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Business Loan Basics

Funding a business is hard work, especially in the start-up phase. Initial expenses, such as building rent, employee training, and marketing outreach, can cause a great deal of costs that many budding companies just don't have access to. Even for long-standing firms, sometimes an extra hand in budgets can truly be a blessing during busy season.

It is often said that it takes money to make money, but how does this happen when you don't have the initial funds? You take out a business loan.

Getting to the Basics

Just as it sounds, a business loan is a loan that is used specifically for business purposes, such as starting up a company or finding funds to expand a department.

Like all loans, the act of taking out money that needs to be paid off in the future involves the creation of debt that will need to be repaid with added interest. Interest is the payment from a borrower to a lender that is above the amount of the initial lump sum agreed upon. Usually, interest makes the task of lending money more economically beneficial to the moneylender.

All business loans, like a majority of other credits and borrowings, are either secured or unsecured.

With a secured loan, the borrower pledges an asset in order to obtain the financing. The asset is usually a tangible item that is of worth to the business and acts as an incentive to get the debt repaid. Typically, in a business loan, the assets may be anything from equipment, stock, or business property. If the borrower is not able to pay off the loan, the moneylender gets to legally keep the asset as collateral.

In an unsecured loan, there is no asset to pledge, which makes the act of borrowing much more risky on the lender's end; although, usually, unsecured loans have a higher interest rate to make the transaction more worthwhile.

Types of Loans

There are a wide variety of business loans available for companies and, depending on what is needed for your industry, one loan may have more benefits for your need than another.

SBA Loan 

  • Loan Amount: Up to $5 Million
  • Loan Term: Maximum 20 years
  • Fixed or variable rates with a margin over Wall Street Journal prime
  • Speed: as little as 30 days

SBA, the Small Business Administration, is a federal agency dedicated to helping entrepreneurs improves their small businesses, take advantage of contracting opportunities, and gain access to loans.

To receive this type of loan, businesses must contact their bank to see if it is offered. The initial route involves a lengthy process where lenders will review your credit and financial statements and expect you to have collateral to secure the loan. In most cases, SBA lenders will look for borrowers with good credit, a solid business plan, collateral, and a demonstrated ability on a repayment plan for the loan.

Traditional Term Loan

  • Loan Amount: up to $5 Million
  • Loan Term: Typically up to 5 years
  • Interest Rate: Fixed or variable interest rates
  • Speed: as little as 2 days 

A traditional term loan is probably the most common form of business loans available today. Because it's so common, most people tend to understand it quite easily. First, the borrower takes a fixed amount of money, often used for a specific purchase for the company (like working capital, tax obligations, or even paying off previous debt), and pays back the loan over fixed amount of time.

Since they are so common, there are a wide variety of traditional business loans that are offered to companies with various needs, and both traditional banks and non-bank alternative lenders provide them.

To get a traditional term loan, most investors ask for collateral, or an asset, and many also only lend to businesses with good credit. Sometimes, there are prepayment penalties or fees that are tacked on to traditional term loans, so be sure to ask your investor what these terms may be before agreeing upon a contract.

Business Line of Credit 

  • Loan Amount: Up to $5 Million
  • Loan Term: Up to 1 year
  • Interest Rate: Fixed or variable interest rates
  • Speed: as little as 2 days

A business line of credit is quite similar to a personal line of credit. Typically, an institution or investor grants access to a specific amount of financing, but it is not needed to make payments or incur interests until you tap into those funds. This type of funding is good for people who need a cash-cushion when required, such as short-term financing like payroll and seasonal expenses. 

A good example of how a Business Line of Credit works is as followed: If you were given access to a $60,000 line of credit and decide to take out $30,000, you will still have access to the remaining $30,000. If you pay off the amount you took out, then you go back down to $0, owe nothing, and still have access to the original $60,000. However, going over the amount is where interest occurs. 

There are a multitude of business loans available for the start-up company and the long-lasting franchise. Depending on what is needed for your industry, one loan may have outlasting benefits over another, so definitely do your research and ask your bank or lender the terms of each option before settling on a loan contract.

