Seeking capital can be a challenge for many business owners especially when they are yet to build their credit. They are either too big to get microfinancing, yet too small to get commercial bank loans with favorable terms and rates. But when it’s time for growth, bakeshop owners need to raise funds to expand their business and meet customer demands.
Here’s the million-dollar question: how do you know when enough is enough? How do you determine how much cash your business actually needs?
First, let’s discuss how lenders determine the amount of money you are qualified to get. The loan amount lenders grant you varies depending on the type of financing you’re applying for, the lender you’re working with, and your credentials as a borrower.
In most cases, lenders would lend you no more than 30% of your bakery’s annual gross revenue. This gives lenders a bit of security that you won’t have a hard time repaying your loan. In other words, you are more likely to get approved for a loan if you have positive cash flow and your business is deemed creditworthy.
Now, let’s talk about why borrowing “just enough” will have a positive long-term effect on your business.
Generally, lenders would offer the highest possible loan amount to eligible borrowers, or those who have high personal and business credit scores, can put up substantial collateral, or already have a credible history of debt repayments. These are the borrowers who are more likely to pay off their debts on or before they’re due.
Many entrepreneurs fall prey to lenders who would offer them the highest possible loan amount, payable at a certain amount month-on-month. While they think they can afford to repay the loan based on the schedule their lenders will give them, this can take a toll on their cash flow.
Instead of borrowing the amount that already suffices your needs, you may end up paying more in the long run if you choose to get beyond your asking.
Not to mention, some types of financing may require you to make a downpayment of at least 20% of the principal amount. If you will be getting the maximum loan amount you may be qualified for, you need to make sure that you have this much money floating in your bank account.
How to know how much capital you need for your bakery
Business owners often find themselves in a difficult situation when it comes to borrowing money. On one hand, they want to make sure they are borrowing enough money to grow their business. On the contrary, they don't want to take on too much debt and risk bankruptcy.
To know if you’re borrowing the right amount of money for your business, there are a few key factors you need to take into account.
Step 1: Know why you need a loan
The first thing you need to do is make sure that you’re borrowing for the right reasons. You should only borrow money if it will help improve your business or will help you generate more income–not just because you want more money in your bank account.
If the loan is for working capital, you will need to borrow an amount that can cover your costs without putting your business in a financially precarious position. On the other hand, if you are borrowing for expansion or equipment purchases, you will need to factor in the expected return on investment from these projects.
Once you have a good understanding of your costs, you can start thinking about how much capital you'll need to meet your business needs.
Step 2: Determine how much you think you need to serve the purpose
Once you’ve determined why you need the loan, the next step is to figure out how much money you actually need. You don't want to take out too much and have difficulty making repayments, but you also don't want to take out too little and miss opportunities for growth.
This can be a tricky process, but it’s important that you don’t borrow more than you can afford to pay back.
Step 3: Compare lenders, rates and terms
Finally, make sure that you compare different lenders and find the best interest rate possible. By taking all of these factors into account, you can be sure that you’re borrowing just enough capital for your bakery.
Still in doubt? It’s best to talk to experts
If you’re having a hard time determining how much your business needs, it’s best to talk directly to finance experts. They can help you create a budget and forecast for your business. This will help you determine how much money you need to borrow in order to reach your goals for the bakery.
About the Author
Matthew Gillman is a business financing expert with more than a decade of experience in commercial lending. He is the founder and CEO of SMB Compass, a specialty finance company providing education and financing options for business owners.