A small business loan can mean the difference between staying in business and going bust. Small businesses often do not have the luxury of sitting on a pile of cash in the bank like large corporations do. Enter the small business loan. While getting a loan to finance future growth can be great, it can also burden your company will additional bills that you have to plan for. Just because you have additional funds, does not mean your cash flow is improving. Loans can mask deeper, fundamental, problems within a company. This is why you should consider a few things before signing on the dotted line.

Reasons For The Loan

What do you really want to do with this loan? Are you planning for business expansion, or is this loan going to be for operating expenses. Banks will lend money to a promising company to pay the bills, but operation-type loans are much riskier. If you need a loan to pay for expenses, it signals that your company isn’t generating enough revenue. You could be a young business or you could be on the verge of bankruptcy in the eyes of a bank.

If you need money to expand a business, and you have demonstrated a history of positive cash flow, your odds improve for a loan approval. In a sense, you must demonstrate that you’ve already achieved some measure of success before a bank will lend to you. As ironic as that sounds, it makes sense. Think about it. A bank wants to lend to a promising beginner, but to demonstrate that you must show that you’ve taken some risk already. If you’re not willing to put your own money into your company, and you haven’t shown any evidence that you can succeed, why would a bank lend you a large (or even a small) sum of money? Answer: they wouldn’t.

What You Plan To Purchase

You should list all items you intend to buy with the loan proceeds. You’ll have to list this for the bank anyway so it’s a good idea to do this in the initial stages of planning. Your list should detail the good or service you plan on buying and the dollar amount you intend to spend. In effect, you’re creating a budget for the loan proceeds.

Once you have a budget for the loan proceeds, explain why you need to purchase these goods and services. Justify your purchases. First, pretend you are the bank. Make an argument against the loan and purchasing the items you have listed. Then, explain the negative consequences of not purchasing these goods and services at the prices you’re projecting.

Existing Business Debt

Examine your existing business debt. This is important since a bank will want to know why you’re requesting a loan in light of existing business debt. If your debt levels are too high, you might be turned down for the loan if you don’t have an explanation for the bank. If you plan on consolidating business debt, have this explanation worked into what you plan to use the loan proceeds for.

If your debt levels are over 40 percent, consider paying some of your debt off before asking for a loan. In general, a lower debt to income ratio is good.

Repayment Plan

Every loan has a repayment plan. Write down how you will repay the loan. This might involve projecting future sales or it might involve projecting the sale of certain assets that the company no longer needs. If you plan on acquiring an existing business, you can project the income that your new acquisition will bring to your company.

Knowing how you will repay the loan is probably the most important part of this process. You’ll want to examine at least two ways to pay off the loan – with one method reducing total payments, and thus interest, to the bank and another method assuming the fully amortized loan amount. Use the fully amortized payment plan as a backup for your own custom prepayment schedule. This way, you will decrease the likelihood of you defaulting on the loan. If you are unsure of whether you will be able to repay the loan, don’t even apply. It will save you years of harassing phone calls and you’ll keep your good credit intact.

Guest post contributed by Charles Ronson. Charles is a freelance business writer. He has extensive experience in consulting with small to medium sized businesses. His articles appear on various business blogs. Wonga for Business specialize in small business financing.