Top 7 Reasons for Why Businesses Should Take a Loan

Top 7 Reasons for Why Businesses Should Take a Loan

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For a business, loans might be the optimal option for financing growth and covering operational expenses. So, let’s see when companies might want to take a loan.

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You’ve heard the old saying; you need to spend money to make some. It’s true, you know. You have to pay tons and tons of money to get your business, making some in return. Marketing, real estate, transportation, industrial plants, and numerous other things just don’t come cheap. You have no business if you have no money, and you have no money if you have no business.

The problem with this vicious cycle is that most small businesses need both at the same time, a high growth rate, and lots of money, to survive the competition. This means they have to break the cycle by either acquiring cash some other way than making sales or sacrifice their growth. 

You don’t want to do the latter.

Guess how you can get money without making a single sale. Right, either by equity or loan. As you might have already guessed from the title, we’ll be talking about loans in this article.

Nobody likes loans. When was the last time you heard someone exclaim in great joy that he just got into debt with some? Never. Nobody likes owing money to banks or any other lender. But if you think about it, loans aren’t such a bad thing. In fact, they can save your business at one point or another. They are only bad when you can’t repay them.

For a business, loans might be the optimal option for financing growth and covering operational expenses. So, let’s see when companies might want to take a loan.

Loans are Cheaper than Equity

Let’s start with the best one. What if we told you that if you take a loan, you’ll pay fewer income taxes and finance your operations at a cheaper rate than you would have done with equity financing?

When companies encounter an unplanned expense or just want to grow, they need the money, and they need it quickly. This means they either have to sell shares, get additional investment from owners or apply for a loan.

We understand that equity sounds better, but in this case, a loan might be a better option. Here are three reasons why:

First of all, debt comes without tax. This means that the interest expense is deducted while calculating the company’s taxable profit and, consequently, reducing tax liability. You’re getting to grow your business with this money. Because the loan interest is considered a business expense, the revenue service sees the interest in your business loan is tax-deductible. On the other hand, dividends paid to equity holders are not tax-deductible.

For example if you are paying 10% interest and have profit tax of 30%, your actual cost of debt capital is 7% (Interest Rate (1- profit tax) == 10%(1-30%))

However, it does not mean that capital can be entirely financed through debt because when the company becomes over-leveraged, the cost of raising additional debt becomes more expensive.

Second, you’ll get the money much faster than if you’d have gone with equity.

And third, in case of bankruptcy, debt-holders have the first claim on the company’s assets, while equity holders have a residual claim on the assets. Since debt has limited risk, it is usually cheaper (interest cost is lower than dividends). On the other hand, Equity entails more risk; hence shareholders need to be compensated with higher dividends or growth (to increase the value of their share in the company).

Autonomy

Another reason why, in some cases, loans might be better than equity is autonomy.

A lender will not come to tell you how you should run your organization. However, by taking equity, you will have the investors on the board of your company. Which, in turn, might mean that you now have an overseer keeping track of your every decision. In many cases, you will have to conform to their expectations regarding how your company should be run.

It is not hard to imagine how the owner’s control might get severely limited, which is never a good thing. In the best scenario, the investor should act as an advisor, a strategist, and certainly not an overseer.

Growth

Probably, this is the most obvious one. When business is booming, continuing to grow your business can help ensure that your profits don’t plateau or shrink. This is the time you need to be working the hardest.

You may find a cash injection from a loan helpful in achieving your desired growth, as expansion is a costly enterprise. It can help pay for the new revenue stream in its early stages before it starts to pay for itself and help you achieve your planned expansion earlier than you may have through organic growth.

Inventory

Inventory management is one of the most significant expenses in many industries. The problem is that you have to invest in it before the sale covers the costs of buying it.

You need to consistently and simultaneously be replenishing your inventory to satisfy the demand. But it’s not always that easy to deal with these costs, especially when you need seasonal supplies.

Loans can allow you to keep your inventory in a healthy state better.

Cash Flow

If there is one thing small businesses struggle with is maintaining stable cash flow. Especially when clients aren’t paying on time or when your stuff isn’t selling so well, and you have tons of it lying in your warehouse.

And even having that stuff lying there doesn’t come for free. Usually, it has enormous upkeep costs.

When a company can’t deal with its fixed costs in such dry times, loans can allow you to manage these upkeep costs better and maintain healthy cash flow.

Plants and Equipment

Every business has plants and equipment that are vital for production. And none of them are cheap to buy and maintain. More so, if you consider the fact that everything depreciated and breaks down at some point.

Unplanned expenses like this can completely disintegrate your revenue streams and ruin your plans for any kind of growth. From small businesses, this is even more devastating.

Where do you get this much money so fast? Right, loans. They might help you up in situations like this as you will be able to repair/replace quickly whatever requires it and get on with your business as usual.

Improve Your Credit Score

And last but not least, taking loans can help you get a bigger loan with better conditions in the future.

Suppose you’ve been in business for less than a year. In that case, you won’t have a business credit score because credit reporting agencies don’t yet have enough information about how your company manages debt. Instead, lenders will look at your personal credit score to determine if you’re qualified for a loan. So, make sure everything is in order over there.

Now, how do you build a viable credit score? By taking loans, of course. But if you want a good credit score, you should also throw in paying them back on time in that equation.

If you think your business will need a massive loan at one point or another, you better start building your credit history up-front. The more loans you take, and the more times you pay them back on time, the better conditions you’ll get on your future loans (but this comes at a cost – interest paid for money you actually do not need, so you have to weigh your options carefully).

So, think carefully if you will need an excellent credit history. If you’re sure that you will, then it’s time to take your first short-term loan.

Obviously, no business should ever take any kind of loan if it brings no benefit. But as we already saw, there are quite a few good reasons why taking out a loan isn’t such a bad idea. More so, it might be the only option in some cases.

Still, be careful and do your homework before doing anything like borrowing even a hundred dollars. More than enough businesses lost everything by taking out the loan they couldn’t pay back.

You can use our simple loan payment calculator to avoid mistakes like this.

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Financial Dictionary for Small Businesses

Financial Dictionary

Accounting Terminology Income Statement An income statement is a financial statement that shows you how profitable your business was over a given reporting period. It shows your revenue, minus your...

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