Securing small business financing can fuel your growth and ensure you’re financially prepared to survive cash flow shortages, but it’s important to know exactly what type of financial arrangement you’re committing to before you sign on the proverbial dotted line.
Here are some common mistakes rookie business owners make when securing small business funding, and how to avoid them.
The cost of your financing arrangement can be highly influenced by the interest rate associated with the agreement, and how it’s calculated. If an interest rate is fixed, it generally cannot change once funding is secured. If the interest rate is variable, it could change at any time. On top of that, it’s important to confirm you understand how the interest is calculated.
- A simple interest rate is calculated by the loan amount (principal), multiplied by the annual interest rate, multiplied by the duration of the financing agreement.
- A compound interest rate is calculated using the principal and all accumulated interest on the loan. You could pay interest on top of interest, and your balance could climb, despite making payments each month.
Not Understanding the Real Cost of a Long-Term Loan
In addition to the interest rate, your small business financing arrangement could refer to an annual percentage rate (APR). If the financing includes closing costs or similar fees, they may be “rolled into” the amount of funding you’re approved to potentially access. Long-term loans with low monthly payments may appear to be affordable, but could be far more costly when you calculate the implications of paying interest for several years.
Not Making a Distinction Between Opportunity Cost Versus Real Cost
Opportunity cost may not come with the same percentages and numbers as a real cost, but it has value all the same. Opportunity cost can be thought of as what you give up now in order to gain something of greater value later. In terms of business finance, opportunity cost can mean that working capital or access to financing allows your business to seize new opportunities that prove to be more valuable than the money you have to spend to secure financing.
Borrowing More Than You’re Capable of Paying Back
Cash flow is a key concept when you’re a small business — and lack of it can cause you to go out of business. Though a business of any age could experience times of unforeseen reduced demand, small businesses can be particularly vulnerable to ebbs and flows in revenue, or expenses. Until you have a steady financial base and a few years experiencing full business cycles, it’s important to ensure that you can repay any financing arrangement that you secure so you don’t miss payments or put unnecessary financial strain on your operations.
Not Being Aware of Hidden Fees
Some financing agreements may include fees for late payments and/or missed payments. Others may charge fees if you attempt to pay the loan in full before the duration ends. Confirm that you know exactly what fees accompany any financing deal to ensure you understand the terms of the agreement.