Taking out a loan is a crucial decision for business owners, and it requires careful consideration and planning. Unfortunately, there are several common mistakes that are often made when borrowing money for your business.
By being aware of these mistakes, you can avoid potential pitfalls and make informed financial decisions. Here are eight mistakes that business owners should avoid when taking loans.
1. Weak Business Plan
Showing up to a lender without a credible plan will most likely kill your chances of receiving a loan. It shows you haven’t done your homework. You might be able to see how much sense your plan makes, but you won’t get far if you can’t persuade your lender to get on board. You must be able to clearly explain your company’s business plan, past performance, competitive advantages, and proposed project.
Top Tip: Prepare your business plan and pitch. Focus on explaining your business and how you’re going to use the money you want to borrow in clear and compelling terms. Remember a big part of your sales job is persuading your lender to have confidence in your management acumen and ability to build a strong business (and pay back the loan).
2. Poor Financial Records
It’s essential to keep good financial records, including year-end financial statements. Messy financial records can leave you in the dark about how your business is performing until it’s too late to take corrective action. It can also make it difficult to approach a lender for a business loan because not only do you lack documentation, but you’ve also shown a lack of managerial acumen.
Top Tip: Commit to impeccable financial record-keeping. If this means investing in a good accountant, do so. Also, consider getting help from a business coach to get your business on the right track.
3. Leaving It to The Eleventh Hour
Funding expansion projects with your cash flow might seem prudent, but paying for investments with your own money can put undue financial pressure on your growing business. You may find yourself needing to borrow money quickly and doing it from a position of weakness.
When there’s a sense of urgency, it usually indicates to a lender that there was poor planning. It’s often harder to access financing when you’re in that position.
Top Tip: Prepare 12-month cash flow projections that take into account month-to-month inflows and outflows, plus extraordinary items such as planned investments. Then, engage with your lender early to discuss your plans and financing needs so you can line up the funding before you need it.
- Underestimating How Much Money You Need
You’re right to be careful about how much debt you take on. However, underestimating how much a project will cost can leave your business facing a serious cash crunch when unexpected expenses crop up.
Top Tip: Develop a cash flow forecast for each individual project, including optimistic and pessimistic scenarios. And then borrow enough money to ensure you can cover your project’s unforeseen contingencies and the working capital required to bring it to completion. Remember that there can be fees associated with loans. Add them to the amount you request
- Not Researching Your Lender Thoroughly
Taking a loan is a big decision that significantly affects your financial life for an extended period of time. While lending is largely well-regulated, there are still less than scrupulous lenders in some locations who use predatory practices to make a profit. So, the best way to safeguard yourself and your finances is to research the lender that you are considering before you approach them for a loan.
Keep in mind that a reputable lender will make the whole process of borrowing transparent and will take the time to explain the process to you. They will disclose all aspects of the loan sanctioning charges upfront and offer legitimate repayment options.
Top Tip: Opt for a financially regulated organisation as they will be under strict compliance, ensuring consumer safety.
- Not Understanding the Loan Product
Loan products can seem complex because they are often presented with plenty of information and jargon that can be difficult to interpret. It is absolutely essential for you as a borrower to understand what loan product you are signing up for before you accept the loan.
The interest rate on your business loan is important, but it’s far from the whole story. Other factors can be just as important, or even more so.
- What loan term is the lender willing to offer?
- What percentage of the cost of your asset is your lender willing to finance?
- What is the lender’s flexibility on repayments? For example, can you pay on a seasonal basis or pay only interest for certain periods?
- What guarantees are being asked from you in the case of default? Do you have to pledge personal assets?
Top Tip: Conduct a thorough review of potential loan packages. Look beyond the interest rate to terms, flexibility, and what collateral might be at stake.
- Putting All Your Financial Eggs in One Basket
Having a relationship with just one financial institution can limit your options, especially if your business hits a bump in the road. You don’t want one lender holding all the cards should something go wrong. Just as you would diversify your suppliers, customer base, or your own personal investments, you want to diversify your lending relationships.
Top Tip: Meet with other lenders and consider using different institutions for different types of financing products.
- Paying Your Loan Back Too Fast
Many business owners want to pay back their loans as quickly as possible in an effort to become debt-free. Again, it’s important to reduce debt, but doing so too quickly can cost your business. That’s because you may leave yourself short of cash. Or the extra money you’re devoting to debt reduction might be better spent on profitable growth projects.
Top Tip: Compare your projected return on investment to how much interest you’re saving by paying down your loan faster than required. If you expect to earn more by investing the money in your business, consider slowing down your repayment rate.
Your journey to securing a loan should be as strategic and well-planned as every other aspect of your business. Equip yourself with a solid understanding of your needs, a robust plan, and a transparent relationship with your lender. Remember, a well-leveraged loan is a powerful tool for growth. Make it work for you, not against you.
If you’re struggling with your business’s financial planning, you would do well to consider taking on a business coach to develop your knowledge and the performance of your business.
You can explore if I would be a good fit for you by booking an initial complimentary 15-minute call with me at TimeWithShane.com
