Everyday at Fundera, we speak to small business owners around the country who want a loan. However, one of our goals is to transition them from using the word “want” to the word “need”. If you are currently consulting your clients about their working capital options (which we hope you are), we challenge you to adopt that same goal.
Why? Many businesses want a loan, but a loan is one heck of a commitment, so before they take the plunge, it’s important you work with your clients to ensure that they do in fact NEED this working capital, and the reason they plan on taking this debt is valid.
How do you do this? Perform a cost-benefit analysis with your clients that are evaluating a small business loan.
Work with your customers to prove that:
Benefit > Cost
Or that the benefit of this debt outweighs the cost. Sit down with your client and ask them:
- How can we prove this loan will advance your business?
- Is there any way we can verify that this loan will increase revenue?
That’s why it’s important you understand your client’s loan purpose. Just as with most things, there are good uses and bad uses for borrowed funds.
For example?
Good Uses
1. Expansion
Sales from an additional location would certainly contribute to revenue. The client needs to have researched the demand and feel confidant that the new location will perform as expected. Help them create a monthly sales forecast and be sure that the forecasted sales are greater than what the monthly loan payment would be
2. Consolidating Debt
Consolidating business debt is often a very smart move, and something you should try to do with your clients that have multiple loans. It helps reduce the number of creditors they are working with. However, it’s only worthwhile if the client can get a better interest rate.
3. Cash Flow Gaps
If your client is currently waiting to get paid from their customers and they expect it to be a few months before that happens, taking out a short-term loan to overcome this gap can be a good decision, as they know the cash will eventually come in.
4. Marketing
If your client has a marketing channel that they know works, it might be worth it to take out a loan to invest in that channel. After all, it takes money to make money. Just make sure that the channel is a profitable channel (meaning they make more money off the customers they acquire through it than they spend in acquiring the customer).
Bad Uses
1. Paying Overdue Bills
Taking on debt to pay bills is creating a dangerous cycle. Unless your client is, without a doubt, expecting to receive a major cash infusion, they’ll just be creating more problems for his or herself later.
2. Paying Off Another Loan With Lower (or Equal) Interest Rate
If the new loan is of equal or greater interest rate, don’t let your client even think about it. The monthly payment may be lower, but that could be related to the terms of the loan.
3. Buying Something Just to Get a Discount
While we all love a good sale, if your client can’t link the purchase of the discounted inventory or supplies to increasing sales, it’s simply not worth it.
Of course, this isn’t black and white, and this is only a handful of situations. Borrowers #1 use of funds is for “working capital”, but they’re all using this working capital in many, many different ways.
This is what is so exciting about your role in your client’s loan search. With your financial prowess, you are able to sit down with them, identify their loan purpose, and work to figure out what this cash influx will do for their business. If together you can verify that the cost they will incur to take on this debt will be much less than the benefit it will eventually bring, than you can confidently tell your client this is indeed a good decision for their growing business.
If you have any questions on the cost-benefit of business loans, please let us know in the comments or email advisor@fundera.com.
Meredith Wood is Editor-in-Chief and VP of Marketing at Fundera, a marketplace for small business financial solutions. Specializing in financial advice for small business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.