Posted On: December 19, 2018 by Peoples Bank in: Business Financial Education
Operating a business isn’t easy. Whether you’re running a small, growing business or your company has been around for two decades, you’ll likely be in search of cash or assistance at some point.
That’s where business loans can come in handy. Owners have needs for a variety of things, whether it be new equipment, real estate or a company car. Loans can also help fill gaps in seasonal cash flows.
Loans are a regular part of business life, but for some owners, understanding and going through the process can be daunting, especially if they are debt-averse. To help you understand what business loans are and the process it takes to get them, we talked to David Abram, market president for our metro market, to lay out the basics.
The two basic types of business loans
Business loans come in all shapes and sizes — different sums of money, repayment periods or interest rates — depending on the business’s needs.
“That’s the great thing about business lending is there are all sorts of levels of where businesses are at and how they can use that money,” Abram said. “There are all sorts of events that might bring a business customer into a bank for financing.”
While there is a lot of flexibility in business lending, most loans fall within two categories: lines of credit and term loans.
Line of credit: This lending option gives businesses a preset amount of money to borrow. Businesses can pull from the credit up to that allotted amount, then pay back the amount of money borrowed.
Typically used for businesses with seasonal sales, a line of credit is designed to help fill gaps in annual cash flow and is geared toward short-term money needs, like paying employees or fixed expenses in quiet periods.
Credit lines can also help fill gaps when a business operates with large accounts receivable — money owed to the business. Then, when bills are paid and money flows in, the businesse can pay those lines of credit back.
A huge benefit to this type of credit is the ability to pay down the used funds and borrow again, if needed. You also have control over how much the business borrows.
Term loans: Growing businesses can use term loans in helping speed up their expansion. Term loans are funds paid off over a set amount of time, with interest added on top. New companies figure their profits will increase over time, so term loans are usually the best option at the beginning of their growth, especially if they are needed for large purchases.
A new landscaping company may turn to a term loan to buy mowers, trucks and trailers — essential parts of operating. A business may also use a term loan in buying a new space. Term loans are flexible and can be used for any number of needs.
A variation of term loans, Small Business Administration (SBA) loans are low-interest and have longer repayment periods. Banks can help facilitate SBA loans for owners as well.
Applying for a loan
Getting a business loan is similar to applying for an auto loan or mortgage, but it’s a more in-depth process.
Before formally sending an application, have all of your paperwork in line. Abram said having at least the last three years of tax returns on the business is a good start. Owners should also provide financial statements that corroborate tax returns, income and balance sheets, inventory listings, and any other crucial business finance document.
All owners of greater than 20 percent need to gather their personal tax returns for the past three years as well. If the business will use the funds for expansion, make a comprehensive business plan and be prepared to present it.
The bank will also perform some sort of analysis on the business and the person running it. Keep in mind the five C’s of credit — character, capacity, capital, collateral and conditions.
Character focuses on the person applying to borrow money, and lenders will look through credit history, résumé, business history and more. Capacity is a person’s ability to pay the money back. Capital refers to any cash upfront, like the down payment on a mortgage or car. Collateral takes into account any assets the business can put up in case the loan goes into default. And conditions refers to the current local and national economic climate.
Some banks will have the borrower go through an interview process, too. This helps them understand the business, especially if the person isn’t a previous customer of the bank.
After the application process is done, a lender will take all of these factors into account as well as timely variables, like the economy, national interest rates or industry-specific conditions, then make a decision on disbursement, interest rate or any other stipulation.
After receiving the loan, a business is free to use the money within the set parameters — to buy equipment, add to cash flow, etc. — but the money cannot be treated as personal funds.
Getting a business loan is undoubtedly an exciting and nerve-wracking moment, but it’s often one of the first steps toward growth and expansion. Managing your finances well and working with your bank will help the long-term financial health of your company.