Deciding on the right amount to borrow as a loan for your small business can be tricky.
Naturally, you’d want to get as much as possible, because the more, the better right? But if you do that, it could affect your ability to pay back and cash flow.
But you could also play it safe and get a loan that is inadequate to meet your needs.
I can’t decide which is worse.
What I can say is that you don’t want to be in any of those situations.
The best way to avoid any of them is by planning properly.
Factors That Determine The Right Amount To Borrow
Small businesses in Nigeria can choose to borrow between a few hundred thousand Naira to millions of Naira depending on the lender.
But you don’t just wake up one day and decide to get a loan of 2 million Naira from Bank A.
There are a few factors that help you determine the right amount can ask for.
I will discuss a few of these factors below:
1. Business Needs
The first place to start to determine the right amount your business should get as a business loan is its needs.
You should start by evaluating your business plan and determining what it would cost to achieve a specific objective.
If you want to open a new location, for instance, you need to do your analysis and determine how much you need to make that happen.
Without proper analysis, any amount you ask for would be nothing short of guesswork.
2. What Can You Afford?
The amount you want or that your project needs are not always equal to the amount you can afford.
So, you also have to determine how much can your business afford to repay, given your current financial reality.
If you don’t, your lenders will, and you may end up getting your application rejected or getting an amount much lower than you want.
So, how do lenders determine the amount you qualify for?
a. Collateral – Do you have any form of collateral that the bank can use in case you default? If you do, that’s great. The more valuable it is, the more likely that you would qualify for more.
b. Cash flow – Lenders would use your cash flow to determine your ability to repay your loan as agreed. The poorer your cash flow, the less your business can qualify for.
c. Credit Score – Lenders use your credit score to determine your creditworthiness. The higher your score, the lower the risks for them and the higher you qualify for.
e. Debt – A high debt level is a huge risk for many lenders because it is an obstacle to your repayments.
f. Relationship – A good relationship with your lenders can go a long way in determining the amount you get in the end. The longer and more valuable the relationship you have is, the more they can give you.
This is one of the merits of building good business relationships.
Generally, the right amount your business should ask for is a cross between what it needs and what it can afford to borrow.
3. Return on Loan
You don’t want to get a business loan that costs your business more than it gains.
The right amount of loan for your business should be the amount where you would pay a lower interest rate and gain profit.
The more your business receives as a business loan, the more it would have to pay interest.
If your analysis shows that a loan of 2 million Naira will end in a loss for your business due to the costs, you should apply for a loan that would be profitable.
To do this analysis, estimate the total amount it would cost you to get a loan of a certain amount; the cost of application, interest rate, etc., and subtract that from the revenue you expect to generate from utilizing the loan, and see if you would turn a profit or loss.