Is Your Business Loan for Expansion or Consumption?
By: Sean Goss
The biggest concern with most budding entrepreneurs, is the availability of start up capital. A wide array of organizations, are availing funds to small business. Business loans are however, are becoming more difficult to secure. Many determined entrepreneurs have managed to scrape the necessary funds together, and build their businesses without any outside loans or funding. They however, are in the minority. Other small businesses, on the other hand, still failed despite the injection of loans into their businesses.
Many businesses, successfully securing loans have squandered their loans on irrelevant luxury items and assets not useful to the business. Lending institutions are continuously tightening the lending criteria, to avoid problems of this nature.
This article will not focus on loans failure statistics or debate whether a business loan is indeed necessary. Here I will attempt to address the proper utilization of a business loan for the growth of the business.
Funding of a business can come in various forms, i.e. loans from government, loans from a bank, second mortgage over property, equity/venture capital, loans from family or savings or investments.
When business owners calculate their requirements, they invariably add in their inventory and overhead costs to their capital requirements, such as machinery and equipment, and arrive at a total loan requirement, comprising capital and working capital requirements.
If more than 40% of the loan requirement is for working capital, the loan would basically fund consumption and not expansion of the business. A build-in working capital requirement in a loan is understandable. But a high working capital component reveals nervousness, on the part of the business owner, in dealing with future uncertainties. Business is all about risk, so a loan cannot cover dangers that the business will inevitably face!
Working capital and day-to-day expenses should preferably be funded from current revenues, not loans. This is a contributing factor to loans being rejected. Since lenders are averse to funding operational costs, from loans. In the same way as loans and credits cards are dangerous to funding living expenses, so are loans used for the operational costs of a business.
Apart from the danger of utilizing loans for consumption, there is a basic reason why lenders prefer to finance capital equipment, as opposed to overheads. The reason is quite simply, SECURITY! A business that goes belly-up, can either return financed assets, or the lender can attach these assets to defray any costs incurred, by the lender. No recourse is available to the lender, if the bulk of the loan was applied to overheads.
When writing a business plan, for a loan, the business owner should clearly list assets required, its value, and importantly the projected return on that investment.
The focus of the loan requirement should always be on capital needs. Many institutions will gladly provided a 10% working capital component in the total loan, if the business plan is convincing. Another advantage would be the "own contribution", by the entrepreneur. The higher the own contribution, the better the prospects of securing the loan.
It is advisable that any business owner should engage the support of financial consultants and accountants, not only prior to the loan application, but after securing the loan as well. A frugal plan, and budget should be drawn up to guide the business, as well as monitor the utilization of the loan. The budgets should also be split between normal income and expenses, and capital budgets. This will ensure that the business derives maximum benefit from the loan, boost revenues, so as to ensure that the loan commitment is settled speedily, hopefully before expiry date.
Sean Goss For finance, accounting and business advice, visit us at http://www.sgafc.co.za
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