Financing Terms Small Business Owners Should Understand
In the business finance world, there is a lot of terminology, some of which you might not be familiar with. As a business owner, it is important to know and understand the terms you will be using when financing your business. Common business finance terms are listed below along with their definition to help you be informed and prepared.
Annual Percentage Rate (APR)
The annual percentage rate is the total annual amount you will have to pay on a loan, expressed as a percentage of the principal. It is similar to an interest rate, but the APR includes any additional costs you will have to pay. When applying for a loan, the APR will give you the best picture of how much you will have to pay back.
A credit score is a three-digit number based on your credit history. Your credit score tells lenders your credit worthiness, or how likely you are to repay your loans on time. Your credit score is determined by the number of accounts you have, your total amount of debt, your repayment history, and other factors. Credit scores usually range from 300 to 850; a score above 670 is usually considered a good score.
Business Line of Credit
A business line of credit is a loan that operates like a credit card and is used only for business purposes. Like a credit card, a business line of credit has a spending limit and only accumulates interest on the balance. A line of credit is beneficial for keeping your business operating and covering expenses such as payroll, inventory, rent, etc.
Business Term Loans
Another financing option is a business term loan. A business term loan is a lump sum of money you borrow then pay back within a set period of time. Interest rates can be fixed or variable, depending on the lender. A term loan has a set repayment schedule, usually weekly, bi-weekly, or monthly. Interest rates are also typically lower for business term loans.
Collateral is a valuable asset pledged to a lender to ensure that the borrower will repay the debt on time. By requiring some form of collateral, the lender minimizes risk. When financing your business through a loan, you might pledge equipment or real estate owned by the business as collateral. In the event that you default on the loan, the lender could then seize the asset and sell it to recoup their loss.
Your business’ cash flow is the net sum of cash or cash equivalents being transferred in and out of your business accounts. Shareholders look at a business’ cash flow statements to assess its liquidity or its financial flexibility. A business with positive cash flow is more likely to pay its shareholders, expand and grow the business, repay debts, and be prepared for financial adversity.
A lender might require a co-signer—someone who can guarantee the loan will be paid if the borrower defaults. A good co-signer is someone you can trust, has a good credit score, and has assets available to them in the event that they will have to pay off your debt.
An alternative to borrowing money is equity financing—the selling of shares in the company, either to public or private buyers. The two most common types of shares are common stock and preferred stock. Owning common stock gives a shareholder a small say in company decisions. Preferred stock owners, while they do not have any voting power, are paid dividends before common stock owners.
Loan Origination Fee
When you are approved for a business loan, you might have to pay an origination fee. A loan origination fee is a service fee charged by a lender for processing your loan application. Typically the fee is between 0.5% and 1% of the total loan amount. Sometimes this rate can be negotiated, but a lower origination fee could mean a higher interest rate on the loan.
The maturity date is the date on which a loan must be fully repaid. The maturity date marks the end of the debt agreement so interest payments will cease on this date. Most loans have a fixed maturity date but in many cases the borrower can pay back the principal amount in full before the loan reaches maturity.
Profit and Loss Statement (P&L)
A Profit and Loss (P&L) statement is a financial statement that outlines the revenue, costs, and expenses your business incurred over a quarter or a fiscal year. A P&L statement reflects the company’s ability to generate profit by increasing revenue and/or reducing costs. Both outside investors and internal managers use P&L statements to assess the overall financial health of the business.
SBA loans are business loans that are partially guaranteed by the Small Business Administration. Lenders and banks that work with the SBA will accept borrowers who would otherwise be too great a risk. SBA loans typically have more flexible terms and lower interest rates, making them a good option for businesses that lack the creditworthiness to qualify for a loan on their own.
Now you have learned or refreshed your memory on some important terms that every business owner should be familiar with. This selection of business finance terms is not an exhaustive list of all the things you will need to know. Part of your job as an entrepreneur is to continue learning every day and use the resources and tools available to you.
PlainsCapital Bank uses its expertise and industry knowledge to educate current and prospective customers on business and finance. We have a large library of informational articles that cover everything from business financing to cybersecurity to fraud prevention. To learn more, visit PlainsCapital.com/Insights.