It doesn’t matter if you’ve been a small business owner for decades – or for 30 seconds. Looking for business financing can feel like a daunting and uphill climb.
If this is your first experience with business financing and the loan application process, some questions may be running through your head:
Why does your credit score matter? How do I compare one loan to another?
As small business owners gain experience in financing, knowledge becomes power. Your experience and knowledge give you the ability to compare and make informed choices about your business loan.
Below are some key business financing terms everybody in the small business world needs to know:
1. Business credit score
Establishing and maintaining a high business credit score is crucial for keeping borrowing costs low and maintaining access to credit.
Your business credit score is scrutinized by lenders as they review your credit history and what kind of loans you might qualify for. Your credit score also is a factor in determining interest rate.
Established business credit is an asset that can make a small business more attractive to potential investors. Strong, established credit histories can lead to more diverse loan portfolios that include equipment loans, credit lines and leases.
Paying on time and paying early over many years helps build a positive credit history.
2. Business line of credit
A perfect way to build your business credit score is to start a business line of credit. A line of credit works more like a credit card than a traditional small business loan.
For instance, you can borrow up to a specific amount (your credit limit) and pay interest only on the money you actually borrow.
Lines of credit give flexibility in managing working capital needs. However, there is one caveat with lines of credit. They often have adjustable interest rates, meaning your interest costs can go up or down depending on the market.
3. Annual percentage rate (APR)
If you’re wondering what a loan will actually cost over several years of payments, look at the APR. The annual percentage rate calculates the actual interest rate on the loan, including fees that you might have to pay. Small business owners should use APR to compare different loans and their total costs.
4. Equity financing
Equity financing refers to raising money for your business by selling a share of ownership.
For example, let’s say you own 100 percent of your business, and it’s valued at $2 million. If you sold 20 percent of the company to a new partner, you would get $400,000 and would own 80 percent of the business.
Small business owners use equity financing when they don’t have enough money to grow the company on their own, if they don’t qualify for a bank loan or if they don’t want to take on more debt.
5. Cash flow
For a small business needing to pay bills and meet payroll, cash flow is too important to ignore.
Cash flow is the total amount of money coming into your business, minus money going out. To have a healthy cash flow your sales must be higher than your costs. A positive cash flow is crucial for any small business owner looking for financing.
A positive cash flow shows that you are covering all of your expenses on a regular basis. Lenders will look at you as a lower-risk borrower and offer better rates and loan terms when your cash flow is strong.
6. Maturity date
This is the date when both the principal and the interest on your loan are due in full. Credit lines, adjustable-rate loans and mortgages often have maturity dates with interest-only repayment periods to start things off and a final payment at the end of the term.
7. Business term loan
This is a type of loan where you receive a large sum of cash and pay it back with interest over a period of one to five years. Most small business owners use this type of loan to finance capital improvements, equipment purchases and business expansion.
Term loans come with daily, weekly or monthly payments. If paid off correctly, these types of loans can improve your credit score. However, some term loans may require collateral.
8. Profit & Loss Statement
As a business owner, understanding your P&L is essential to increasing profitability and growing your business. Your P&L will identify successes and areas for improvement. A P&L statement acts as a barometer of performance, detecting drops in sales, income and margins or spikes in expenses.
Monthly review of your P&L ensures that the causes of these drops and spikes are identified so you can make adjustments immediately and better prepare for future months to bring growth and top performance.
The P&L Statement also can be used to compare your company’s actual performance with industry benchmarks, as well as show the business growth and financial strength over time. Past performance trends will help in formulating reasonable forecasts.