Small business loans are financial instruments designed to provide entrepreneurs and business owners with the capital they need to fuel various aspects of their operations. From stocking up on inventory and purchasing new equipment to expanding into new markets, these loans offer the financial flexibility to make strategic moves.
However, small business loans come with their own set of challenges, such as interest rates and stringent repayment terms. Failing to meet these obligations can lead to financial strain and even jeopardize the business's long-term viability.
That's why you should only secure a small business loan for essential, well-planned purposes. If you need one, you must have a solid plan for how you'll use the loan and a realistic strategy for paying it back. To help you in your journey, MoneyGeek explored some of the best uses of small business loans in this guide.
When you're running a business, expenses don't wait. Having adequate working capital ensures that you can meet obligations — like payroll, utility bills or immediate inventory needs — without a hitch. A small business loan dedicated to boosting working capital can be particularly beneficial during seasonal lulls or unexpected downturns.
For instance, a retail store might experience slower sales after the holiday season but still needs to pay its staff and keep the lights on. A working capital loan can bridge this financial gap, allowing the business to operate smoothly until sales pick up again.
Moreover, working capital loans can offer the flexibility that other types of loans may not provide. These loans often have shorter repayment terms and may not require collateral, making them more accessible for businesses that might not have extensive assets. This flexibility allows you to adapt quickly to market changes or capitalize on new opportunities.
Before applying for a working capital loan, first calculate your working capital needs accurately. One common method is the “Current Ratio,” which is your current assets divided by your current liabilities. A ratio above 1 indicates that you have more assets than liabilities, but that doesn't necessarily mean you have enough liquidity to cover immediate expenses.
Equipment purchases can be a significant capital expenditure for small businesses, but they're often necessary for growth or even just to maintain current operations. Whether you're in the food industry and need a state-of-the-art oven to meet increased demand or you run a digital marketing agency and need high-performance computers for your team, the right equipment can dramatically improve efficiency and product quality.
A small business loan can enable you to acquire these vital assets without depleting your working capital. The beauty of equipment loans is that they often come with terms that match the lifespan of the equipment itself. This means you're not stuck paying off a loan long after the equipment has become obsolete. Plus, the equipment itself often serves as collateral for the loan, reducing the need for additional assets to secure the funding.
When considering a loan for equipment purchase, perform a cost–benefit analysis to ensure that the investment will generate a positive return. This involves calculating not just the cost of the equipment and the loan interest but also the expected increase in revenue or decrease in operational costs that the new equipment will bring.
Inventory stocking is often a delicate balancing act for small businesses. On one hand, you don't want to have too little inventory and miss out on sales opportunities; on the other, overstocking can lead to increased holding costs and potential waste. A small business loan can be a strategic tool to optimize your inventory levels, especially when you anticipate a surge in demand or when suppliers offer bulk purchase discounts.
Using a loan for inventory also allows you to improve your business's cash conversion cycle. By having the right products available at the right time, you can speed up sales and thereby the rate at which inventory turns into revenue. This is particularly beneficial for businesses with seasonal sales cycles or those dealing in perishable goods.
Before taking out a loan for inventory, establish a solid inventory management system first. Utilize tools or software that can help you track sales data, seasonal trends and customer preferences. This data-driven approach will enable you to make more accurate forecasts about the types and quantities of products you'll need.
Business expansion is often a pivotal moment in a company's lifecycle, signaling readiness to scale and capture a larger market share. However, expansion comes with its own set of financial demands, from leasing a new space and renovating it to fit your needs, to hiring additional staff and launching marketing campaigns to attract new customers.
A small business loan can provide the necessary capital to fund these activities in a structured manner. For instance, if you run a successful coffee shop and have identified a new neighborhood lacking in quality coffee options, a loan can help you secure that prime location and customize it to mirror the ambiance and service quality of your original outlet.
The strategic use of a loan for business expansion can also open up new revenue streams that help you pay back the loan more efficiently. For instance, if you own a fitness center and decide to add a spa service, not only do you attract a new customer base interested in spa treatments, but you also offer an additional service to your existing gym members. This can significantly boost your monthly revenue, making the loan a worthwhile investment.
Conduct thorough market research to validate the demand for your product or service in the new location or segment you're targeting before taking the plunge into business expansion. Utilize surveys, focus groups or even a soft launch to gauge customer interest. Also, prepare a detailed financial model that includes projections for revenue, expenses and cash flow in the expanded business.
