How do you determine the right amount of money you should borrow for your small business?
Most businesses estimate the size of their loan solely based on what their business needs and others by the amount of money they can get.
Determining the correct amount of money your business needs is essential because if you ask for too much, lenders will question your ability to repay and reject your application, and if you do not ask for enough, it would not help you achieve your funding objectives.
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To determine the correct amount of money your business needs, there are a few factors you need to consider:
1. What is the purpose of the loan?
A critical factor that determines the loan amount your business needs is what it wants to use the loan for? There are different needs for a loan in business and to satisfy each need would require varying amounts of money. This is why you have to be clear about the purpose of your business loan from the beginning as it would determine the amount that is needed to meet a chosen need of your business. To buy equipment, for instance, you need to create a detailed cost projection of everything you would need to complete the purchase.
2. What can your business afford?
If you only factor the needs of your business to determine your loan amount, you may not be able to repay it. That is why it is important to also evaluate the loan capacity of your business. To determine what amount of loan your business can afford, you have to estimate your cash flow projections and compare that to the total cost of the loan; the interest rate, processing fees, etc.
By breaking down your annual cash flow to a monthly estimate, and comparing it to your monthly loan repayment you can determine whether your business can afford to pay the monthly required amount or not.
3. Calculate Your Funding Gap
After you are clear on the exact purpose of the loan and the estimated amount you would need to meet that objective, you should be able to subtract what your business can contribute towards meeting your specified purpose. The difference is the amount of money your business should apply for as a loan, keeping in mind what it can afford from the previous calculation.