It is key for every entrepreneur and business owner to know how business loans work, as we know, the majority of businesses will require some form of a loan or credit in their existence. Small business loans allow entrepreneurs to grow their businesses and fund any gaps they may have in cash flow. There are a variety of business loans available and some are more suitable than others depending on the type of business you have. The details of your business, (such as your time in business, financial health, credit score, and available collateral) play a role in determining the type of business loan you qualify for. Below, we walk you through the qualifying criteria and how exactly small business loans work.
How Do I Qualify For a Business Loan in South Africa?
Preparation is essential when applying for any business loan. Below are two ways to increase your chances of qualifying for the business funding your business needs.
- Have a good personal and business credit score, anything above 650
- Prepare your financial statements and management accounts
The Types of Small Business Loans:
1. Traditional Short Term Business Loans
South Africa’s leading banks all offer a range of loans for businesses, from short term to long term loans, as well as specialised loans for equipment and vehicles.
Applying for a traditional business loan can take up to an average of two months and there is a lengthy application process with many stringent requirements. You will need to fill in an application and submit it together with supporting documentation and information. Many banks require business plans, financial statements tax records, and even financial forecasts.
If your application is successful, you will have to wait an additional period of time before you receive your funding. This is obviously not ideal for a small business owner who requires a short term loan immediately.
2. Debtors Factoring and Invoice Discounting
Debtor financing is where a financial institution purchases a business’s debtor book or lends money against it. A debtors book is just a collection of all of your receivable invoices. This type of finance is also known as Invoice Financing, Invoice Discounting or Factoring. Essentially, it’s a tool that business owners can use to unlock value within their business to grow their business or their cashflow. With debtors factoring, a business can accept longer payment terms from their corporate customers and therefore take on more or larger projects. As an alternative, businesses can also use debtors factoring to overcome cash flow hurdles while they wait for their customers to make payment.
3. Business Lines of Credit
A business line of credit provides flexibility that a regular business loan doesn’t offer. A business line of credit allows you to borrow up to a certain limit and pay interest only on the portion of the money that you borrow. You can then withdraw and repay funds as you wish, as long as you don’t exceed your credit limit. A line of credit works similarly to a credit card.
4. Bank Overdrafts
A bank overdraft is where a business’ bank account is allowed to go into a negative balance up to an approved limit. Some banks will impose two kinds of limits on your overdraft: a lower “soft” overdraft limit as well as a higher “hard” overdraft limit. You’ll be able to exceed the soft limit but will incur additional charges or will be penalised with a higher interest rate. The hard limit can never be exceeded.
To get a bank overdraft, a long trading history is a requisite, starting from a minimum of two years. There is usually no fixed repayment date, you just need to pay the interest on the overdraft every month without repaying any of the capital/principal amounts. You will also have to pay monthly account or facility fees to keep the overdraft active, even if you’re not using it. It’s important to consider these additional charges that may be excluded in the advertised interest rate.
5. Merchant Cash Advance
A merchant cash advance is ideal for businesses within the retail and restaurant industry, primarily those who make sales to customers through credit card payments. The amount loaned is calculated based on the average monthly turnover of the business. The repayment term ranges between 6 to 12 months, but can vary as the repayments are adjusted based on the business’ monthly credit card sales. In other words, if a business has a great month, the repayment costs are slightly higher than normal, while during quieter months, the repayments are less. Amounts repaid and outstanding balances are difficult to manage and keep track of as repayments happen on a daily basis.
6. Business Credit Cards
Business credit cards work similarly to consumer credit cards, only difference is that the chances of approval are low. Business credit cards provide a great way to earn extra rewards and perks, but keep in mind that reward rates tend to be lower compared to consumer credit cards.
Your business performance and credit score play a crucial role in the size of the credit card limit that your business will be approved for. Credit cards also serve as a good way to build your business credit score and your ability to obtain other forms of business finance in the future.