5 Tips to Keep in Mind When Obtaining a Small Business Loan

More likely than not, if you are starting a small business, you will need to secure a small business loan. The U.S. Small Business Administration (SBA) offers help and advice on securing a small business loan. Some of the points to consider before applying for a loan include the following:

1. Assessing your financial needs. First, determine how much money you will require from the small business loan. For what purposes will that money be used? How will the money that is loaned out to you help your business plan? Incidentally, if you have no business plan, make sure to write one now. Most lending agencies will want to take a look at your business plan and where the capital will be allocated before any loans are considered.

2. Borrowing money. When borrowing money for your small business, there are usually two types of financing: equity and debt. Equity financing (also known as equity capital) occurs when a company raises capital in exchange for ownership shares in the business. The money that is raised does not need to be repaid over a set period of time. Debt financing is when a company borrows money and must later repay it, usually with interest. The lenders do not own shares in the company when debt financing is secured.

Regardless of whether equity or debt financing is secured, lenders and venture capitalists will assess the company's debt-to-equity ratio before making an investment. In most cases, investors prefer that a business's total debt and/or liabilities not be more than four times the amount of the business's equity. Ability to repay, the amount of business collateral, management experience, as well as personal and business credit history, are also examined.

3. Establishing business credit. Many business owners assume that business credit and personal credit are separate entities. However, if you have not owned a business in the past, the only credit your lenders can examine is your personal credit. Therefore, prior to taking a loan, it is imperative that you get your personal finances in order. Obtain your credit report from agencies such as Equifax, Experian, or Trans Union and note any errors or omissions that may be present.

4. Estimating startup business costs. It costs more money to start a business than to simply keep it going. Additionally, while some businesses can be started using almost no cash, others require extensive initial spending. To find out how much seed money you will need, estimate the costs of business operation for at least several months. Separate one-time from ongoing costs; for example, incorporating your business is a one-time cost, while utilities and insurance are ongoing costs. Likewise, divide your expenses into the following two categories: fixed and variable. Fixed expenses are items such as rent and insurance. Variable expenses are items such as sales commissions, shipping charges, and inventory storage charges. An effective tool for making such calculations is the following Starting Costs Calculator.

5. Creating financial statements. Once your small business loan is secured, you will need to track it and make sure that it is being spent wisely. Tracking your loan may even be a requirement if you have secured equity financing from private stockholders and venture capitalists. Most businesses track and report their financial activities via balance sheets and income statements.

The balance sheet explains a company's financial health at a certain point in time. On the balance sheet, several items are listed, including company assets, liabilities, and net worth. The balance sheet is so called because at the document's bottom line, the company's assets must equal its liabilities plus net worth. Assets are all the items of value that are owned by or due to the business. Liabilities and net worth are typically the business's source of funds.

The income statement (also known as the profit and loss statement) describes a company's profitability over a set period of time. Income statements are useful because they show how much net profit a business is generating after all expenses are accounted for. In order to generate a balance sheet for your business, or an income statement, you may go to the following SBA resource.