8 Steps to Being a Responsible Borrower
Considering taking out a small business loan? A loan is a quick and convenient fix to safeguard your business as well as to grow it. But a loan is also an obligation that could affect your business negatively. Thus, we’ve compiled a guide of handy tips on being a responsible borrower after speaking to experts in the field. If you’d like to jump right to the meat of it, we’ve summarized a 8-step plan for you to get the most out of your business loan.
1. Build a good relationship with your vendors.
Your vendors are crucial partners, and could potentially ease your cash flow problems. Being a responsible borrower means producing a compelling business plan to negotiate your own payment arrangement–you could reduce the size of your loan, or realize you no longer need a loan at all.
2. Figure out your debt coverage ratio.
Compare annual profit (excluding interest, depreciation, amortization) and annual debt service (the principal and the interest). A ratio of 1.0 is a great threshold indicator to being a responsible borrower.
3. Figure out your debt-to-income ratio.
Compare your monthly debt obligations with your income, to find out the percentage of your income that goes towards paying debts. The ideal ratio is subjective and dependent on your other expenses and needs. Nonetheless, tracking this ratio helps you to clearly track and gauge how many more debt obligations you would be comfortable with taking on.
This would be helpful for your own estimation, too, as you decide how many obligations you would like to take on.
4. Create an emergency store of working capital.
The exact amount would depend on the dynamics of your industry and the seasonality of your business, but maintaining a financial cushion — whether through loans or other means — is invaluable. Some small businesses store up to six months of working capital.
5. Create a reliable business plan for the next 24 months.
This business plan should include projections of the breakdown of expenses and costs on a monthly basis. This will allow you to plan the amount of capital you’ll need, and the size of the loan you would like to get.
6. Consider all your options.
Being a responsible borrower, you should never eliminate any options, or get obsessed with only one particular type of loan. You’ll be selling yourself short! After all, you don’t want to end up in short-term loan if an SBA loan is better for you.
7. Try separating your lending into more than one loan.
Breaking out short- from long-term expenditures would allow you to negotiate different teams for each expenditure. This could potentially reduce the interest you have to pay, and you could save some money.
8. Scrutinize all of the terms in any contract.
It’s easy to be excited when you are offered a loan, but make sure you examine the provisions of the contract carefully. You don’t want to run into any unexpected problems in the future.
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