subject: Putting Unsecured Small Business Loans in Context [print this page] Putting Unsecured Small Business Loans in Context
There is a prevailing view that there are good and bad loans. Loans with low interest, or low monthly payments, are considered to be best, and the loan is considered "worse" depending on how high the interest is, or for other requirements. Unsecured small business loans typically have higher than average interest and are often put into this camp of bad loans. Today we will provide some larger context to understand the time and place for loans of this type and hopefully add some new perspective on things.
First to the issue of interest rate. To look at interest rates as either good or bad is ignoring the context. Sure we all know that paying a lower interest rate is better than paying a high one, but this ignores the reason behind the loan in the first place. We'll look at an example of when this is relevant. Let's say you have a piece of equipment that makes widgets for your company. These widgets are sold out the front door for $10 each. They cost you $4 to produce. If you sell 100 of these a day you make $600 profit.
Now what if the widget making machine breaks and requires a $6000 repair? What if a traditional loan for this repair takes 10 days longer than unsecured small business loans? That means NOT getting the loan for those ten days costs you $6,000 in lost profits. So how high could the interest rate be to make a faster loan worth the money? A LOT higher, if you are paying off the loan within only a couple of months, hundreds of percent higher. You must put interest rate in the context of opportunity cost, not just comparing the two rates as if they represent an identical proposition.
The concept applies to new opportunities for businesses without established credit as well. Unsecured small business loans are easier to get for new small businesses than loans designed for established business, or venture capital often times. If your business needs money to pay for new opportunities, you should weigh the potential profits from these new opportunities against the cost of acquiring the funding for it. One mistake you should try to avoid though is applying a 100% chance of success when doing your calculation. Unlike existing processes, like in the case of the widget machine, you don't know 100% that your new opportunity will pan out into profits.
When deciding whether or not to pursue this new venture, you must give an honest assessment of the chances of success and calculate that into your cost benefit analysis. If it still seems like a good plan at the price point you've established, don't worry about interest rate, you've made a good decision and should move forward as planned.
