- Understand Loan Terms Inside Out
- Calculate Cost of Loan Carefully
- Create a Comprehensive Repayment Plan
- Optimize Cash Flow Management
- Explore Debt Consolidation and Refinancing Options
- Build Strong Lender Relationships
- Finding the Right Balance for Your Business
Is it better to maintain cash reserves or make larger loan payments?
It’s a question that small and medium business owners have struggled with for years. And to be fair, it’s a tricky balance to strike. A longer loan term means more borrowing costs. But, for small businesses, draining their cash reserves to pay off a loan faster can also leave them vulnerable when liquidity is most critical.
To navigate this situation, entrepreneurs are on the constant hunt for strategies to streamline loan repayments and optimize cash flow in order to keep operations running smoothly. Often, this requires an immense understanding of various loan types, their implications, and efficient financial and strategic planning.
If, as a business owner, you find yourself struggling with these concepts, consider these effective strategies for business loan repayments — and make informed choices that support both your short-term needs and long-term success.
Understand Loan Terms Inside Out
No two loan terms are alike. Some small business loans have higher interest rates, while others have longer durations. Beyond that, many are loaded with penalties and fees, which are applied at the discretion of the lender.
Fortunately, this also means that loans can be negotiated. Whether you’re looking to apply for a small business loan or streamline payments on an existing loan, it’s crucial that you understand how various loan concepts relate to one another.
While some terms — like interest or principal — are well understood, others, such as amortization or ballooning payments, aren’t. But that doesn’t mean they’re not crucial.
- Consider amortization or the process of paying off a loan in a fixed number of payments. An amortized loan requires upfront interest payments, but payments are spread over a long period. This can be a pro or con, depending on your needs.
- Ballooning payments, on the other hand, refer to large payments that are due at the end of a loan duration. They aren’t often included in loan terms, but when they are, they come as a surprise to businesses that don’t plan ahead.
Similarly, breaking other complicated loan terms down into simpler language can help secure favorable small business funding and craft more efficient repayment schedules.
Calculate Cost of Loan Carefully
Calculating the cost of a loan may seem straightforward, but there are several factors to consider.
What is the impact of interest fluctuations? How does amortization impact monthly payments? Are you paying a disproportionate interest over time?
Answering questions like these is key to better business loan management.
To calculate costs, it’s not just necessary to account for interest but also calculate the annual percentage rate (APR). This figure represents the total cost of repaying a loan over a year, including both interest and fees. This is an important distinction to make, as loans could come with any number of fees that businesses fail to consider. Such as:
- Origination fees
- Closing costs
- Late payment fees
- Application fees
Furthermore, some loans may have prepayment penalties, which come into effect when a loan is paid off before the duration. Having such a condition included in the terms is a glaring red flag—as it only benefits the lender and never the borrower. While such penalties can sometimes deter businesses from paying off their loans early, it’s essential to evaluate them in the correct context.
This is because, in some scenarios, prepayment may make financial sense for your business despite the penalties. For instance, if the interest savings from paying off the loan early outweigh the penalty costs, it could be beneficial to repay the loan sooner.
Create a Comprehensive Repayment Plan
Armed with this knowledge, focus on creating a repayment schedule that neatly aligns with your cash flow goals. Some strategies for this include:
- Consider all payment plans: Loan payments can be fixed-rate, interest-only, revenue-based, or more. Consider which plan closest meets your needs
- Be realistic: Leverage various financial planning tools to realistically determine the maximum amount you can afford every month without hurting operations
- Budget for payments: Loan payments must be given equal priority as rent, payroll, and other non-negotiable expenses
- Monitor progress: Once a payment plan is initiated, monitor progress to streamline future payments and take corrective action
Companies can also leverage debt amortization schedules when assessing how to manage business loan repayments.
This schedule offers a comprehensive breakdown of loan payments. It allows you to see how much interest you’re paying, how much of the principal you are covering, and the overall balance due at any given point of a loan’s lifecycle.