Marketing and Advertising
Marketing and advertising are often the engines that drive business growth, but quality campaigns require financial investment. Whether you're looking to launch a comprehensive digital marketing strategy, invest in pay-per-click advertising or even sponsor a local event, the costs can add up quickly. A small business loan can give you the financial leeway to execute these plans effectively.
The advantage of using a loan for marketing and advertising is that these activities often generate measurable returns. Unlike some other expenses, marketing campaigns can be directly tied to increases in customer engagement, brand awareness and ultimately, sales. This makes it easier to justify the loan as an investment in your business's future.
Have a well-defined marketing plan with clear objectives and key performance indicators (KPIs) before applying for a loan to fund your marketing and advertising efforts. This will not only help you determine how much funding you'll need but also enable you to measure the effectiveness of your campaigns. If possible, start with smaller test campaigns to gauge ROI. Use the insights gained from these tests to refine your larger, loan-funded campaigns.
Debt consolidation can be a strategic move for small businesses juggling multiple high-interest loans or lines of credit. The complexity of managing various repayment schedules, interest rates and terms can not only be a logistical nightmare but also lead to missed payments and higher costs in the long run. By taking out a single, lower-interest small business loan to pay off existing debts, you can simplify your financial horizon.
The benefits of using a small business loan for debt consolidation extend beyond mere convenience. By replacing multiple high-interest debts with a single loan that has a lower interest rate, you can significantly reduce the amount you'll pay in interest over time. This can free up cash flow for other essential business activities or even allow you to pay off the consolidated loan more quickly.
Carefully review the terms of your existing loans and compare them with the terms of the new consolidation loan. Look out for any prepayment penalties on your current loans and factor these into your calculations.
Emergency expenses are often unforeseen but can have a significant impact on your business operations. Whether it's a sudden equipment breakdown, unexpected legal fees or urgent repairs due to natural disasters, these costs can disrupt your cash flow and put your business in a precarious position. A small business loan can help in such situations, allowing you to address the emergency without derailing your regular operations.
The advantage of using a small business loan for emergency expenses is that it enables you to continue your business. Instead of diverting funds from other areas like payroll or inventory, a loan ensures you can meet both the emergency costs and your ongoing operational expenses. This is particularly important for businesses with tight margins or those in highly competitive markets, where even a short period of inactivity can lead to a loss of customers.
While a loan can be a lifesaver during emergencies, you should also build a contingency fund for your business over time. Use financial planning tools to set aside a portion of your profits for unexpected expenses. Having a contingency fund can reduce your reliance on external financing and give you more control during crises.
Factors to Consider Before Getting a Small Business Loan
Before diving into the world of small business loans, evaluate various factors that can influence not only your eligibility but also the long-term impact on your business. These include:
Your credit score: Lenders may use your personal credit score or business credit score as a measure of your reliability. If you have a high credit score, you're more likely to secure a loan with favorable terms. However, if your score is low, consider ways to improve it before applying for a loan to avoid high-interest rates or rejection.
The interest rate: The interest rate is a major component that determines the overall cost of the loan. While a low-interest rate can save you money in the long run, it's essential to understand whether the rate is fixed or variable. A variable rate might start low but could increase over time, affecting your repayment plan.
Additional fees: Beyond the principal and interest, some loans come with additional fees like origination fees, late payment fees or prepayment penalties. For example, an origination fee could add an extra 2–3% to your loan amount, increasing the total cost of borrowing. Always factor these into your calculations to understand the true cost of the loan.
Collateral requirements: Some loans may require collateral, such as business assets or even personal assets, to secure the loan. Understand what's at stake and whether you're comfortable using specific assets as collateral. For instance, using your home as collateral might secure a larger loan but also poses a significant personal risk.
Cash flow and financial statements: Lenders will scrutinize your financial records to assess your ability to repay the loan. Ensure your financial statements are up-to-date and accurately reflect your business's health.
Type of loan: Different types of loans serve different purposes, from equipment financing to working capital loans. Choose the type that best suits your specific needs. If you're looking to stock up on inventory for the holiday season, a short-term loan might be more appropriate than a long-term loan meant for business expansion.
Frequently Asked Questions
We compiled a list of frequently asked questions that business owners grapple with as they consider taking out a small business loan.
About Christopher Boston
- U.S. Small Business Administration. "Loans." Accessed September 11, 2023.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
Editorial Disclosure: Opinions, reviews, analyses and recommendations are the author’s alone and have not been reviewed, endorsed or approved by any bank, lender or other entity. Learn more about our editorial policies and expert editorial team.