When your business is in a bind, you might find it hard to resist the first emergency loan you come across. Before you sign on the dotted line, though, know that fast cash comes at a cost—in some cases a steep one. Wise up before you hit your next financial speed bump: learn the hidden costs of fast cash, how to stay smart when seeking quick business loans, and how to avoid fast cash scenarios in the future.
Why Fast Cash is Costly for Business Owners
If you’re trying to get a small business off the ground, likely you’re all too familiar with how easily your business’s credit can take a hit. Less than stellar credit, compounded with the age and size of your business, may rule out some of the most desirable lending options. Enter fast capital and alternative lenders, ready to accept your business’s risk and hand over that much-needed cash ASAP—for a price.
Fast capital might arrive in the form of a merchant cash advance, a short-term loan, medium-term loan, or invoice financing—all types of faster business loans. These loan products can help panicked business owners like you cover unexpected damage, jump on an exciting growth opportunity, or tide a business over until a delinquent account pays up. You’ll receive fast service and get that cash in hand quickly.
This kind of financing moves faster than traditional lending for a variety of reasons. Generally, alternative lenders aren’t subject to the same regulations as banks and, as a result can afford to be more lenient. Many of today’s alternative lenders use online submission technology and underwriting algorithms to evaluate applications in a matter of days, rather than weeks.
However, in spite of the obvious conveniences, this kind of financing can be costly. Expect higher interest rates (possibly 20, 30, 40 percent or even higher), higher fees, and faster repayment periods than you’d experience with longer-term loans. If you’re at all uneasy about your cash flow or your business’s ability to recover from these costs, hit the brakes before committing.
What to Do if You Have to Use Fast Cash
Before you accept that fast capital, understand how much new debt your business can afford. One way to improve this understanding is by getting familiar with your debt-service coverage ratio. This ratio is your total annual net operating income divided by your total annual debt service. A DSCR of greater than one indicates your business can comfortably afford to take on more debt. (You can roughly calculate your DSCR yourself, though bear in mind that each lending institution calculates this number differently.) You could also run a business loan performance analysis, which will teach you even more about how your emergency funding might impact your business’s bottom line.
The idea is to understand what your monthly loan payments will come (total them if they’re daily or weekly) and see what sort of impact this will have your cash flow, Is this going to leave you barely making ends meet? Or, will you still have enough cushion in case cash flow slows in a particular month?
How to Avoid Needing Fast Capital in the Future
Understanding the loan approval process and your business’s eligibility will help you make smart financing decisions the next time disaster looms. In addition to knowing your DSCR, know where your business stands regarding the Five C’s of Credit and how lending institutions will perceive the health of your business according to these criteria. You might find your business qualifies for better financing than you originally thought.
Cash flow crises are never fun but armed with the right information, you can protect your business from costly financing mistakes.