#53 How to Determine the Right Loan Amount for Your Business: Focus on Use of Funds

Why Use of Funds Matters

When applying for a business loan, lenders typically want to know how you plan to use the money. This isn’t just about ensuring that you’ll use the funds responsibly. It’s about understanding how the loan will impact your business’s financial health and growth. The loan request should align with the specific goals you’re aiming to achieve.

A common misconception among business owners is that they should request the highest amount they qualify for. The logic is simple: more capital sounds like a good thing. However, this approach ignores a critical factor: your cash flow.

Here’s why it’s essential to align the loan amount with your use of funds:

1. Aligning Borrowing with Business Goals Whether you’re looking to expand, purchase new equipment, hire staff, or streamline operations, the purpose behind the loan matters. The loan request should be tailored to the specific use case, as this will help you avoid over-borrowing and accumulating unnecessary debt.
2. Understanding Your Cash Flow Your ability to repay the loan is directly tied to your cash flow. For example, if your business made $40,000 in revenue last year, requesting $250,000 in financing might seem extreme unless you have a clear plan for increasing revenue or reducing costs. Lenders will assess your cash flow to gauge your repayment ability. If your current cash flow doesn’t support the repayment of a large loan, it may not make sense to request such a large amount—even if you qualify for it.

The Example: $40K in Revenue and $250K in Loan Request

Let’s break this down with a real-world example:

Imagine your business earned $40,000 in revenue last year. You decide you want to expand, buy new equipment, and hire staff, and you believe that a loan of $250,000 will help you do so. But before jumping into such a large loan, you must ask yourself: Can I comfortably repay $250,000 based on my cash flow?

Here’s a simplified breakdown of what you need to consider:

• Interest Rates and Loan Terms: A $250,000 loan might come with a 6% interest rate and a 5-year repayment term based on current market conditions. Your monthly payments could be roughly $4,800 (excluding other potential fees and factors). If your revenue is only $40,000 annually, that’s only about $3,300 per month. Can your business generate enough extra cash flow to cover these payments while still being able to cover operating costs? Likely not.
• Loan Purpose: Now, think about how much of the $250,000 is actually necessary to achieve your goals. For example: Equipment purchases: $75,000 New staff hires (salary + benefits): $50,000 Marketing campaign: $25,000 Working capital: $25,000 Miscellaneous expenses: $25,000 Total Loan Request: $200,000

By detailing your use of funds, you can see that $250,000 might not be as necessary as you first thought. Reducing your loan request can make a significant difference in managing your cash flow.

Cash Flow: Your Secret to Success

Lenders will scrutinize your business’s cash flow to determine how much they’re willing to lend you. The more money you borrow, the more difficult it will be to manage those repayments unless your business can increase revenue or decrease costs.

Consider your past financial statements and future projections carefully. If your cash flow has been stable, it’s essential to project how your business will support the repayment of the loan. For example:

• Will your equipment purchases result in more efficient operations or increased sales?
• Will the new staff generate additional business?
• Will your marketing campaign yield increased revenue?

The Bottom Line: Borrow Only What You Need

Rather than borrowing the maximum you qualify for, be realistic about the amount of capital necessary for your business to achieve its objectives. This doesn’t just mean you’ll be in a better position to repay the loan; it also ensures that you’re not overburdened with unnecessary debt.

By clearly identifying your use of funds and aligning the loan request with your actual financial needs, you set yourself up for success. A loan that matches your cash flow and business goals is a smarter choice than one that simply leverages the maximum qualification amount.

Final Thoughts

When you're looking for a business loan, please focus on the purpose of the funds. Your loan request should directly align with your business’s needs, helping you achieve specific goals. More isn’t always better when it comes to borrowing, and knowing exactly what you need—and how it fits into your cash flow—is key to securing the right loan for your business’s success.

In short, Be strategic, and let your business goals guide your loan amount, not just your borrowing capacity. Doing so’ll set yourself up for smarter growth and financial stability. #Bookanappointmentwithaloanbroker #tdjequityfunding