Lending options for small businesses come in a variety of shapes and sizes. Lending sources are used to fund an expanding business or provide financial assistance to a struggling one. While gaining access to funds can help run and manage your business, challenges can arise when small businesses look to lenders and other sources for business loans, term loans, or lines of credit.
Traditional types of small business lending
There are several different types of loans available to small businesses. Here are some options traditionally used for small business lending. Before you take out any loans, we strongly suggest you review these options carefully with your accountant or CPA.
A business line of credit
Often used for buying inventory, managing cash flow, financing receivables, or covering a considerable expense, this type of loan that functions somewhat like a credit card. The owner can borrow up to a specific limit and pay interest only on the portion of the money used. You can then draw and repay funds so long as you don’t exceed the credit limit. It is important to note that this type of loan should be used for short-term funding requirements and often carries a provision stating that the line of credit be paid down for 30 days through a calendar year.
A term loan provides the borrower with a lump sum, repayable over a set amount of time using a specified repayment schedule. This type of loan is typically used for long-term financing (significant investment in plant or equipment). It has become increasingly challenging for small businesses to get these loans from commercial banks. This has led to the advent of non-traditional lenders such as lendio, ondeck, or Rapid Finance, listed on Best Money as some of the best business loan lenders of 2021.
Factoring for small business lending
A factor provides cash and funding in exchange for purchasing the business’ receivables at a discount or for a fee. Factoring is also known as receivable financing. Investopedia describes factoring, “Factoring allows a business to obtain immediate capital or money based on the future income attributed to a particular amount due on an account receivable or a business invoice. Accounts receivables represent money owed to the company from its customers for sales made on credit.” It is important to note that factoring is an expensive way to finance receivables but provides a significant increase in cash flow since the factor will buy your receivables within days of you billing your client. If properly managed, factoring can provide businesses with working capital quickly and efficiently. Kabbage is one of the more popular factoring services for small businesses.
When should I apply for a small business loan?
You’re growing, and you need to fund it. Sales are strong, the business is healthy, and you can take on some debt to support the growth.
- You’re going to hire an additional 10% to your workforce
- The building you occupy is for sale, and purchasing the building will reduce your overall expenses.
- Extra equipment is needed to sustain the expansion and support new sales initiatives.
- Additional funds are needed for business expenses, paying down debt, and paying within vendor that offers discounted payment terms.
Now that you have determined the need for a business loan, you need to examine your working capital. Working capital is a gauge of a company’s short-term financial health. It is reflective of its ability to pay bills, short-term expenses, and debt. Positive working capital indicates that the business has enough cash to pay off its debt and still invest in it. Positive working capital is critical for any business to continue to operate and grow. Negative working capital shows the debt is higher than the cash in hand. If a business has negative working capital, the company may not be able to continue to pay bills and service its debt. When a business finds itself in this position, management should review its cash flow and determine steps to correct this situation.
Cash flow impact on small business lending
Before taking on debt, you will need to evaluate how the debt will affect your cash flow. Your business will need to have enough cash flow to pay the debt created by the loan you are considering and still have positive cash flow. Managing cash flow is always an essential part of managing and growing a business, but for SMB’s it presents a unique challenge that their larger brethren can often avoid. Mid-market and large corporations typically have ready access to cash that SMB’s simply don’t have. They also have tools in place to manage cash that SMB’s lack.
A recent article on Forbes simply states, “Cash flow means as it sounds: the ebb and flow of cash within a business. In simple terms, positive cash flow means a company is making money, whereas a negative cash flow means a company is losing money. Insufficient cash flow is one of the top reasons a business fails and is a red flag that lenders look for when considering a funding application.”
Automated bookkeeping solutions make managing your cash flow simple and easy. Expex balances human accountants and automated tools to provide you with the clean, tax-ready financials that lenders are looking for.
Financial challenges facing small businesses
Before beginning the process of applying for a business loan, you need to examine your company’s financial health. Many businesses operate partially in the ‘financial dark.’ They obtain new clients, pay their bills, collect receivables, and assume the company is healthy. Once a year, they meet with their accountant and review their financial statements and performance and often find they are not as healthy as they thought.
The majority of these challenges reside in poor or absent bookkeeping habits.
- Neglecting monthly reports such as balance sheet, income statement, P&L, A/R, and A/P aging, and Statement of cash flow.
- Absence of a budget or reporting
- Inconsistent cash flow
- Not paying bills on time
Automated bookkeeping services such as Expex help you understand your finances and provide clean, tax-ready books critical to your ability to secure small business loans and funding.
Expex, based in Schenectady, NY, offers convenient and innovative bookkeeping services to help your business succeed. Our application, Carly, can do everything a traditional bookkeeper does and more. This financial management program expertly delivers bill payments, bank and credit card reconciliation, and financial records consolidation. Call (518) 389-2305 today to get started, or contact us to learn more about Carly.