of the loan term. This could be a substantial amount, depending on the size of the loan and the amortization schedule. It's important to plan for this payment and ensure that you have a strategy for covering it. This could involve selling the property, refinancing the loan, or using other business assets.
• Prepayment - Some commercial real estate loans allow for prepayment, where you can pay off the loan before the end of the term without incurring a penalty. Others might impose a prepayment penalty to compensate for the interest the lender would lose. Check the terms of your loan agreement to understand the rules around prepayment.

Remember, the specifics of your repayment plan will depend on the terms of your loan agreement, so it's crucial to understand these details before you sign. Also, ensure that you manage your finances effectively to avoid defaulting on the loan, as this could lead to the loss of your property.

Conclusion

Getting a commercial real estate loan is a significant undertaking that requires careful consideration and preparation. However, with proper planning and research, you can find the right option.

*The information in this blog is for informational purposes. It should not be used as legal, business, tax, or financial advice. The information contained in this page is Lendio’s opinion based on Lendio’s research, methodology, evaluation, and other factors. The information provided is accurate at the time of the initial publishing of the page (December 7, 2023). While Lendio strives to maintain this information to ensure that it is up to date, this information may be different than what you see in other contexts, including when visiting the financial information, a different service provider, or a specific product’s site. All information provided in this page is presented to you without warranty. When evaluating offers, please review the financial institution’s terms and conditions, relevant policies, contractual agreements and other applicable information. Please note that the ranges provided here are not pre-qualified offers and may be greater or less than the ranges provided based on information contained in your business financing application. Lendio may receive compensation from the financial institutions evaluated on this page in the event that you receive business financing through that financial institution.

Running a small business often requires making savvy decisions about acquiring necessary equipment without overspending. One popular strategy among small business owners is equipment leasing, which allows you to use high-quality equipment without the financial burden of buying it outright. 

This guide will demystify equipment leasing, explaining why it's an attractive option for your business and providing insights to navigate the process effectively.

What is equipment leasing?

Equipment leasing is a long-term rental agreement. A piece of equipment is purchased by a lender and rented to a business for a specific period. In return, the business pays the lender a monthly fee for the duration of the rental agreement (aka lease) and can use the equipment as if it were their own.

When the lease ends, the business has the option to renew the lease, purchase the equipment, or return the equipment to the lender. 

Lease payments usually remain consistent throughout the lease term.

Terms

While term lengths vary and will depend on your lender and unique situation, two-, five-, and 10-year terms are common.

The amount available will depend on the cost of the equipment you are leasing, but can range from $5,000 to $5 million.

Cancellation provisions.

An equipment lease agreement will likely have a cancellation provision that addresses whether and when a lease agreement can be canceled and if there are any fees associated with a cancellation.

Qualification criteria.

Lenders will look at a combination of your credit score, annual revenue, time in business, and the value of the equipment you are leasing. In general, you will need a minimum credit score of 520 and an annual revenue of $50,000. While some equipment lenders do work with day-one startups, they will have higher minimum credit score requirements starting at 650.

If you are leasing used equipment, the financier may also place restrictions on the age or mileage of the equipment.

Equipment leasing vs. equipment financing.

Your decision to lease equipment vs. finance equipment involves several considerations including the type of equipment you’re considering, how often you’ll use it, the cost of maintenance, the projected ROI, the resale value, and, of course, what you can afford (our equipment loan calculator can help with this). But these general rules will hold true across the board:

• Lease, if you’re considering a piece of equipment in danger of becoming obsolete.
• Finance, if the equipment is integral and a long-term part of your operation.
• Lease, if immediate cash flow is a concern, leasing may be more affordable.
• Finance, if investment, resale, and ROI are important to you.

Is it cheaper to lease or buy equipment?

The answer to this question depends on various factors, such as the cost of the equipment, the length of time it will be used, and the financial situation of your business. In general, leasing may be more affordable in the short term due to lower monthly payments, but buying can be more cost-effective in the long run, as you will own the equipment outright after making all payments. It's best to weigh the pros and cons of your specific situation before making a decision.

Capital lease vs. operating lease.

Think of a capital lease as something akin to ownership. When you enter into a capital lease, it's generally for the long haul, and the asset in question appears on your balance sheet. It's like taking out a loan to purchase the equipment outright, but you're making lease payments instead. This type of lease is usually for longer terms and by the end of it, you might even have the option to purchase the equipment for a nominal price.

An operating lease is more like a rental arrangement. You're essentially renting the equipment over a shorter period, and it doesn't show up on your balance sheet. Operating leases are typically for less than the full useful life of the equipment, and once the lease term is up, the equipment is returned to the lender. This type of lease can be a good fit if you're after the latest tech and want to regularly upgrade your equipment.

Types of equipment capital leases.

The following are examples of how a capital lease would be structured.

Equipment financing agreement - Fixed payments are made over a set term, after which you own the equipment in full. While similar to a loan, you pay a financing fee instead of interest. If you go this route, be prepared for slightly higher payments, but with no additional buyout cost at the end of the agreement. Note that tax benefits could help offset the cost of the monthly payments.