Cash Management Techniques

The term cash management refers to the collection, concentration, and disbursement of cash. In many ways, managing cash flow is the most important job for business managers. If a company happens to miss paying an obligation due to lack of cash, the company becomes insolvent, which is the primary cause of bankruptcy. Not only this, but having a poorly managed cash flow leads to having no margin of safety in case of unanticipated expenses, trouble finding funds for expansion, or difficulties in hiring and retaining employees.

Typically, cash flow problems are the leading cause of business failures — so it is important to make sure you understand every technique available to keep your business afloat. To have a successful business, you need to be able to manage your cash flow well. Here are some useful cash management techniques to help you as you grow your business.

Monitor Your Cash Flow Regularly

Staying on top of your cash flow is the first and foremost important aspect of cash management. To help with this, create a cash flow budget that charts finances for shorter and longer terms. This will assist in understanding where your money will be going and how much is necessary, as well as keeping track of what finances you currently have and should be spending. 

Bill Promptly and Accurately

The faster you mail an invoice, the sooner you will be paid. If your company's deliveries or services do not automatically trigger an invoice, then establish a weekly billing schedule to stay on top of things. Along with this, always include a payment due date to encourage customers to pay quickly.

Encourage Faster Payments

If payments are coming in at a rate that isn't beneficial to your company, it's time to begin encouraging faster payments. There are options such as offering discounts for early payment that can be used or other incentives that your company can offer. Be sure to ensure that getting paid early is worth the loss, though. Too much of a discount could only be more of a financial burden.

Designate a Cash Flow Monitor

Choosing a trustworthy employee to monitor cash flow provides your business with someone to watch and inform you when your company reaches a certain threshold. This is an excellent way to stay on top of things efficiently without taking up too much of the company's time and resources.

Cut Costs Where You Can

To manage your cash well, it's important to make sure your company isn't spending more than it can handle. Cutting costs such as subscriptions or services you no longer need, cutting back on utilities, rent, or payroll, or renegotiating terms of outstanding loans or leases are different ways to save your company money.

Get a Business Line of Credit

Lines of credit are good insurance policies against cash flow problems, but it's important to get a business line of credit before you find your company needing one. If you use either your accounts receivable or inventory as collateral, you may even be able to get a line of credit for a percentage of them. 

Delay Payments to Vendors

To keep the cash in your account for as long as possible, wait to pay your vendors as long as you can (without risking late fees). The only time that it is a better option to pay early is if there is a worthwhile incentive available, otherwise, stick with waiting. 

Use Available Technology

There are different professional accounting software solutions available that will assist you in your finances, as well as cash flow spreadsheets in the cloud at sites such as Dropbox or OneDrive. The benefits of these include being able to access your financials from anywhere and at any time. 

Use Banks Wisely

Banks can offer incredibly useful services such as overdrafts or credit that are great for businesses, especially those that are just starting out. The First State Bank provides services such as Business Online Banking, Merchant Card Services, Remote Deposit Capture, and many others that are perfect cash management tools that will assist in recognizing your cash flow and keeping track of it.

These are just a handful of the many different cash management techniques available. Remember, cash management is one of the most important aspects for businesses to keep themselves successful and running smoothly. Recognizing your cash flow and understanding where there is room for improvement is crucial for all businesses, and these cash management techniques are the first steps to helping you become more fiscally responsible. 

Bank Accounts to Open for Your Small Business

One of the most important decisions you'll make when starting a business is choosing the right bank accounts. As an entrepreneur, you'll want to make sure you don't mix your personal finances with your business money: If your cash isn't kept separate, it could be hard to meet IRS recordkeeping requirements, and that could lead to tax penalties. Opening new accounts in your company's name is typically a better practice.

Having separate bank accounts could also help limit your personal liability. Say someone were to sue your company; your business assets might be at risk, but your personal assets would likely be protected from legal action.

Here's a look at three common types of accounts to consider for your company. 

