All the Costs Associated with a Small Business Loan
We are living in a fast-paced, highly competitive era. As a small business owner, you already know how this affects running and expanding your business.
One of the most effective ways to keep your business alive and to ensure its future growth is to do some renovations. You do not want to lose your position in the market. You want to beat your competitors. You need to invest money to make more money!
Financial investments play a crucial role in the success of your business. They provide capital for much- needed aspects such as expansions, equipment, upgrades, and inventory.
For small businesses, most growth opportunities come at a hefty price. They can require a capital investment that surpasses what you have available in the bank. So taking out a small business loan might become a fitting solution for you.
However, before you decide to apply for a business loan, you need to make a few decisions to ensure that you are headed in the right direction, and to avoid unnecessary risks for your business.
Here are the main questions you need to answer before applying for a business loan:
- What is the exact amount you need?
- How are you going to use the capital?
- What is the current state of your business financial health? (i.e. cash flow)
- When do you need this extra capital?
- What is the total cost of your required loan? (including interest rate, and other costs)
- What is the loan payment schedule?
- How long will the application process take?
Depending on your answers to these questions, you can figure out the best way to go about acquiring a loan for your business.
Case Study: Practical Implementation of a Small Business Loan
To better understand how a small business loan works and its possible effect on a business, take a look at this brief case study of a business owner contemplating whether or not to apply for a loan.
Business: Michoacán Aguas Frescas
Type of business: Food Industry
Manuela Vargas has a small food stand in her town’s city market where she sells delicious aguas frescas. During the warmer days of the summer, there’s a line of customers eager to drink one her 100% natural, artisan refreshments. She has a net monthly profit of $600. She knows that if she had a few more top quality blenders and a second cooler she could expand her line of products to also offer smoothies. She calculates she needs about $4,500 to get the equipment. It’s not a large quantity, but she doesn’t want to strain her savings. She considers taking a small business loan. She has never applied for a loan before, but she knows it comes at a cost. Will she able to take the loan? Will it be worth it? She resolves to use a commercial loan calculator.
To arrive at a conclusion, these are the fields she has to complete in the calculator:
- Loan amount: $4,500
- Payment term: this is the number of monthly payments she wants to make. From the drop-down menu, Manuela picks 24 months, since she doesn’t want to expend the term for too long.
- Monthly interest rate: the interest rates from this particular lender who provides the calculator range from 1% to 2.5%. Manuela is not sure of the interest that will be applied in her case, so she stays in the middle and picks 1.75%.
Then she simply clicks on “calculate” and these are the results she gets:
- Total interest paid: $1,049 (this includes the monthly 1,75% interest rate during the life of the loan)
- Closing fee: $314.6 (this is the only fee that this lender applies)
- Cost of the loan: $1,364.20 (this is the sum of the two figures above)
- Monthly payment: $231.24
Manuela is happy with these initial results since the total interest seems reasonable and the only fee to pay is the closing one. Still, she follows the recommendations attached to the calculator:
- They advise making sure your monthly payments don’t exceed more than 80% of your monthly net profit. Is this the case? Yes: 80% of $600 (Manuela’s monthly net profit) equals $480, and the monthly installments are much lower than that.
- They also recommend that the earnings you expect after making the investment should always surpass the total cost of the loan. Manuela is still unsure of how much she will get once she starts selling smoothies, but given the increase in customers she sees every day, she’s positive that after 24 months her profits will exceed the $1,364 that the loan costs.
Once conveniently informed, Manuela decides to contact this lender.
As we observed in this case study, acquiring a business loan can have a huge impact on your business. However, it is extremely important for you to have informed details of the total costs included in a loan before taking a serious step.
Like Manuela, you need to be sure that:
- The monthly payments do not exceed 80% of your monthly net profit.
- The total cost of the loan does not exceed the total return expected after the investment.
Still having doubts about how to figure this out? Then use a commercial loan calculator to make sure you are making the right move before approaching your lender.