A business loan is not always the right answer. If repayments would put more pressure on already-stretched cash flow, or the borrowing does not address the underlying problem, taking on more debt could make matters worse.
Before borrowing, consider what the money is for, how it will be repaid and what the total cost and risks will be. Here are some situations where it may be sensible to pause and look at other options first.
1. You are taking new loans to repay existing ones
Taking out further short-term loans to keep up with existing repayments, sometimes called loan stacking, can create a difficult cycle. Each new facility adds another commitment, and the business may end up borrowing again simply to cover earlier borrowing.
That does not mean every business with more than one loan should rule out further finance. But before adding another facility, make a clear list of what the business owes, including balances, repayment amounts, fees and any settlement costs. Then look at whether the new borrowing would solve a short-term timing issue or simply defer a wider cash-flow problem.
Some steps to consider first include:
- Reviewing your customer order book and outstanding invoices. Who owes you money? Are any invoices overdue, and can you follow up with those customers? Would any customers be willing to pay early?
- Speaking to your accountant. Ask them to review a cash-flow forecast with you, so you can see when money is expected to come in and when bills are due.
- Checking whether an HMRC payment plan may be appropriate. If a VAT or Corporation Tax bill is the pressure point, our guides to VAT funding and Corporation Tax funding compare borrowing with HMRC Time to Pay. You can read about setting up a payment plan with HMRC. HMRC will assess your circumstances and whether the proposed repayments are realistic and affordable; an arrangement is not guaranteed.
- Talking to suppliers or contractors. If you owe them money, ask whether they would consider an extension, payment plan or line of credit while you get a clearer view of cash flow.
- Understanding your existing loan agreements. If affordable, continuing with current repayments may be more suitable than taking on another loan. Check the terms and speak to the lender if you are concerned about meeting payments.
Debt consolidation may be worth exploring in some circumstances. However, a lower monthly payment can result from extending the repayment term, which may increase the total amount paid. Some lenders may also ask for security against business assets or property. Read our guide to business debt consolidation for more information.
The British Business Bank’s guidance on refinancing and debt consolidation also notes that restructuring debt may not be enough if a business’s income is continuing to fall. If you are worried about the business’s ability to pay its debts, speak to your accountant or a free, independent service such as Business Debtline promptly.
2. The repayment term does not suit your plans
A longer loan term can reduce the regular repayment, but it may mean paying interest for longer and increasing the total cost. A three-year term and a five- or six-year term can have very different total repayment amounts, depending on the interest rate, fees and agreement.
Think carefully about the term you need, especially if the agreement does not give you the option to settle early. Check the terms before committing: early settlement may not be available, or it may involve conditions or costs.
Ask for the total amount repayable as well as the monthly repayment. Consider whether the term matches the purpose of the borrowing. For example, it is worth questioning whether a long repayment commitment makes sense for a short-lived cash-flow need.
3. You may need to replace an asset used as security
Asset refinance can be one way to raise capital by borrowing against equipment or vehicles the business already owns. But consider the condition and likely remaining useful life of the asset before proceeding.
If machinery or a vehicle is starting to show faults, you may need to replace it soon. Refinancing it could leave the business with repayments secured against an asset that also needs repair or replacement. That could create extra pressure just when a significant cost is due.
Before using asset refinance, check how the repayments fit your forecast, what security the lender will require, and whether the asset is likely to remain reliable throughout the agreement. Consider getting advice on its condition and replacement costs where appropriate.
4. A personal guarantee could put too much at risk
Before agreeing to a personal guarantee, consider how much you have already guaranteed on other loans or facilities. Ask what could happen if a lender called on the guarantee because the business could not repay.
A personal guarantee may make you personally responsible for some or all of a business debt, depending on its terms. Consider whether your home, savings or family finances could be affected. It can be a difficult conversation, but it is important to understand the commitment before signing. Our guide to unsecured business loans explains how personal guarantees typically work.
Read the guarantee and the finance agreement carefully, and consider taking independent legal advice if you are unsure what you would be agreeing to. Ask the lender or broker to explain the relevant terms, including the extent of the guarantee and when it could be called upon.
5. The return on the investment may not justify the borrowing cost
If you are borrowing to buy stock or fund another investment, estimate the likely return and compare it with the full cost of borrowing. Be realistic about how long it will take to sell the stock or generate income, and whether the business can afford the repayments if things take longer than expected.
For example, purely as an illustration, a business might expect to make a 40% margin on stock and repay a loan in three months, with a borrowing cost of 8%. That might appear worthwhile, if the figures and timing prove realistic. But if stock may take a year to sell, a 20% margin alongside a 20% borrowing cost could be much harder to justify.
These are simplified examples, not client cases or a recommendation to borrow. A margin and a finance cost are not necessarily calculated on the same basis. Include other costs, overheads, potential delays and the effect of the repayments on working capital. A forecast should also consider what happens if sales are lower than expected.
A final check before you borrow
A business loan may be more appropriate when there is a clear purpose, a realistic repayment plan and enough room in the forecast to manage the repayments. Before proceeding, ask yourself:
- What exactly will the funds pay for?
- How will the borrowing be repaid, and when?
- Have I checked the total amount repayable, not just the regular instalment?
- Could a late-paying customer, delayed sale or unexpected bill affect affordability?
- What security or personal guarantee is required?
- Have I explored practical alternatives, such as collecting overdue invoices or discussing payment terms?
A broker cannot plan your business for you. Our role is to explain the options available through a specialist lender panel and make sure you understand the relevant costs, repayments and risks, so you can make an informed choice.
SME Finance Hub is a trading style of Capital Business Loans Limited, an FCA-authorised credit broker, not a lender. There are no upfront broker fees and no obligation to proceed. Commission is paid by the lender and disclosed before you commit. Enquiring involves no hard credit search and does not affect your credit score; if you choose to proceed, further checks may apply and will be explained beforehand.
To discuss your options, call 01244 906505 or email hello@smefinancehub.co.uk.