Small Business Financing 101
Business loans differ from personal loans in that lenders focus heavily on your Cash Flow and DSCR (Debt Service Coverage Ratio). This calculator helps you determine if your business can afford the monthly debt service.
Types of Business Loans
- Term Loans: Lump sum cash upfront, repaid over 1-5 years. Good for expansion or equipment.
- Line of Credit: Revolving credit like a credit card. Only pay interest on what you use. Good for working capital.
- SBA Loans (USA): Government-backed loans (7a, 504) with lower rates and longer terms (10-25 years) but strict paperwork.
- Merchant Cash Advance (MCA): Fast cash repaid by taking a % of daily credit card sales. VERY expensive (APRs can hit 80%+). Avoid unless desperate.
The Impact of Processing Fees
Business loans often charge an "Origination Fee" or "Processing Fee" of 1-5%. This is deducted from the disbursed amount.
- Loan: $100,000 for 3 years at 10%.
- Processing Fee: 2% ($2,000).
- You Receive: $98,000.
- You Pay Back: Principal ($100k) + Interest on $100k.
- This effectively increases the APR of the loan.
DSCR Explained
Lenders want to see a DSCR > 1.25. This means your Net Operating Income is 1.25x your annual debt payments. If your profit is just barely covering the loan (DSCR = 1.0), you are considered high risk.
Prepayment Penalties
Many business loans come with a nasty surprise: You can't pay them off early without a fine. This is called "Defeasance" or "Yield Maintenance" in commercial lending. Lenders count on that interest profit. Always check if your loan allows early payoff without penalty.
Factoring vs Loans
Invoice Factoring is another financing route. You sell your unpaid invoices to a factor for 90% of their value cash-in-hand. The factor collects the full amount later. This is effectively a high-interest loan but technically an "asset sale", so it avoids debt covenants.
FAQs
- Do I need a Personal Guarantee?
- Usually yes. Most lenders require the business owner to personally guarantee the loan, meaning your personal assets (house, car) are at risk if the business defaults.
- Fixed vs Variable Rates?
- Lines of credit usually have variable rates (Prime + X%). Term loans often have fixed rates, which aids in budgeting.
- What is a balloon payment?
- Some loans have low payments for 5 years but the remaining balance is due all at once at the end. This is a "Balloon". Be careful with these.
- What is a UCC Filing?
- A Uniform Commercial Code (UCC) lien. The lender files this public notice to claim their right to your business assets if you default. It can make getting second loans difficult.