Optimize Cash Flow Management
In Canada, cash flow problems are a common challenge that plague both small and medium businesses. According to a recent survey, 60% of all businesses said they experienced challenges while managing cash flow. This makes the dilemma of whether to maintain cash reserves or make larger loan payments a critical issue.
Draining your cash reserves to accelerate loan payments can leave your business vulnerable, especially if unexpected expenses arise or if your revenue streams are inconsistent. Without sufficient liquidity, you may also struggle to cover operational costs, leading to potential disruptions in your business activities.
To mitigate these risks, we recommend a balanced approach that protects your operational liquidity while improving cash flow.
If you are seeking to improve cash flow for loan repayment, these two broad strategies that could help:
Effective Invoicing and Collection Practices
Businesses can greatly benefit by eliminating manual invoicing and collection practices in favor of new solutions. The rise of cloud-based software and increased automation, for instance, has had a transformative effect on the process of requesting, scheduling, and following up on invoices. Electronic billing and payment options, meanwhile, can streamline the collection process.
Negotiating with Suppliers
By maintaining strong relationships with suppliers and negotiating effectively, you can optimize cash flow by securing better deals. Many suppliers offer early payment or prepayment discounts as an incentive for timely payments, which helps businesses manage their cash flow more effectively and stay on top of their loan repayment schedules.
Explore Debt Consolidation and Refinancing Options
Refinancing and debt consolidation are two popular loan repayment strategies. Refinancing involves repaying an old loan by taking out a new loan with better terms, while consolidation refers to the practice of paying off multiple debts by taking out a single loan with favorable interest rates.
There are many reasons a business would want to consolidate or refinance business loans. The most obvious is that interest rates have dropped since the last loan was financed or that you were able to secure more favorable terms.
Many businesses in Canada, for example, consider refinancing CEBA loans to relieve themselves of high interest rates.
Debt consolidation, meanwhile, also allows you to improve your credit score as you close multiple loans on time. However, if you are bound by prepayment penalties on any of your existing loans, it’s more cost-effective to stick it out.
If you decide to refinance or consolidate business debt, ensure you work with a lender you trust. Negotiate terms carefully and maintain positive credit to secure better loans.
Build Strong Lender Relationships
Building better relationships with lenders relies on transparent communication. When you keep lenders in the loop and proactively address your financial situation with them, you build trust. This lets you secure favorable terms.
A lender who trusts you may be more willing to offer assistance programs or more flexibility in repayment schedules. This helps you avoid defaulting.
The best way to build a relationship with a lender is by maintaining a solid credit history. A positive financial record can help you negotiate better terms, access increased lines of credit, and benefit from lower borrowing costs.
Finding the Right Balance for Your Business
The nature of your business is an important consideration when deciding between maintaining cash reserves and making larger loan payments. While strategies such as improving invoicing practices and negotiating with suppliers are effective, tailoring these approaches to your specific industry or business model can also make a significant difference.
For instance, if your business is a seasonal one and experiences fluctuations in cash flow throughout the year, you may need to adopt different repayment strategies as compared to businesses with steady revenue streams.
Moreover, as a seasonal business, you might also benefit from structuring loan repayments in a way that aligns with your peak cash flow periods. This will ensure you have sufficient liquidity during slower months.
Customizing repayment strategies to fit your business’s financial needs not only enhances cash flow management but also supports long-term financial stability.
The Bottom Line
Managing loan payments can be a headache sometimes — especially when navigating the murky waters of small and medium business loans. But it doesn’t have to be.
By following these business loan repayment tips, entrepreneurs can build a command over complicated loan terms, create more comprehensive repayment schedules, and gain access to the latest tools and techniques to optimize cash flow management. If you’re looking to manage business loans and reduce debt, there’s no better time to start than now.
Consider consulting a financial advisor for more personalized advice and create a loan repayment plan before it’s too late.
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