When it comes to your personal life, you know staying out of debt is the responsible move. If you want a new iPhone, you’re going to save up and pay for it yourself — not max out your credit cards.
But what’s financially responsible at home can get you in trouble while running a business. It’s easy to simply ask yourself, “Do I need a business loan?” as if it were a personal financial decision. But it can be harder to remember that there are times when borrowing money is a smart financial decision, while not borrowing can end up being the most expensive option of all.
The Cost of Doing Nothing
If you take a Finance 101 class, one of the first lessons will likely cover opportunity costs. Whenever you make a financial decision, there are two types of costs — what you actually spend on your decision and the profit you’ll miss out on from not moving forward with whatever option you don’t choose.
When it comes to short-term business loans, your two options are of course borrowing and not borrowing. If you take out a loan, there’s a clear cost: Whatever you’re paying in interest and fees to borrow money. When you do nothing, however, there’s no out-of-pocket cost, which can make it feel like the less expensive option.
But then what about the missed chance to earn money? When you factor in that missed opportunity, your business could be worse off because you didn’t borrow. Here are some examples of that missed opportunity cost in action.
One of the clearest examples of losing money through not borrowing is missing a sale because you didn’t have enough cash to complete the deal.
Let’s say you’re running out of inventory but can’t afford to buy more until you get paid for another project. You figure it would cost $2,000 to borrow the $10,000 needed to resupply. And let’s say selling the extra inventory would earn you enough to pay back the entire loan, along with an additional $18,000 in profit. By borrowing money, you effectively spend $2,000 to make $18,000. That’s an 800 percent return on your $2,000 investment.
Another way to look at it: Doing nothing costs you $16,000 because of the missed opportunity.
Short term business loans can also bridge the gap in payroll when you’re temporarily short on cash. If you’re late on paying your employees, even if just by a few days, chances are they’re going to start looking for other career options.
On average, it costs $4,129 to hire a new employee, according to the Society for Human Resource Management. They also determined it takes 42 days to find someone new, which is time when your business won’t be operating at 100 percent. The benefits of making payroll can easily offset the cost of a short-term loan.
Expanding Your Business
You can also use a short-term loan to expand your business by hiring new staff, buying new equipment and/or launching a marketing campaign. Once again, this decision is a trade-off between borrowing to expand right away versus waiting until you can pay for everything yourself.
For example, you predict that by investing an extra $100,000 in your business, your profits will grow by $30,000 a year. You can either borrow the money today, which will cost $30,000, or save it up from your current earnings, which will take three years.
Borrowing will cost $30,000, but by waiting to save the money, you’re passing up $90,000 in future profits. The cost of doing nothing is much, much higher.
The Bottom Line — Do I Need a Business Loan?
As you go over the considerations for a business loan, include the opportunity cost of not borrowing in your decision. This isn’t to say that borrowing money is always the right decision. Short-term loans aren’t a blank check to spend on just anything.
But if you determine your business will gain more than the cost of the loan, borrowing money can be the right financial move. You can even buy that new iPhone — if you have the numbers to back it up.