Why Do Small Businesses Take Out Loans

why businesses need loans imageWhen small or medium sized companies need extra money for their business the first place they will resort to would be small business loans. There are all kinds of reasons why a small business would need a commercial loan. Local banks and credit unions are usually the first place where they would go. Is that the best place to start, well we will see as there are better ways to get loans. Credit unions and banks may ask for some form of collateral to secure a loan. Inventory and accounts receivables are a form of collateral that can be used. There is also a cost to borrowing money and in some cases it could be expensive, so one would need to look at the risk to reward ratio. 
It may be smart to look ahead before getting a small business loan because after it funds a company will be taking on debt and will be on the balance sheets. 

Equipment Purchases and Leasing

Another reason why small businesses need loans is to get equipment. There are a couple of ways to do this with regard to equipment acquisition. They can either lease it or purchase it. 
If they decide to buy it using a loan then a company can take a tax write-off of up to $25,000 for the 1st year of equipment usage and over its economic life depreciate the rest. (Tax laws change frequently so check with your accountant for the latest). Companies will use a piece of equipment for its duration then, when done, get sold for its salvage value. 
How does one even know if leasing or purchasing equipment is right for them? A cost benefit analysis should be performed before making a decision. Intermediate-term loans are commonly used by banks when lending money on equipment. These loans range from 10 to 15 years.

Operations Expansion and Purchasing Real Estate 

When a company has a need to expand their operations or they want to purchase some sort of commercial property, again most will start with their bank and may need financing for commercial property. If they have a great relationship with that bank then it will work well for them. This may be because the bank knows that the company they take deposits from is successful and they may extend offers for loans. 
When a company is expanding this will mean they are certainly profitable and there is ample positive cash flow. On top of that they may even have a positive outlook and forecast for even more success. This is the type of scenarios that banks have an appetite for and will be likely that a loan will go to funding.  Commercial real estate mortgage loans are long term notes that are usually up to 25 years. The collateral is the subject property used for the financing.

Inventory Purchases

product inventory purchasesWhen a small or medium sized business needs to purchase inventory sometimes banks will lend money on this. There are several types of businesses out there that are seasonal especially in the retail sector. The holiday season, usually November and December is one example of this. In this case most of the sales made by a seasonal business like this will be in this time period. 
This means that before the holiday season begins they will need to purchase most of their inventory and prepare for sales ahead of time. Unless they have big cash reserves they may need to get some sort of loan to buy the inventory that they need. Loans to purchase inventory are short term inventory loans and they are paid back quickly. Many businesses use the funds they earned from their sales to pay these inventory purchase loans. 

Working Capital

What is the working capital formula? This is the money a business uses in the management of the day to day operations. There are times when a business will need to get a working capitol loan in order to meet their daily operations needs until their earning assets are adequate to cover that working capital. In order for a business to get up and running these short term business loans can help as long as the funds are used correctly. Ideally a business should use these funds to get what ever assets they have to produce income. Once income and cash flow are consistent, that money can pay back the short term working capital loan to the financial institution that provided it. 
Note: Working capital can be provided in two main ways
1. As a loan from a lender that has a term and an interest rate
2. A merchant cash advance – (structured as a lump-sum payment to a business in exchange for an agreed-upon percentage of future credit card and/or debit card sales. These use a factor rate instead of an interest rate.) source.
If you own or operate a business in the United States and you found this article online and are in need of a loan or a source of funds for your company, be sure to inquire with us as we have several relationships with lending institutions. Many are better than a bank or credit union and want to help you. I hope you have enjoyed this post about Why do small businesses take out loans?
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