$1 buyout lease - A $1 buyout lease is a lot like an equipment loan. You make payments to rent the equipment and purchase it for $1 at the end of the lease.

10% purchase upon termination (PUT) lease - With a 10% PUT lease, you purchase the equipment for 10% of its original cost when the lease ends. This structure allows for lower monthly payments with a predetermined cost for the final purchase.

Types of equipment operating leases.

The following are examples of how an equipment operating lease would be structured.

Fair market value lease - With a fair market value lease, you make payments and use the equipment during the lease. At the end of the lease, you have the option to buy the equipment at fair market value, return it, or renew the lease. This type of lease is generally used for equipment that quickly loses its value such as computers or gym equipment.

10% option lease - The 10% option lease lets you make payments and purchase the equipment for 10% of its initial value or walk away once the lease comes to an end.

Terminal rental adjustment clause (TRAC) lease - Typically used for semi-trucks and other vehicles, a TRAC lease comes with the option to purchase the commercial vehicle for the agreed-upon residual amount, or the lender will sell the vehicle to a third party. If the vehicle is sold for less than the residual amount, the lessee will owe the difference.

Equipment leasing rates

The cost of an equipment lease is determined primarily by the depreciation rate of the equipment, plus fees and taxes.

The fee the company charges is called a money factor instead of an interest rate. It is multiplied by the financed amount plus the residual value of the equipment to create the monthly rent charge. That rent charge is then added to monthly depreciation to come up with your final lease payment. 

Depending on the structure of the lease, you will also either pay taxes up front, or they will be incorporated into your monthly payment.

What is depreciation?

Depreciation refers to the gradual loss of value of an asset, such as a piece of equipment, over time due to usage, wear and tear, obsolescence, or age. 

Additional costs

• Down payment - Many lease agreements offer 100% financing with no down payment. However, they may require your first and last monthly payment upfront.
• Documentation/processing fee - Some will require this fee, which is paid to the lender for processing your loan or lease application.
• Appraisal/site inspection fees - There may be a fee to appraise the equipment being purchased or to inspect a work site.
• Insurance - Equipment breakdown insurance is typically the responsibility of the lessee. You'll likely have to provide proof of insurance before you can take possession of the equipment.
• Maintenance costs - Depending on the structure of the lease, you may be responsible for any maintenance costs.
• Transportation/assembly costs - If the equipment needs to be transported to your place of business or assembled, you may have to cover that cost as well, which can be included in your total lease amount.

Benefits of equipment leasing.

There are numerous benefits that equipment leasing offers to small businesses, making it a compelling option for many. Let's delve into some of these advantages.

Manages obsolescence.

Some pieces of equipment risk becoming outdated. If you are considering using a piece of equipment that is in danger of being obsolete in the future, an equipment lease may be a better option than a loan. 

Cash flow benefits.

Equipment leasing often has a lower impact on cash flow. Leasing spreads payments out over the duration of the lease, allowing your business’ cash to be used for other opportunities like paying expenses or funding your growth. 

Tax benefits.

Lease payments are considered a tax-deductible expense. For a capital lease, businesses can also deduct the depreciation of the equipment. For operational leases, businesses can deduct depreciation if they purchase the equipment at the end of the lease.

100% financing.

Unlike an equipment loan, which requires a down payment, many equipment leases offer 100% financing with no down payment.

No debt on the balance sheet.

If a company opts for an operational lease, it doesn’t appear on the debt or balance sheet, opening up more opportunities to secure other types of business financing at the same time.

Steps to get an equipment lease.

Getting an equipment lease involves a systematic process. Here are the suggested steps to follow:

1. Identify your needs - Determine what type of equipment you need for your business. Whether it's machinery, vehicles, or office equipment, knowing what you need is the first step.

2. Research leasing companies - There are numerous equipment leasing companies out there. Take your time to research and find the ones that cater to businesses like yours.

3. Acquire quotes - Once you've identified suitable leasing companies, reach out to them for quotes. This will give you an idea of what the lease will cost you.

4. Review the terms of the lease - Read the terms of the lease agreements you receive. Make sure you understand all the terms and conditions, including the lease duration, monthly payments, and what happens at the end of the lease period.

5. Apply for the lease - After you've decided which leasing company and lease terms work best for you, fill out an application. You'll likely need to provide information about your business and financial situation.

6. Approval and signing - If your application is approved, review the terms one last time, sign the lease agreement, and make any required down payment.

7. Start using the equipment - Once everything is signed and sealed, the equipment is yours to use for the duration of the lease.

Remember, always consult with a financial advisor or legal counsel before signing any lease agreements to ensure you're making the best decision for your business.

In conclusion, equipment leasing and loans are powerful tools that can help you acquire the necessary equipment for your business' operation without breaking the bank. The right choice will largely depend on your business' unique needs and financial situation.  

At Lendio, we're here to make the process of acquiring business equipment as straightforward and cost-effective as possible. Visit our equipment financing page to learn more about how we can help your business grow.