How to Determine if a Small Business Loan Can Benefit Your Company

Have you been overwhelmed during peak seasons, unable to keep up with customer demand? Perhaps your phone has yet to stop ringing, leading you to turn away repeat clients because you simply need more hands on deck. You wish to hire another employee to handle appointments, but your current income needs to stretch farther to cover the additional payroll. This situation is common to all growing businesses. One solution is to get a small business loan. But how do you know that you can afford this loan?

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In this article, we’ll walk you through the steps to determining if getting a small business loan is right for you. Loans can open up opportunities, but you must ensure it’s worth it.

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Determining When To Get a Small Business Loan

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Taking on additional liabilities is a huge decision, so you establish that you need them. Here are several trends or indicators that signal you might need a loan:

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Struggling to Take On More Clients

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Your business might grow rapidly, and you can no longer keep up with new client inquiries and appointments. For example, you could have onboarded three more clients for the month but don’t have enough workers or service vans. Here’s how to calculate the potential income loss from these clients.

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1. Calculate your average fee per client.
2. Multiply that fee with the number of lost customers.
3. Calculate this lost income as a percentage of your total monthly revenue.

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For example, if you charge a client $5,000 for a service and away 3 extra clients that month, your lost income would be $15,000. Let’s say your business earns $25,000 monthly. Your lost income as a percentage of your revenue is: $15,000/25,000 X 100 = 60%.

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Struggling to Cover Expenses During Slow Months

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According to the SCORE Foundation, 82% of small businesses fail because of cash flow problems. A positive cash flow means more money is coming in than going out from your company. This shows you have enough cash to pay for your daily operations, also known as working capital, including having reserves when business is slow.

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To determine if you have enough cash buffer, calculate your total monthly expenses and multiply that with the number of projected slow months. If your cash inflow is insufficient to cover utilities or payroll for several months, a loan might help tide you over in the short term until your sales ramp up again.

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Struggling to Execute Your Growth Strategy

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Part of your growth strategy might include increasing the number of your long-term clients. But to do so, you might need to expand your operations into another location where your target customers are. This would require building a new office, hiring more workers, and buying more equipment. But if you have limited resources, your growth projects are limited too. Getting a small business loan can help you prioritize your overall expansion plan so you can start scaling up or exploring new offerings without worrying about your cash flow.

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Determining Your Financial Capacity to Pay Off Loans

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Now that you’ve established you need a loan, it’s time to analyze your financial health. This will let you know if you can take on a loan without getting overwhelmed by interest payments.

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Analyze Your Financial Statements

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Your Income Statement (also known as the Profit and Loss Statement) will let you know if you’re earning enough to pay for your current expenses, including existing loan payments, by listing your sales and operating costs. Meanwhile, your Balance Sheet will show you how many liabilities your business already has, including long-term debts, and if your assets, like cash, can fund these liabilities. Finally, your Cash Flow Statement will let you know if you have a positive operating cash flow, meaning you can fund your daily operations and pay off your short-term debts. Comparing your revenue/assets versus your expenses/liabilities will help you determine whether you have enough funding for new liabilities. These statements are typically required when you apply for a loan, so it’s a good idea to have them ready.

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Create a Loan Repayment Plan

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The next step is to make a detailed plan to pay off your loans quickly and cost-efficiently. This includes studying the terms and conditions, including interest rates, payment schedules, and penalties for missed payments. If these steps are overwhelming, consider hiring an accountant or financial advisor to guide you. Preparing in advance can give you peace of mind that you have covered all your bases.

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Evaluating the Investment Opportunity

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Now that you have a repayment plan, it’s time to choose which opportunity is best for your business. Remember that just because there’s an opportunity doesn’t mean it’s right. You have to conduct a cost-benefit analysis before committing to any expensive investments.

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Here’s how:

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• Establish the main goal. What does success look like for this investment? Is it more sales or reduced expenses? For example, consider investing in bookkeeping software with a built-in invoicing feature to track and lower your unpaid invoices (accounts receivable) over the next 12 months.
• List your costs and benefits. List your projected costs and benefits for this investment. This can include direct costs (hiring a service provider) and indirect costs (utilities and rent). Benefits include direct (reduced aging invoices) and indirect benefits (fewer sick leaves for your finance team due to stress). After you’ve listed them, assign a dollar value for each cost and benefit.
• Add the total value of the benefits and costs. Tally the dollar value of the benefits and costs to compare them. If the total benefits are higher than the total costs, then it’s a good investment.

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Determining the Return on Investment

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When assessing the viability of a small business loan, it's crucial to determine the anticipated return on investment (ROI). This involves calculating how long the investment will take to generate a profit.

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For instance, using the Payback Period method to evaluate ROI if considering new equipment. This method calculates the time needed for the investment to 'pay for itself' through generated income.

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Example: You purchase a new cargo van for $30,000, anticipating it will generate an additional $10,000 in revenue each year. If the operating costs related to the van (fuel, maintenance, insurance) total $3,000 annually, the net additional income (or profit) is:

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Net Income = Revenue−Operating Costs = $10,000−$3,000 = $7,000

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To calculate the payback period:

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Payback Period = Cost of the Equipment/Net Annual Income = $30,000/$7,000 per 𝑦𝑒𝑎𝑟 ≈ 4.3 years

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This calculation indicates that the van will pay for itself through the net income it generates in approximately 4.3 years.

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ROI can also be expressed as a ratio of net benefits to the investment cost:

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ROI = (Net Benefits/Total Costs) × 100

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Example: Considering a QuickBooks Basic subscription costing $328 annually, which saves you $1,500 per year in operational costs, the net benefits would be:

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Net Benefits = Savings − Cost =$1,500 − $328 = $1,172

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ROI = ($1,172/$328) × 100 ≈ 357%

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This adjusted calculation still shows a 357% return on your investment, confirming a significant gain.

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Prepare For Your Small Business Loan With Decimal

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A loan can accelerate your business growth, provided you use it wisely and choose the right investments. If you’re looking to see if you’re financially ready for a small business loan, Decimal can automate your bookkeeping and financial reporting so you can have updated and accurate data for decision-making.

‍Schedule a meeting with us to learn how we can make your financial operations stress-free.