How to find the perfect small business loan

As a business owner it is easy to become overwhelmed by the types of lending tools available, but the good news is there is probably a loan that meets your specific business needs. The bad news is when you get pigeon-holed into the wrong type of loan, your business is likely to suffer.

A good suggestion is to match the type of loan to the asset being financed. Here are several principles that ensure the loan you choose is appropriate to the business need you're trying to meet. 

Principle 1: Use short-term financing for a short-term need

If your company is feeling pressure from growing its accounts receivable, you should seek a bank, factoring or asset-based line of credit. These types of credit facilities are revolving, and the loan balance normally moves up or down depending on the asset (usually accounts receivable).

By definition, a short-term asset has a life of less than 12 months. Short-term debt is debt that is paid off within 12 months.

Business owners should consider financing short-term assets (accounts receivable and inventory) with short-term liabilities (loan of less than 12 months to maturity). Using this method nearly always results in the least cost to the borrower but more importantly, it keeps your business from using long-term loans to finance working capital or worse, use working capital to pay for long-term assets.

Principle 2: Finance long-term assets with loans that have maturities that match the useful life of the equipment

Avoid using your working capital to buy long-term assets and leasehold improvements such as equipment and office space, even though these improvements made will pay off over the long run.

From an operational standpoint, spending your working capital on improvements will benefit your business in terms of improved productivity and efficiency.

However, a better solution for business owners out there is to line up a five or seven-year long-term loan to pay for all the new equipment and leasehold improvements as you probably need to save your working capital to pay your employees and other supplies.

Though it is not impossible, it is going to be much harder obtaining a loan to pay for the consolidation costs and leasehold improvements after the fact than if you had arranged the financing beforehand.

Principle 3: Sometimes you have to ignore Principle 1 or Principle 2

Once in a while, your business will need permanent working capital, which refers to a sum of money that needs to stay in the company for the purpose of paying short-term debts only.

A business should only resort to using a long-term loan to provide working capital when it has exhausted all other avenues for providing short-term debt.

The problem with using a long-term loan for short-term purposes is that the cost of borrowing is higher, and that if you need more working capital you probably can't go back to your lender to ask for more until the loan is a couple of years old.

Companies that use this strategy should be prepared to pay off their loan as quickly as possible while keeping as much money available for working capital as possible.

In our current economy, banks are much less willing to loan money for short-term working capital than, say, to finance a new lathe for a machine shop. But there are still options, and if you look hard enough you can find short-term financing for your working capital and long-term financing for capital expenditures and leasehold improvements.

By Sam Thacker of AllBusiness.com

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