Business Loans – What you need to know
Business loans can be great when you need to get your brand up and running or cover unexpected expenses. However, it’s useful to understand the difference between the available options before committing to one. They’re designed to help manage your capital and cash flow.
To help you make the right choice, here’s what you need to know about some of the more commonly used business loans.
Line of credit/overdraft
A line of credit involves overdrawing on your business’s bank account up to an amount approved by your financial institution. Business overdraft is commonly used for short-term capital, or as a source of cash flow to keep operations running smoothly. Line of Credit is usually a long-term arrangement between a business and a lender, where the business can access funds up to an approved limit.
Some advantages of a Line of Credit are that they are very flexible and you can use funds as needed and repay at your own pace. It also allows you to establish a good credit history for future borrowing and it also has the advantage of a simpler application process than other loan types.
Some of the disadvantages of a Line of Credit are that the bigger the overdraft, the bigger the fees and it may incur fees even when not being used.
Bank term loan (secured or unsecured)
A bank term loan is a medium-to-long-term business loan option commonly used for purchasing equipment or covering business start-up costs. It involves borrowing from a lender and making regular repayments over an agreed period.
Bank term loans are flexible and you get to choose from fixed, variable, split rate or interest-only loans. This also allows you to borrow a larger sum over a longer term with lower interest rates. You also may be able to match the loan term to the life span of the underlying asset.
Some of the disadvantages are you may be subject to borrowing minimums. This type of loan attracts set-up and service fees. The variable rates can fluctuate, resulting in higher repayments.
Another form of business loans is a mortgage loan that can be used to cover most of the upfront costs of purchasing a property for your business. The property is then used as collateral by your lender until you’re able to repay the loan amount and the incurred interest.
These types of loans are flexible and you can choose from fixed, variable, split rate or interest-only loans. Some of the features that may be offered are redraw facilities and no-penalty early repayment. These loans may be easier to obtain than a bank term loan.
Some disadvantages may be subject to borrowing minimums and often attract set-up and service fees. The variable rates can fluctuate, resulting in higher repayments.
What is asset finance?
Asset finance includes a range of different loan structures that can help your business buy vehicles or equipment.
Types of asset finance
Also known as an equipment loan. A business borrows money to purchase an asset. The business owns the asset outright, but the lender uses the asset as security until the business repays the loan. This frees capital and ensures the business has security against the loan.
The lender purchases the equipment and rents it to the business. At the end of the term, assuming all payments are made, the business takes ownership of the asset. This is a popular way to spread the cost.
The lender owns the equipment and the business pays a hire fee for use. In some cases, the business may be able to purchase or refinance the asset at the end of the set term which gives flexibility.
The lender owns the equipment and the business pays a hire fee for use. The business does not take ownership of the asset. The costs are deemed operational expenses.
A Novated Lease involves a three-way agreement between an employer, an employee and a lender. The Novated arrangement involves the employee leasing the vehicle directly from the lender. The employer will then agree to deduct lease rentals from the employee’s salary during the term of employment and to pay the rentals directly to the lender. The employee has the use of the vehicle for personal purposes.
Looking for the right business loan?
Understanding how the different business loans vary can help you choose one that best suits your business needs. Make sure you speak with a professional mortgage broker before making any decisions to ensure your business gets the right level of financial support.
How banks calculate business risk
Just like you, banks are in business – they don’t succeed by making bad deals. When they consider your business loan application, they’re calculating the financial risk of entering into an arrangement with you.
What the bank considers:
For the bank, financial risk comes down to whether you can repay your commercial loan and the interest in the agreed time.
According to the Australian Bureau of Statistics, as of June 2016, 12.3% of businesses ceased trading. To protect itself, the bank is looking for evidence that your business loan won’t fail to repay the principal amount.
When assessing financial risk, one of the main factors the bank looks at is you, the business owner. What skills and experience do you have? Do you understand your business and have a clear and realistic plan for developing it? Importantly, they’ll also be looking at your credit history, and any debt you may have.
Banks also consider:
The bank will evaluate what you’re offering as security against your business loan – this might be a family home or other assets such as stocks and shares.
