Small business financing can be a powerful tool for entrepreneurs seeking to grow their ventures, yet, to get the most out of it, it is important to understand the difference between leverage and debt.
Debt is a term that often produces a negative reaction from individuals as mainstream media commonly focuses on the risks and pitfalls of taking on too many of them.
However, a less frequently mentioned concept is leverage, which refers to the possibility of using debt productively as a resource to materialize a project or venture.
The following article will focus on how small business financing from companies like Camino Financial can be used to grow a company.
How does financing for small businesses work?
Small business financing is a type of debt consisting of multiple credit instruments including credit lines, installment loans, secured loans, and title loans.
Nowadays, both traditional financial institutions and financial services companies offer access to financing for small businesses yet this last group often offers more flexible terms and expedited application and approval processes.
For example, Camino Financial, a California-based fintech company, offers small business financing at competitive rates starting at 1% per month with the repayment period going from 24 to 60 months depending on the borrower’s credit situation and the amount of the loan.
Meanwhile, the criteria used to qualify prospective borrowers to tend to be less strict compared to financial institutions and the application process can be completed in less than 10 minutes.
Businesses can use these kinds of loans for multiple purposes including the purchase of inventory, fixed assets, or to fill temporary budget gaps caused by unexpected business downturns.
What are some of the benefits of financing for a small business?
Aside from the relatively easiness of obtaining small business loans nowadays through fintech companies, there are also tax advantages associated with taking on leverage for your company. First of all, interest rates are tax-deductible. This means that a portion of the interest a company pays for this kind of financing can be deducted from its annual tax bill.
Apart from this, there are also cases in which local or federal institutions can assist businesses in securing a better interest rate by guaranteeing a portion of the loan.
For companies seeing sustained growth in their business volumes, these kinds of loans can be an easy way to secure the resources needed to further expand their operational infrastructure and working capital, allowing them to either buy more inventory, hire more staff, or even acquire the equipment necessary to keep growing their sales.
This is where the concept of leverage becomes important, as the proceeds obtained from the growth of the business can be used to pay the cost of borrowing this extra capital through small business financing instruments.
As long as the business can generate a sufficiently high-profit margin to cover its operating and financial expenditures, this kind of financing should help the company move forward towards achieving its mission.
Some recommendations for entrepreneurs seeking small business financing
Despite the multiple benefits associated with taking small business loans, it is important to follow some of the recommendations we will outline below to make sure you make the most out of them while avoiding some common pitfalls associated with misusing this form of debt.
- Tip #1 – Set a limit for the amount of debt your business will take
Leverage can be turned into debt when a business exceeds the amount of financing that is considered healthy based on its cash flows, profitability, and balance sheet.
Some indicators can be used to keep track of how big a company’s debt burden is such as the long-term debt-to-equity or long-term debt-to-assets ratio.
One way to avoid a situation of over-indebtedness is to set a maximum limit for these two metrics while keeping track of their evolution on a monthly or quarterly basis to make sure that the threshold is not exceeded.
- Tip #2 – Avoid using the proceeds from the loan for illiquid assets
Illiquid assets are those that cannot be turned into cash quickly. As a rule of thumb, most companies will often struggle when it is time to repay their loans if the proceeds of the credit have been used for the purchase of illiquid assets such as machinery or equipment.
For this reason, unless you consider yourself a fairly disciplined financial manager, you should avoid buying illiquid assets and use the proceeds from a loan to purchase liquid assets like inventory which can be easily turned to cash when it is time to repay your small business loan.
- Tip #3 – Understand your business’ cash cycle
A company’s cash cycle illustrates how long it takes for $1 invested in raw materials or finished goods to be turned into cash after the proceeds of a sale are collected.
It is important to know the length of this cycle because business owners can have a clearer idea of how long it may take to get back the money invested into the business’s core operations.
The longer it takes for the cycle to be completed, the more likely it will be that the company will face difficulties in staying current with the loan. Therefore, business owners should either make sure that they have enough cash reserves to pay for these obligations punctually or they can also look for ways to shorten the length of this cycle.
- Tip #4 – Stay current on your loan payments
Although this might sound obvious, some owners may ignore the importance of staying current with their loan payments as they might feel that as long as they pay there will not be consequences to such delays.
However, these delays are not viewed positively by credit bureaus and can lead to a deterioration of the firm’s credit situation – which often results in less favorable credit terms, higher interest rates, and lower odds of getting approved when applying for additional financing.
Bottom line
Now that you know the benefits and caveats of small business financing you can decide if your business is ready to use the proceeds obtained from these instruments to keep growing your venture.
Keep in mind that fintech companies like Camino Financial have expedited the process of obtaining small business financing by offering a quick application and approval process and flexible credit terms, so give them a look if you decide to move forward with the process of obtaining funding for your company.
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