With interest rates set to rise this year, many businesses are thinking about getting access to some additional cash before the cost of borrowing goes up. However, just because interest rates are going up, is that a good reason to get a loan?
A better question to ask is “regardless of interest rates, is getting a loan the smart thing to do?” It depends on what you need the money for and how sure you are that future cash flow will enable you to easily make your loan payments. Are you thinking about a loan to hire some employees? As a bridge to get you over an anticipated dip in cash flow? To purchase equipment or lease office space?
Be careful. Although there are situations in which getting a business loan makes perfect sense, sometimes wanting a loan is a symptom of financial trouble that is better addressed by treating the disease instead of reaching for a “money band-aid.”
Business loans are risk-reward decisions. When you get a business loan, you’re signing a contract with a financial institution that won’t be warm and fuzzy about when you should pay them back. The new financial obligation you’re taking on is a risk that should be worth the benefit that this new money will bring to your business. But how do you know whether this is the case, and what is the “right” amount of money to ask for? What’s the probability of a return on the investment?
I remember years ago I turned around a company that had taken out a loan against their accounts receivable and then used the proceeds to pay management and sales team salaries. They justified the spending with ‘we are building our team for growth’. When the growth did not come and they did not have the courage to stop the bleeding and were forced to file for bankruptcy.
Answering these questions requires a reasonably accurate 360-degree picture of your company’s financial health and how a loan fits (or doesn’t fit) into it. You should look at revenue history, predicted revenue, current and projected cash flow, existing debt obligations, and other factors. Although that may sound tedious, you’ll need to present all that to the bank anyway as part of your loan application, so there’s no way to circumvent it.
Lastly, some loan programs, especially with the government, have restrictions on how you can spend the funds. You should be careful with those as well. Spending restricted funds on non-operating expenses could have you under audit at some point.
Although interest rates are going up this year, they’re still relatively low compared to interest rates that were in effect before the Great Recession caused the Federal Reserve to slash them. So, no, the window isn’t closing on small business loans yet, but getting one now is still better than waiting until the cost of borrowing goes up.
Since I make a living as a financial coach, I can help you through the process of understanding your company’s true financial health. More importantly, I can help you decide whether applying for a loan is the right decision, or whether your need for cash can be handled without taking on a bank obligation. Contact me any time — I’d be glad to see if I can help.
