5 Common Mistakes When Borrowing Money for a Business

There are a host of reasons why one might need to seek out a loan for their business. A loan may be necessary to start a business, to expand a business, to buy equipment or inventory, or to cover unexpected expenses, among other scenarios. While business loans can be helpful, borrowing money always comes with risk especially if you’re not well-researched and prepared. Let’s take a look at some common mistakes when borrowing money for a business.

Not using the right loan

All loans are not created equal and the best loan for one expense may not be the best loan for another expense. “You want to understand what you’re going to use the money for and get the right loan product that goes with what you’re buying,” says Diana Waterman, Fractional Controller at Finatics Accounting. For example, a business might use their Line of Credit to purchase a piece of equipment – when it may be better to get a longer term loan that has lower monthly payments to buy the equipment and save the Line of Credit as a safety net for their operational expenses to reduce cash flow risk. By using the right loan for what you need, it will better set your business up for success.

Not considering the whole picture

When determining if a particular loan is best for what you need, there are other factors to consider outside of the loan term and interest rates. Although these factors are very important, so too are the loan size, level of payment flexibility, and default conditions. For example, if you default on your loan, will the bank have the right to sell collateral, such as your assets, inventory, real estate, or other items? To assess the borrowing risk involved with a financial institution, be sure to get the whole picture of the loan agreement. It can be helpful to talk to different lenders to consider the various agreements they are able to offer.

Borrowing too little or too late

The apprehension of borrowing a lot of money is understandable. However, it may create a greater risk down the road. For example, if you under-projected how much a project was going to cost, borrowing too little may mean being faced with a cash flow issue when unforeseen expenses arise. Similarly, borrowing too late can also create risk. If you decide to finance a project up until you need to borrow money, this can not only put financial pressure on your business but you may also run the risk of getting an undesirable loan in order to quickly pay for the expenses.

One way to mitigate these risks is to ask your trusted accountant to develop cash flow projections and forecasts to help you plan ahead, consider worst-case scenarios and to ensure you borrow enough money to cover unexpected expenses.

Not being prepared

Depending on the size of the loan you need, getting the loan approved may be straightforward or can be more involved. Lenders may require you to provide a clear and solid business plan, financial reports of the company’s performance, how you plan on using the borrowed money, and projections. An insubstantial, vague application can give the impression that you may be a high-risk borrower and could result in your loan application getting rejected. It’s important to be very prepared when applying for a loan – practise your pitch and know your numbers so that lenders will feel confident that you won’t run the high risk of poor financial management and potential default.

Not staying on top of finances

Financial management can too often fall to the wayside when business obligations and tasks may be needing your immediate attention. Receipts and invoices pile up, record keeping gets backed up, and accounting issues rapidly increase – making it difficult to get a loan but also, if you were able to secure a loan, you run the risk of not being able to make timely payments. It’s important to be diligent with your financial records. If you don’t have time to keep on top of record keeping, offload the task to a bookkeeper so that you can feel confident your books are up to date and you’re not in the dark about the financial health of your business.

Think you need help preparing for a business loan? Our team at Finatics Accounting can help – get in touch.