One of the most tedious yet crucial aspects of taking out small business loans is determining how much you should borrow. If you ask for too little, you won’t be able to grow your business to the extent you had in mind and prevent revenue from improving. If you ask for too much, you’ll have to dig into your personal or operational funding to pay off the debt and risk bankrupting your business.
Luckily, calculating the right loan amount is as simple as experimenting with a single, mathematical formula. This formula will reveal your debt service coverage ratio (DSCR), the value of which will tell you whether or not you can pay off a small business loan while running your business smoothly. Banks and alternative business lenders use it to assess the risk of a business loan because the DSCR is based on cash flow, or how much money is coming in and out of your business.
But before you get to that formula, you must first produce the numbers required to complete it.
CALCULATING YOUR DSCR
On one side of the DSCR is the cash you have on hand to pay back a loan in a year’s time, while the other side consists of the amount of money you’re looking to borrow per year, with interest included. So to figure out the first part of the ratio, add the money you have on hand at the beginning of the month to the money that comes into your business by the time the month ends. This will tell how much cash you have available for a given month, or your total cash.
Now subtract how much money comes out of your business each month, including all your expenses, from your total cash for the month. The answer is your monthly cash flow for your business, one of the number lenders will pay most attention to when deciding whether or not to approve your loan. Multiply your monthly cash flow by twelve to reveal your annual cash flow.
The second part of your DSCR requires you to estimate how much you need for your investment as well as interest rates in order to determine how much you would have to owe a year.
WHAT KIND OF ANSWER ARE YOU LOOKING FOR?
Let’s say you earn $120,000 per year and, if approved, would owe $100,000 per year. $120,000 divided by $100,000 comes out to a DSCR of 1.20. If your DSCR comes out to anywhere from 1.15 to 1.25, you will most likely be able to pay off your loan while running your business smoothly. The closer your DSCR is to 1.15, the easier your loan payments will be. So, if you’re not sure how much you should ask for, put a few numbers into the DSCR formula and use the always-reliable process of trial and error.
YET ANOTHER QUESTION ANSWERED BY RESEARCH
You will get an even clearer idea of how much you should ask for when you embark on yet another incredibly tedious aspect of small business loans: Documentation.
Applying for a small business loan requires you to conduct extensive research on your business and industry. When the time comes to speak to a lender, any claim you make about your business’s financial health, revenue projections, and how much you need to borrow must be supported by numerical evidence.
You will use this research to compile a series of financial documents such as a profit and loss statement, balance sheet, and cash flow statement. As you develop these documents, you’ll learn how much money your company is projected to earn, how your industry and company have evolved as of late, and, if your DSCR didn’t tell you this already, how much debt you can afford to take on without jeopardizing cash flow.
Presenting a detailed knowledge of your business’s finances will prove to lenders that you take your work seriously and are certain you can pay off debt. Once you’ve determined how much you need to borrow, you must make sure you contact a lender that can offer the terms that generated your best DSCR.
APPLYING THIS KNOWLEDGE TO PEOPLE WHO CARE
United Capital Source is renowned for distributing business funding programs with terms so flexible that even the most unstable industries are able to pay them off and make good use of them. Traditional bank loans, on the other hand, carry extremely generic terms that are non-negotiable, regardless of inevitable inconsistencies with revenue.
Seeking an alternative business funding company like UCS would be an incredibly wise choice if you are looking for terms that are tailored specifically for your industry, allowing you to ask for whatever amount of money you believe is necessary to match the growing demand your business has acquired.
Interested in learning more? Ready to solidify your funding amount and start the application process? Our experts are on-hand. You can reach them by phone at 855-933-8638 or you can use our Live Chat feature on our website at www.unitedcapitalsource.com. We look forward to helping your business succeed!