When it comes to securing financing for your small business, the loan application process can be a daunting and complex endeavor, regardless of whether you're a seasoned entrepreneur or a newcomer to the world of business finance. With so many variables to consider and numerous financial terms to understand, it's easy to feel overwhelmed and unsure of how to proceed.

As a business owner, however, knowledge is your greatest ally. By familiarizing yourself with the key financing terms and concepts that are crucial to the loan application process, you can gain the confidence and insight necessary to navigate the process with ease and make informed decisions that will help your business succeed.

This blog post will delve into some of the most critical financing terms that every small business owner should be aware of, ranging from credit scores to loan comparisons and beyond.

Annual Percentage Rate (APR) 

The annual percentage rate (APR) is a crucial factor to consider when comparing small business loans. It calculates the actual interest rate on the loan, including any fees you might be required to pay. By looking at the APR, you can determine the true cost of borrowing over the life of the loan.

Small business owners should use the APR to compare different loans and their total costs. While a loan with a lower interest rate might seem more attractive at first glance, additional fees and charges can significantly increase the total cost of borrowing. By comparing APRs across different loans, you can get a clearer sense of which option is the most affordable and sustainable over time.

Credit Score

A credit score is a numerical rating that reflects an individual's or company's creditworthiness and financial history. It's a crucial factor that lenders examine when evaluating loan applications, and it can have an impact on the interest rate you receive.

For business startups, there won't be an established business credit score since there isn't enough financial history to generate a score. However, the lender may look at both the personal credit scores of the business owners and the guarantors on the loan. For newer businesses, the lender may also look at both the business credit score and the personal credit scores of the guarantors on the loan.

Establishing and maintaining a high business credit score is essential for keeping borrowing costs low and maintaining access to credit. A strong credit history can also make your small business more attractive to potential investors, leading to a more diverse loan portfolio that includes equipment loans, credit lines, and leases.

Business Line of Credit 

One way to establish and build your business credit score is to apply for a business line of credit. A line of credit operates similarly to a credit card, in that you can borrow up to a specific amount (your credit limit) and only pay interest on the money you actually use.

Business lines of credit offer flexibility in managing working capital needs, allowing you to borrow money as needed and repay it on your own timeline. However, there is one caveat to keep in mind: lines of credit often come with adjustable interest rates, which means your interest costs can go up or down depending on the market.

It's important to weigh the pros and cons of a business line of credit before applying. While they can be an excellent tool for building credit and managing short-term expenses, the potential for fluctuating interest rates means that you'll need to stay on top of your payments to avoid accruing significant debt.

Business Term Loans

When you need a large sum of money for your small business, a business term loan is a common financing option. With a business term loan, you receive the funds you need and pay back the loan with interest over a period of one to five years. This type of loan is often used to finance capital improvements, equipment purchases, and business expansion.

Business term loans typically require regular payments, which can be made daily, weekly, or monthly. Paying off your term loan on time can improve your credit score, making it easier to secure financing in the future. However, keep in mind that some business term loans may require collateral as a guarantee of repayment. 

Cash Flow

Cash flow refers to the amount of money coming in versus the money going out of your business. Positive cash flow indicates that sales are exceeding costs, and is a critical factor in securing financing. Lenders view strong cash flow as a lower-risk factor, making it an important consideration for small business owners seeking funding.

Collateral

Collateral is a key concept in lending and refers to an asset or property that a borrower uses as security for a loan. Essentially, it's something of value that the borrower pledges to the lender to ensure repayment of the loan. The collateral can be in the form of real estate, vehicles, cash, investments, or other valuable possessions.

Offering collateral can increase the likelihood of approval for a loan and may even result in a lower interest rate, as it provides the lender with a form of security. In the event that the borrower defaults on the loan, the lender can seize the collateral and sell it to recoup the borrowed amount.

It's important to note that the value of the collateral typically needs to be equal to or greater than the amount being borrowed. While collateral may not always be required for every type of loan, it can be a crucial factor in securing larger loan amounts or loans for borrowers with less established credit histories.

Co-Signer/Guarantor 

A co-signer or guarantor is an individual who signs a loan or lease agreement with the borrower and agrees to take responsibility for the debt if the borrower is unable to make the payments. Essentially, the co-signer/guarantor acts as a safety net for the lender, providing additional assurance that the loan will be repaid even if the primary borrower defaults.

