Securing a business loan is a significant step towards achieving your entrepreneurial goals and ensuring the ongoing success of your business.
However, ongoing effective financial management is important for ensuring you do not find yourself in a position where you can no longer make the loan repayments.
The first step in that regard is understanding how business loan repayments work.
Understanding Your Loan Agreement
The loan agreement outlines all of the terms and conditions of the business loan provided to you by the financial lender. It is a document that you will have signed and should have carefully read containing all the essential details of the agreement.
The most essential parts of the loan agreement are the following:
1. Loan amount
This item is the most straightforward. It is simply the total sum of working capital, i.e., money that you borrowed and therefore have to pay back.
The loan amount, naturally, will affect other aspects of the business loan. The higher the amount, the larger your repayments, the more interest you will pay and the longer your repayment term.
Financial lenders will discuss your business needs with you and use a set criteria of eligibility qualifications to assess the level of risk involved and therefore determine the loan amount you are able to borrow.
2. Interest rate
The interest rate is essentially the cost of borrowing the money. It is expressed as a percentage of the loan and therefore the dollar amount will vary both if the interest rate changes or if the loan amount the interest is being charged on changes. In other words, as you repay more and more of the loan, all things being equal, you will pay less interest.
Understanding the interest rate is essential as it influences your overall repayment cost substantially. Factors such as creditworthiness, loan type, market interest rates and risk factors can all influence what sort of rate a lender may offer.
3. Repayment term
The repayment term, sometimes referred to as the term of the loan, is the duration of time over which you need to repay the loan. This can be a case of months when it comes to smaller loans or years when it comes to larger sums of borrowed money.
Shorter terms for the same principal loan amount translates to higher repayment instalments but less total interest paid. The opposite is also true. The longer the term the lower the repayment instalments but higher the total interest cost.
As with loan amounts and interest rates, the repayment term offered by a financial lender is determined by factors such as the approved principal amount, your business goals, and your company’s financial health.
4. Repayment schedule
The repayment schedule is different to the repayment term, though related. The schedule outlines how frequently you need to repay instalments of the loan (plus interest) back. It therefore also determines the amount your repayments will be.
Most commonly, with business loans, the repayment schedule is in monthly installments but this is not necessarily the case.
Some loans allow for early repayment which can potentially save you significant amounts of money in interest not incurred.
Breaking Down Loan Repayments
To better understand business loan repayments, you should familiarise yourself with the concept of Equalised Monthly Instalments (EMI). This is just an industry term for the fixed monthly repayments most business loans require.
Generally, they can be broken down into two components.
- Principal
- Interest
Principal
This is just the loan amount. It is the actual amount of money you borrowed (see above) that needs to be repaid in full.
Interest
As outlined previously, this is the ‘fee’ paid to the lender for being able to borrow the money.
Equalised Monthly Instalments
The concept of EMI reflects the changing breakdown of your monthly repayments.
In the initial stages of your loan, a larger portion of your EMI goes towards interest due to the amount of money left to repay. As you progress with repayments and owe less and less of the principal amount, the amount you pay of that principal increases, but the interest amount decreases.
How to Manage Your Loan Repayments
Understanding the terms of your business loan, including the repayments, can empower you to make informed decisions during the application process for the loan and when it comes to the loan agreement.
Always compare loan offers
Every business is different and the right business loan for you will depend on your objectives, needs and financial situation.
Consider your cash flow and how you will be able to cover the total repayment cost, principal amount plus interest, over the loan term.
Negotiate the terms of the loan
Having a strong understanding of the different loan components and how they each impact repayments strengthens your negotiation position.
Always discuss interest rates and repayment terms with your chosen financial lender.
Plan your finances carefully
Accurately forecasting your monthly loan obligations and predicting future cash flow will ensure you have sufficient means to meet your repayments whilst still being able to fund ongoing business operations.
Strategies for Streamlined Loan Repayments
Here are some strategies to help make the process of making your business loan repayments smoother.
- Forecast your income and expenses to ensure your business generates sufficient cash flow to cover loan repayments and other operating costs.
- Set up automatic payments to avoid missed deadlines and potential late fees.
- Consider making additional payments during peak earning seasons to reduce your overall loan burden and save on interest costs.
- If you anticipate or expect any financial challenges to meeting your repayment obligations, proactively communicate with your lender to explore possible solutions.
Frequently Asked Questions About Business Loan Repayments
What happens if I miss a loan payment?
Missing a repayment can incur late fees, damage your business’s credit score, and potentially lead to loan default.
Can I refinance my business loan?
Refinancing your business loan can be an option if you qualify for a lower interest rate elsewhere. However, there might be associated fees that should be taken into account.
What if my business struggles to make repayments?
If you anticipate difficulty in making your repayments, contact your lender immediately. They might offer flexible repayment options to help you get back on track.
Fast, Flexible Business Loans with ScotPac
ScotPac is the largest non-bank financial lender in Australia thanks to our ability to provide customised, fast and flexible business loans for our clients.