Business Checking

For entrepreneurs, opening a business checking account means you don't have to ask customers to write checks to you personally. Some customers could view checks written out to individuals as unprofessional, and that could hurt sales. With a business account, checks are made out to the company name.

Many banks offer business checking accounts for a minimal fee. Some even offer free business checking, though your company may need to agree to limit deposits and withdrawals to a set number — say, 300 transactions a month — or agree to keep a certain minimum balance.

When you sign up for business checking, many financial institutions will also offer online banking and payroll processing services.

Business Savings

You don't have to put all your company's cash in a checking account. It may make sense to place money you don't need to spend right away into a business savings account, where it may earn a better rate of return.

A business savings account could also serve as an emergency fund to help pay for business operations if your company goes through a sales slump. And, as with personal accounts, your money would be protected with federal insurance up to $250,000 per depositor.

Business Credit Card

Opening a credit card in your company's name gives your business a chance to establish credit. When you first sign up, you may need to personally guarantee the debt because your company won't have an established financial history. But your company will soon show a track record of payment as you put the card to use. Eventually, business loan and credit requests could be guaranteed by your company, and not your personal finances. 

Opening bank accounts for your business can be an important step in establishing your company's financials. By opening a separate checking account, savings account and credit card for your business, you'll avoid the headaches that mingling personal and business money can create and you'll make your company's record keeping easier and more robust for the future.

© Copyright 2016 NerdWallet, Inc. All Rights Reserved

How to Boost Your Small Business Credit Rating

Are you a small-business owner who's not getting the love you need from lenders? Are suppliers insisting on terms you find downright unfriendly? 

The common denominator may be a poor business credit score. Here are some steps you can take to fix it.

What Goes into Your Business Credit Score?

Just like a personal credit score, a business credit score measures the level of risk you pose for a lender. Unlike personal credit scores, most of which adhere to the FICO model, business credit scores don't follow an industry standard.

The three major bureaus — Dun & Bradstreet, Equifax and Experian — use different methods to compile and monitor business credit scores. Each calculates its scores according to different criteria and uses different number ranges. Here's an overview:

  • Dun & Bradstreet uses a proprietary Paydex score that is based on payment data. You can develop a respectable score by establishing credit with suppliers you are likely to have an ongoing relationship with. That way, you can build and maintain credit, assuming you pay your suppliers on time — and the earlier the better, as the highest rating is reserved for businesses that pay 30 days earlier than terms demand.
  • Equifax uses three assessments to rate businesses: a payment index examines your payment history, a credit risk score evaluates the likelihood your business will become severely delinquent, and a business failure score measures the chance your business will close.
  • In addition to examining credit history, Experian calculates its score by checking public records for liens, judgments and bankruptcies. It also considers demographic information, including how long you've been in business, the kind of business you're in and the size of your business.

Unlike a personal credit report, which you can get for free, you have to pay between $35 and $100 to see your company's credit report. It's worth it, though, to see if you need to take steps to improve your score.

Manage Your Business Credit Score

Regardless of a particular bureau's approach, you can take steps to beef up your business's score.

  • Establish a business credit history. You probably had to start your business using personal funds and credit. As soon as you can, separate your business expenses from your personal finances. Open a commercial bank account and put your company's bills and account in the company's name.
  • Pay your bills on time. This is the most important thing you can do to boost your score. It's the best way to prove you are not a risk to lenders or vendors.
  • Understand all the factors in your score. Payment history is not all that matters. Much more is involved, including the age, size and type of the business and how close to your credit limit you are.
  • Make sure the information in the credit reports is accurate. Monitor your reports, checking for and addressing errors and updating information as your business develops, because changes in things such as your company's location, staff size and revenue can affect your score.
  • Examine the credit of your customers and vendors. The more creditworthy the people you do business with, the more smoothly your business will run and the less likely some problem with an account will ripple through and end up dinging your score.

Taking steps now to improve your business credit score is a smart idea. The better your company's credit, the more favorable terms you're likely to get from vendors and lenders. And should you face hard times, it can be tough to get small-business loans with bad credit. 

© Copyright 2016 NerdWallet, Inc. All Rights Reserved


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