Lenders view some industries as riskier than others, because of conditions such as competition, profitability and the economic climate. If your industry is seasonal, such as tourism or agriculture, they’ll want to know how you’ll manage repayments in the off season.
ASIC reports inadequate cash flow among the top reasons why companies become unable to repay debt. The bank will want to see what revenue you have coming in, and be assured you can pay wages, keep the business ticking and make your business loan payments on time – even if something unexpected happens.
Show the bank you’re managing risk
Having higher risk doesn’t mean you won’t get a business loan. But you need to show the bank you’re aware of the risks and are taking the necessary steps to manage them.
Start by making a risk management plan that documents your business’s specific (financial and other) risks and identifies the steps needed to reduce or manage them. See business.gov.au for useful tips on risk management and tools to plan for it.
Regularly review and act on your plan. No matter the size of your business, that’s an essential part of good business management.
Next, when preparing your loan application, think about what will convince the bank you’re on top of your business risks. Here are some ways to do just that:
- Provide all the documentation the bank asks for.
- Use a business plan to succinctly explain what your goals, objectives and target markets are with any forecasts that might help.
- Supply solid evidence of your personal experience and credentials.
- Make sure your financial records and forecasts are in good order (poor financial control and lack of financial records also rate highly among ASIC’s top reasons for company insolvencies).
Convincing the bank that you’re on top of risk management doesn’t involve smoke and mirrors. It’s about understanding your business, having robust practices, planning for the future and demonstrating you’re on top of any present or potential risk.
Six tips when taking out a business loan
A small business loan can be invaluable when you’re establishing your business or when an unforeseen setback occurs but you don’t want a loan to be short-term gain and long-term pain.
Here are six tips businesses should consider when it comes to commercial finance.
Business Loan Tip #1: Getting the right loan
A thriving business requires enough capital to meet expenses, expand and invest but it’s important to know why you need the funds and what loan best suits that need.
Do you need to cover short-term cash flow shortages, for example? A line of credit could help, where you can access funds up to a pre-approved limit, and only pay interest on the outstanding balance.
Maybe you need new equipment? In this case, ask your mortgage broker about an equipment loan, where the asset is used as security while you make your repayments. This can potentially help make the loan easier to secure.
Business Loan Tip #2: Having a business plan
Lenders want to understand your business’s operations and how it will make money – in other words, that your current and future cash flow will cover the repayments of the loan.
A strong, well-considered business plan demonstrates your goals and how you plan to reach them, and shows you’ve thought through all the details. When you can clearly explain your business model, products, services and target audience, lenders will be in a better position to tailor a financial product to your needs.
Business Loan Tip #3: Having thorough, up-to-date financials
Precise, current financial records allow lenders to understand your business’s exact position. If you can’t provide sufficient information, they will either reject your application outright or ask you to spend more time preparing the necessary details.
Before approaching a lender, get your books up to date and prepare reports such as balance sheets, profit and loss statements, recent business activity statements (BAS) and tax returns, cash flow projections and debtor and creditor reports. Depending on the size of your business, you may also need to provide information on your personal financial status.
Business Loan Tip #4: Paying attention to interest, fees and hidden expenses
It’s crucial to understand and calculate the full cost of a loan before committing to it. Apart from interest expenses, there are likely to be application fees, administration fees and contract or appraisal costs. These will be incurred regardless of the size of the loan so you might find it worthwhile to discuss increasing your borrowing amount with your broker to cover those costs.
Business Loan Tip #5: Checking your credit record
Is your credit record clean? You should find out because lenders are certain to check it when assessing your application. This can have a big impact on the interest rate you’re offered.
Ask for a copy of your credit file from a reputable credit reporting body and go through it carefully to make sure all the information is accurate. If it’s not, take steps to correct it before starting the loan application process.
Business Loan Tip #6: shop around
Having the funds to run and grow your business is important, but make sure you take the time to shop around for a loan that won’t create extra pressure in the long run.
Need some Advice about Business loans?
A mortgage broker can help you find the right loan and secure the commercial finance that’s most suitable for your business. It will also ensure you avoid making mistakes.
Any questions you may have regarding refinancing contact Annette Tothill on 0420 973 551.