Managing finances is one of the biggest challenges faced by SMEs, and business loans are often used to access funds and help the business to grow. A loan can provide support for growth, purchasing assets and bridging gaps.
This blog will break down how a business loan works.
Why businesses choose to take out a loan
Business loans remain a popular choice of finance for many reasons, including:
- Bridging cash flow gaps (e.g., when customers pay late)
- Upgrading equipment and assets
- Hiring staff
- Boosting working capital
- Consolidating existing debts
- Funding expansion, refurbishment or relocation
They are great for enabling stability and growth and are not just about a one-off windfall – in fact, 69% of SMEs state their reason for requiring external finance was cash-flow related.
How a business loan works
- Application
The first step in the business loan process is when a business approaches a lender or broker with a borrowing request/application.
- Document submission
The lender will require documents such as:
- Business bank statements
- Accounts
- Cash flow forecasts/budgets
- ID
- Proof of address
- Details of any existing debts
- Business plan for the money
- Decision and offer
The lender will review the application and credit history to establish the business’ suitability for a loan. If accepted, the lender will propose the loan amount, interest rates/fees, repayment schedule, loan term, and any penalty terms.
It is important to review the offer thoroughly to ensure it is the right decision for the business.
- Acceptance
Once the business accepts the offer formally, the lender transfers the funds.
- Repayment
Repayments are made in line with the agreed offer. Some lenders allow early repayments, but some charge fees, so it is crucial to review the offer terms fully before making any early repayments.
Understanding costs and risks
Before committing to a business loan, it is essential to understand costs and risks. These include:
- Interest: often called APR (annual percentage rate), the interest is the core cost.
- Fees: any fees that may occur such as early repayment fees, legal fees or underwriting fees
- Guarantor: many lenders require a personal guarantee from the business director/s, meaning that if the company defaults the individual may be pursued.
- Early repayment fees: fees paid if the business settles early
- Overborrowing: if the business takes out more debt than it can sensibly manage, it may come under strain
How easy is it to get a business loan?
There is no one-size-fits-all answer to this question. It all depends on the business’ financial position and the lender’s requirements.
Lenders will look for:
- A track record: many lenders prefer businesses with a few years of trading under their belt.
- Strong, consistent cash flow.
- Well-prepared business plan showing how the funds will generate return
- Good credit records
- Collateral or security
- Good, well-organised documentation
The lower your risk in the eyes of the lender, the easier it is to get a business loan.
Tips for businesses considering a loan
Before starting the process of taking out a loan, it is crucial to establish the reason for the loan and how the money will be used, so that you can choose the right type of finance. You should also evaluate the business’ current financial situation to figure out how much you can realistically afford to borrow.
Many businesses choose to speak with a finance broker who can help you through the whole process and make an informed decision.
In conclusion, business loans are a popular way for businesses such as SMEs to source cash that can help them grow and expand, and the process must be followed to ensure the right decision is made. A finance broker can help you through the process.
Looking for business finance services? Get in touch with our friendly team today.