Say your business needs capital for growth. Do you tap into savings to cover the costs or take out a loan?
Both approaches have advantages and risks. The one that's right for your business will depend on several important factors. To help determine which source to use for covering your organization's growth, ask yourself these four questions:
Do I need to build my business credit?
Having an excellent and long-standing credit history for your business is crucial to its future success.
If your business is fairly young, you may not have had the opportunity to establish a strong credit history. This can make it difficult or impossible to obtain large, long-term loans in the future. It will also drive up your interest rates on smaller loans.
If you anticipate applying for large-scale financing for your organization within the next few years, start building that credit history now. One of the best ways to do so is by applying for smaller, short-term loans, and make your monthly payments on time.
If your business has already established a strong credit history, tapping into savings can be the better choice for you.
Does the Return on Investment (ROI) outweigh the cost of the loan?
Every loan you take out will cost you money. However, those interest payments might be worth the price if you’ll be using the loan to help your business reach a new tier of success.
To determine whether a business loan is right for you, calculate the anticipated ROI of the loan. Will you be earning a profit that is high enough to make the interest rates worthwhile for you?
Often, the answer is no. Giving the office a facelift might be an aesthetic improvement, but it likely won’t generate additional revenue for your business. Under these circumstances, you’re better off using your business savings to fund the expense.
If, however, your business loan will be used to expand your product line or open a second location, the interest rate can be a small price to pay for the potential strong growth in revenue.
How large is my business savings account?
If tapping into your savings to fund a business venture will leave your business savings account depleted, it’s best to take out a loan instead. It’s important to have a safety cushion, and waiting until you save up enough money to cover this expense could also mean losing out on a prime opportunity that forgoes months of increased revenue.
On the other hand, if using a portion of your savings for a business expansion will only make a small dent in your funds, it’s likely the better option for you. Make sure to leave enough in your to cover several months of business expenses, your quarterly taxes, and the occasional cash-flow issue.
Using savings instead of a loan will enable you to take on the expense of your venture in one shot instead of feeling the squeeze for months or years to come.
Will I use the money wisely?
No one likes owing money, but being in debt actually encourages discipline. Knowing the money you’re working with is borrowed will motivate you to optimize every dollar. You’ll think three times before spending the loan money, and you’ll likely make better financial choices, too.
However, if you’re always disciplined with business funds and you know you’ll spend your savings carefully, you may want to use your savings instead.