How to Understand What Loan Amount Won't Hurt Your Business

Contents:

• Why you shouldn't borrow extra money to develop your business
• How to understand how much money you need to borrow
• How to reduce the financial burden when borrowing
• How to increase the likelihood of investing in your business
• The main thing about business loans in 3 points

Sergey Fedoreev, founder of the VDelo crowdlending platform, shared recommendations for properly applying for a loan. The right approach to borrowing will help you avoid financial difficulties and effectively manage your resources. It's important to assess your capabilities, understand the loan terms, and choose the right option to achieve your goals. Small business loans are becoming increasingly expensive, with interest rates at banks reaching 25-30% per annum and on crowdfunding platforms averaging 27.9%. Seeking insurance, entrepreneurs often take out larger loans, believing that the extra funds will help them cover the initial payments. However, this approach can backfire: high interest rates reduce profitability, and accumulated debt hinders further business development. In this article for the Skillbox Media "Business" editorial team, we will discuss key aspects to consider before applying for a loan. You will receive useful information on how to properly assess your financial capabilities, choose the right loan product, and avoid common mistakes. Understanding these nuances will help you make an informed decision and minimize risks when applying for a loan.

• Why you shouldn't borrow extra money to develop your business;
• How to understand how much money you need to borrow;
• How you can reduce the financial burden when borrowing;
• How an entrepreneur can increase the likelihood of investing in their business.

Why you shouldn't borrow extra money to develop your business

Some entrepreneurs raise more funds than their project requires, hoping that the created "safety cushion" will help them survive a temporary decline in revenue and make the first payments. At first glance, this strategy seems reasonable: it is better to be on the safe side than to face a cash flow gap. In practice, however, high interest rates begin to eat into profits before a business has a chance to develop, and the payment schedule becomes a heavy burden, exceeding the market pressure.

We analyze the situation using data.

To open a semi-finished product manufacturing plant, an investment of 4 million rubles is required. To minimize the risks associated with potential unforeseen expenses, the entrepreneur decides to take out a loan of 6.5 million rubles. The loan term is 18 months, and the interest rate reaches 28% per annum. This approach provides a financial safety net and avoids potential financial difficulties during the business launch process.

When using annuity payments, the difference in amounts becomes significant: instead of 291,000 rubles per month, the company is obligated to pay 473,000 rubles. The overpayment on the small loan is approximately 1.24 million rubles, while for the larger loan, this amount reaches 2.04 million rubles. These additional expenses double the debt burden and increase the risk of a cash flow gap before the business begins to generate profit. Cash flow management is becoming critical to a company's successful operation, and it's important to carefully plan borrowing terms to avoid unexpected financial difficulties.

An entrepreneur is forced to pay interest on funds that aren't producing any value. This reserve doesn't protect the business; on the contrary, it hinders its development. Instead of using funds for marketing, increasing turnover, or developing new areas, the company pays off creditors every month. This negatively impacts the financial condition and growth of the business. Optimizing cash flows and effectively managing reserves will help avoid such situations and direct resources to investments that promote the growth and development of the company.

How to Understand How Much Money You Need to Borrow

When planning a loan, focus not on the maximum amount lenders are willing to provide, but on the actual needs of the business. To do this, you should create a simple financial model that includes monthly revenue, expenses, and a repayment schedule. This calculation will help determine the true financing need and avoid placing an unnecessary financial burden on the business. Proper loan planning promotes business sustainability and enables effective cash flow management.

The optimal strategy involves modeling the worst-case scenario: determining the minimum possible revenue and assessing whether it is sufficient to cover payments. This approach helps answer the key question: "How much money do I really need to cover my financial obligations in the worst-case scenario?"

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A financial model is an essential tool for business analysis and planning. It helps entrepreneurs and investors evaluate financial performance, forecast revenue and expenses, and make informed decisions. Developing a financial model involves several key stages.

The first step is collecting data on the company's current financial position, including revenue, expenses, assets, and liabilities. Next, it is necessary to determine key parameters, such as the target audience, market trends, and the competitive environment.

The next stage involves creating revenue and expense forecasts based on the collected information. It is important to consider various scenarios to assess possible risks and opportunities. After this, the model must be tested under various conditions to ensure its robustness and accuracy.

A financial model must be flexible so that it can easily adapt to changes in the business or market. Regularly updating the model will keep it relevant and improve the effectiveness of financial management.

A properly developed financial model facilitates a deeper understanding of the business and its financial aspects, which in turn allows for more strategic decision-making.

How to Reduce the Financial Burden When Taking Out a Loan

During loan repayments, it is possible to negotiate favorable terms of cooperation with counterparties. For example, you can discuss the possibility of providing discounts, agree on payment for services based on performance or in stages. It is also useful to establish key performance indicators (KPIs), which will serve as the basis for calculating the cost of services. This approach will help optimize financial costs and improve the terms of cooperation.

Deferred payments and their connection to revenue are becoming especially important for agencies, contractors, and suppliers. These measures can significantly reduce the financial burden on a business. It is important to remember that your counterparties will be the first to request payment. Therefore, payment terms must be considered in advance, before receiving the funds. Every concession under these conditions is a step toward financial stability and ensures the ability to service loans without undue effort. A proper approach to cash flow management promotes business stability and reduces the risks associated with non-payment.

How to increase the likelihood of investing in your business

A common reason for loan denial is an insufficiently detailed description of the business in the application. Wording such as "replenishing working capital," "for business development," or "for equipment" without further explanation makes the project unconvincing. Specific goals, such as "expand the sales floor to increase revenue by 20%," are much more convincing. It is also important to describe how the business generates income, its experience, and what risks have already been taken into account. A detailed and clear description will help create a positive impression of the project and increase the chances of loan approval.

To successfully attract investment or lending, it is necessary to support the goal statement with specific figures and facts. It's important to present projected revenue, expected margin growth, project timeline, and projected payback to investors or lenders. The more transparent your presentation of the loan's impact, the more confidence you'll inspire in investors in the feasibility of your business plan. The key is not only demonstrating how the funds will be spent but also convincingly explaining why, for example, revenue will increase by a certain percentage. This will help create more reasonable expectations and improve your chances of obtaining funding.

The Key to Business Loans in 3 Points

• Excess borrowed funds don't insure; they increase the monthly burden on the business, reduce margins, and can lead to a cash flow gap before the business begins to generate profit. To avoid falling into a debt trap, it's important to focus on your actual financial needs, not on the maximum amount you're willing to lend.
• A financial model with monthly income, expenses, and a loan repayment schedule will help you avoid overestimating your capabilities. It's worth modeling even the worst-case scenario to check whether your business can handle payments with minimal revenue.
• To secure investment, it's important to explain in detail why you need the money. General statements create mistrust, while specific goals, backed by figures and projected impacts, increase your chances of approval. The better an investor understands how their money will generate profit, the more willing they will be to invest.

Read more articles on business finance from the Business and Management editorial teams at Skillbox Media. Here you'll find relevant materials that will help you better understand the financial aspects of running a business and apply them in practice. We publish tips, insights, and trends to help you make informed financial decisions and grow your business.

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