There are a number of reasons why businesses choose to borrow money, ranging from short-term cash flow needs to long-term expansion plans. In some cases, borrowing can even help to improve a company’s bottom line by allowing it to take advantage of opportunities that would otherwise be out of reach.
Of course, there are also risks associated with borrowing, and businesses must carefully weigh the costs and benefits before taking on debt. However, for many companies, the potential rewards outweigh the risks, making borrowing an essential part of doing business.
Small business owners often think that debt is bad and should be avoided but borrowing money responsibly is actually a sensible thing for a business to do.
In 2021 the normality for companies to borrow money and be in debt, and borrowing money to make money isn’t a new idea.
Just because the entity is borrowing money, this is not a negative thing, there are a number of reasons why business borrow money.
Why Do Businesses Borrow Money?
Businesses borrow money for a variety of reasons. Sometimes it’s to expand their operations or purchase new equipment. Other times, it’s to tide them over during a slow period or cover the cost of unexpected expenses. Whatever the reason, businesses usually have to pay interest on the money they borrow.
The amount of interest they pay depends on the type of loan they take out and the terms of the loan agreement. Some businesses may also have to pay other fees, such as origination fees or prepayment penalties. Businesses need finance for a number of different purposes, but there are some common reasons why businesses apply for funding. Business grants and loans for working capital to buy machinery, to hire more staff, or even re-finance existing loans to reduce monthly outgoing costs.
A survey published in 2019 by the British Business bank found that 44% of SME businesses sought some form of external funding in the previous three years. However, even with these additional costs, borrowing can still be a good way for businesses to get the money they need when they need it.
Read on to discover the 6 most common reasons that most businesses want to borrow money.
1. Start up costs have to be paid
Before a single sale can be made, there needs to be something to sell.
Every business needs some form of investment before it can start trading. This could be as simple as a computer, a telephone and an internet connection. But most need more eg., stock, premises, marketing and something to pay the staff, even if it’s a sole trader.
The money for this could come from a personal loan taken out by the business owner or other flexible sources of finance such as credit cards. The money may even be borrowed from friends, family or effectively from the business owner themselves.
2. Working Capital is Needed to Keep Cash Flowing
Typically, suppliers need to be paid before customers settle their debts. This puts continual pressure on cash flow. To keep this cycle moving, and to avoid running out of money, demands that a certain amount of money is available to the business at all times — working capital.
Over time, the business can finance working capital out of profits, but this only comes after a period of successful trading. If the business is growing quite fast, the capital required could always be ahead of the surplus generated from trade, meaning continual borrowing is needed.
3. Use The Investment To Make More Than It Costs To Borrow
This is one reason why many firms of all sizes continue to use credit, even when they’ve been trading for years. They use the funds to generate enough profits to more than cover the cost of borrowing.
Taking out credit, whether it’s a business loan, invoice finance or an overdraft, allows them to invest in more sales, creating more profit. Successful businesses spot opportunities in the market and borrow the funds they need to seize the moment.
Asking how much it costs to borrow money is often the wrong question. The right question is: “What’s the difference between how much you can make and how much it costs to borrow?”
4. Borrowing Money Reduces Personal Risk
It may seem odd for your business to borrow money when you’ve already got personal savings. But you saved that money for a reason — perhaps to fund children through education or provide for your retirement.
5. Improve your credit rating
When you borrow money, by making your repayments on time you will significantly boost your business’s credit score. Once the business has an excellent credit score, it easier to secure further credit in the future as well at a lower interest rate. This will allow you to continue with growth as well as being successful within business
6. Insufficient Funds
New businesses that are still in the startup stage will need funding to get off the ground. While most directors will use their own funds to start the business, very few manage to entirely self-fund the company to profitability and will therefore have to seek external funding. There are a variety of options for external startup funding, including bank loans, borrowing from family and friends, invoice business finance and equity investment
Whatever that reason is, if you tie up that cash in your business, it’s not available for the original purpose or should you need it quickly.
Taking out credit for your business offers a number of benefits and can improve your chances of commercial success, invoice factoring is one option for business, should you like more information on reasons why businesses borrow money please complete our online enquiry form.
Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.