When NOT to Take Out a Bad Credit Business Loan
When NOT To Take Out a Bad Credit Business Loan
Small business owners often turn to borrowing to meet their capital needs. Lenders provide them with the funds to cover working capital gaps, expand their businesses, and consolidate debt. But there are times when borrowing is not the solution to your problems.
Here are nine situations in which you should think twice about taking out a loan.
Cost of Debt vs. Return
When you are making a borrowing decision, the cost of debt matters less than your net return. For example, if you pay 20% on a loan to develop a new product line, which will return a 35% profit, your net return is 15%. The return on investment or ROI justifies the debt’s cost.
There are times, however, when it will not. If you will pay more to borrow, than the money will return when invested in your business, borrowing is not advised. This is also true when you are unclear about the potential ROI.
Being unable to nail down a potential return on the money you put into the business could indicate that you need to think deeper about your plans. You might need to sit down with an accountant or business planner to help you further develop your ideas and their potential impact. This will ensure that you make a better borrowing decision.
When You Do Not Know Where You Will Use The Money
Borrowing in a panic, or out of fear, could have a long-term negative impact on your business. If you are borrowing because your bank account is negative, or you received a credit card bill with a high balance, but without a clear plan for the money, think twice.
Without a clear idea of how you will use the capital you borrow, you could waste or lose track of the funds. You will not know if the ROI justifies the rate you pay to borrow. And losing track of the money instead of using it to grow your business could put you into a cycle of borrowing simply to keep afloat.
When It’s a Quick Fix
If you have run into cash flow problems that you think a bad credit business loan could fix, take a moment to think about those problems. Have you consistently been struggling to cover payroll? Do vendor payments rarely align with when your bills come due? Your need to borrow could indicate a more significant business problem.
Maybe it is time to examine your staffing needs and make cuts. Or, you could ask vendors to adjust their payment terms. Sometimes borrowing obscures a business issue that keeps coming back, and you should address that problem instead of falling into a borrowing cycle.
Small business owners who have been borrowing regularly might want to sit down and examine their business’ cash flows and their underlying causes before applying for another loan.
When Bad Decisions are Driving Borrowing
Have you ever wondered why seemingly successful businesses fail? Sometimes, capital and cash flow are not the problem, but rather the business owner has made poor decisions in running the business.
A bad decision could relate to signing a contract or taking out a loan with unfavorable terms. Maybe hiring your cousin as a salesperson is not working out well, or you are constantly dipping into company funds to cover personal expenses.
Until you address the bad decisions that have led to the need to borrow, you risk repeating them.
When Something Else is Not Working
Maybe it is not your business decisions or cash flow that are driving the need to access capital, but something else. There are many factors in a business that can go wrong. Before applying for a loan, examine each of them.
Look at your product. Are customers consistently complaining about a product feature or a lack of one? Have sales slowed significantly in one product line? Why? Ask yourself if a few small tweaks in your product line could solve your cash flow problem.
If you are a business that provides services, the same principles apply. Have customers been leaving negative online reviews? Do they mention the same employee or service issue, such as showing up late for appointments? Dig deeper into the negative reviews and the services you offer to see if you need to make changes.
Other things that may not be working include your company, the idea behind your company, or your location. Examine every aspect of your business that could be leading to low revenues and higher expenses, and ask for input.
When You Have Other Options
The rates on bad credit business loans range from 12% to 45%, depending on your credit score, business revenues, and other factors. If you have other options, they could likely cost less.
Would a close friend or relative be willing to loan you the money you need? Could you pull money from your retirement accounts or personal funds? If you have concerns about the rates you will pay for a bad credit business loan, investigate other options.
When your Credit Cards and Lines of Credit are Tapped Out
Not only will you pay a higher rate to borrow if you have tapped out all existing forms of credit, maxed out credit cards and lines of credit should worry you. If you have borrowed up to existing limits and need more money, your business could be unsustainable.
Charging a credit card up to its limit negatively impacts your credit score, making it harder for you to borrow. It is also an indicator that your business is struggling. Borrowing to keep a failing business afloat only digs the hole deeper. It also increases your likelihood of default. Failing to repay your business loan will lead to serious consequences.
Before taking on more debt, figure out why you had to tap into all your currently available credit and make a repayment plan.
Want to Consolidate Debt but Do Not Know How to Budget
Maybe you want to borrow to consolidate those credit cards and lines of credit into one easy payment. Consolidating debt is a solid borrowing strategy and a smart move if it lowers your overall interest rate. But it will fail if you have not learned how to budget.
A budget, in its simplest form, lays out your cash inflows and outflows and makes a plan to align them. When Customer A pays for their shipment, you will turn around and pay Vendor X. A repayment plan for existing debt should fit within your business’s budget. If the net profit between Customer A’s payment and Vendor X’s cost is $5,000, how much of that money can you put to paying down debt?
Consolidating debt can simplify paying it off, but only if you have learned how to make and stick with a budget.
When Repayment is Uncertain
If you have any doubts about your ability to repay a loan, do not borrow. In order to borrow successfully, you should have a clear idea of what the loan will cost, how you will use the funds, and how you will repay them. Borrowing in haste could lead to a loan that cripples your business.
Before you borrow, slot the monthly loan payments into your budget. Plan out how they will affect your company’s future cash flow. Will payments make it difficult to pay suppliers? Will the capital infusion generate new revenues that cover both your loan payments and produce more profit for you?
If you have any doubts about your repayment ability, talk to a financial advisor and your lender. They can help you analyze your situation and potential issues you could run into when repaying the loan.
Just because you can access capital, does not mean that you should. Borrowing for the sake of borrowing often leads to a different set of problems.