Having access to financing is a necessity of modern business. From business loans to investment funding, companies of all sizes need to be able to access cash for a variety of needs. The wisest of company owners knows that different forms of financing apply to different kinds of needs and that the cost of financing need always be considered.
Do you own a business with current funding needs? Are you starting a new business from scratch? In either case, it’s important that you learn the real cost of business loans before you begin applying. Like any other kind of finance, business loans are not free. Borrowing incurs interest, fees, and charges, etc. You need to be aware of everything you will pay into a loan for the privilege of borrowing.
Different Kinds of Business Finance
Before a business owner begins looking at financing options it helps to know what those options are. In short, there is more than one way to fund an immediate need. Business loans from banks and building societies are just the beginning. There are so many other options, depending on a company’s needs.
For example, some companies temporarily increase cash flow through invoice financing. Others establish business lines of credit that allow them to meet expenses without draining their cash. At any rate, every form of business financing comes with its own fees and charges. They all combine to create a total cost of borrowing.
Borrowing Through Business Loans
Traditional business loans represent the most common way of financing small business needs. A business loan is to a company what a mortgage is to a homebuyer. It represents a significant investment intended to meet some immediate financing need. So what can you expect from such loans?
Obviously, every loan includes interest payments. Beyond interest though, small business loans often come with the following fees:
- Application Fee – A fee assessed to cover the cost of processing an application. Some institutions make application fees non-refundable in cases of rejected applications.
- Origination Fee – This fee is assessed only after an application has been approved. It covers the cost of processing the loan (e.g., completing paperwork, moving the loan through the underwriting process, etc.).
- Documentation Fee – A fee assessed to cover the cost of producing the documentation required to finalise a loan.
- Assorted Other Fees – This last category of fees covers a range of different charges. These are things like late payment fees, early repayment fees, cheque processing fees, and so forth.
Understanding the total cost of borrowing is a matter of adding up all the known fees and combining them with interest payments. This number tells a business owner how much he or she will pay over and above the amount borrowed. Why does this matter? Because some forms of financing may be too expensive for the need being addressed.
3 Key Factors
So how does a business owner go about determining the best financing option for a particular need? By considering three key factors: the total cost of borrowing, collateral, and credit history. All three will determine the availability and suitability of funding solutions to meet a particular need.
The cost of borrowing has already been covered in the previous section. If you have a short-term cash flow need that could be met more cheaply through invoice financing than a small business loan, the former is probably the better option based solely on the total cost of borrowing. Now let’s look at the other two.
There are both secured and unsecured business loans just as there are for consumer loans. An unsecured business loan provides the money you need on the principle of good faith. A business owner is expected to repay what has been borrowed without any collateral backing up the loan. A secured loan is just the opposite.
This may be important if a business is unable to obtain unsecured financing. Assuming that a secured loan is the only other option, the collateral being offered in exchange for that loan has to be considered. Is the business willing to put its equipment and chattels on the line in order to borrow?
2. Credit History
The third factor, credit history, comes into play in that it influences the total cost of borrowing. A business with a less desirable credit history will pay more in interest and fees. A company with a stellar credit history will enjoy lower rates and fees. This suggests credit history may steer a company away from traditional business loans and toward less conventional financing options.
Any business entertaining the thought of borrowing should understand its real costs before applying. The real cost of borrowing is critical because it has a real effect on a company’s bottom line.