For borrowers with poor credit or limited creditworthiness, having a co-signer/guarantor can be beneficial. It increases the likelihood of loan approval and may result in more favorable terms and lower interest rates. Additionally, co-signers/guarantors can help borrowers access larger loan amounts that they would otherwise not be eligible for.

However, being a co-signer/guarantor also carries risks. If the borrower defaults on the loan, the co-signer/guarantor becomes responsible for repaying the debt. This can negatively impact their credit score and financial situation, and potentially harm their relationship with the borrower. It's important to carefully consider the risks and responsibilities involved before agreeing to act as a co-signer/guarantor for someone else's loan.

Equity Financing 

Equity financing is a method of raising money for your business by selling a share of ownership to investors. This approach is particularly popular among startups and small businesses that don't have the financial resources to fund growth on their own, don't qualify for traditional bank loans, or don't want to take on additional debt.

Equity financing can be a smart choice for businesses that have a high potential for growth, as investors are often willing to take on additional risk in exchange for the potential for significant returns. However, it's important to carefully consider the terms of any equity investment, as you will be giving up a portion of ownership and control of your business in exchange for funding.

Loan Origination Fee

A loan origination fee is a fee charged by a lender to cover the costs associated with processing a loan. This fee is typically charged at the beginning of the loan process and is usually a percentage of the total loan amount.

The loan origination fee helps cover the costs of underwriting, processing, and funding the loan. It may also cover the cost of any administrative tasks associated with the loan, such as preparing the loan documents and conducting a credit check.

Maturity Date

The maturity date is the point when both the principal and interest on the loan are due in full. Loans such as credit lines, adjustable-rate loans, and mortgages typically have maturity dates that include an interest-only repayment period at the beginning of the term, followed by a final payment at the end of the term. Being aware of the maturity date helps small business owners manage their loan repayments effectively and avoid defaulting on their loans.

Profit and Loss Statement (P&L)

The Profit & Loss Statement (P&L) is a critical tool for small business owners to increase profitability and grow their business. It provides valuable insights by identifying areas of success and improvement. The P&L statement acts as a barometer of performance, detecting drops in sales, income, and margins, or spikes in expenses.

Regular review of your P&L, typically on a monthly basis, ensures that any negative trends are identified early and adjustments can be made immediately. This proactive approach helps businesses better prepare for future months and achieve growth and top performance.

SBA Loans

If you're a small business owner looking for financing, SBA loans are a great option to consider. SBA loans are guaranteed by the Small Business Administration (SBA), which reduces the risk for lenders and makes it easier for small businesses to get approved for loans.

There are several different types of SBA loans, each with its own specific purpose. The most common types of SBA loans include:

• 7(a) loans are the most popular type of SBA loan and can be used for a variety of purposes, including working capital, equipment purchases, and refinancing existing debt.
• CDC/504 loans are designed for small businesses looking to purchase real estate or large equipment.
• Microloans are small loans (usually under $50,000) that are ideal for startups and businesses with low capital needs.
• Disaster loans are available to businesses that have suffered physical or economic damage as a result of a natural disaster.

To be eligible for an SBA loan, your business must meet certain requirements, such as being a for-profit business operating in the United States, having a certain net worth and number of employees, and not being delinquent on any existing debts.

The application process for SBA loans can be lengthy, so it's important to be prepared and have all necessary documentation ready. However, the advantages of SBA loans, such as lower interest rates and longer repayment terms, make it a worthwhile option for small business owners in need of financing.

From SBA Loans to Equipment Financing: Stearns Bank Has You Covered

At Stearns Bank, we are dedicated to helping small business owners overcome financing challenges and achieve their goals. From SBA loans and equipment financing to commercial financing and personal banking services, we offer a range of award-winning solutions to support your business at every stage of its growth.

Our experienced lenders take a holistic approach, considering factors beyond just credit scores, such as cash flow and overall financial profile, when evaluating loan applications. We believe in personalized service and work with each borrower on a case-by-case basis to find the best solution that fits their unique situation. At Stearns Bank, exceptional customer service is our priority every step of the way.