Before Taking a Business Loan, What Should You Calculate?
Taking a business loan can provide the funds needed to start a new venture, purchase equipment, expand a shop, increase stock or manage working capital.
But before deciding how much to borrow, it is important to understand whether the business can comfortably handle the repayment.
A loan should be looked at as more than the amount you receive from the bank. The interest, monthly repayment, business expenses, existing commitments and expected cash flow all need to be considered together.
So, what should you calculate before taking a business loan?
- Calculate the Actual Amount You Need
Start with the purpose of the loan.
If you are opening a new business, list the expected costs such as equipment, interiors, rent deposit, licences, initial stock, salaries and other setup expenses.
If you already run a business, identify exactly what the additional money will be used for. It could be machinery, renovation, additional inventory, a new branch or working capital.
Avoid choosing a loan amount simply because a lender is willing to offer it.
Borrowing more than the business actually needs can increase your repayment burden without necessarily increasing your ability to generate income.
The loan should be based on the actual financial requirement of the business, not simply on the amount available from the lender.
- Work Out Your Own Contribution
A business loan may not necessarily cover the entire project cost. You may need to bring some money into the project yourself.
For example, if a proposed expansion costs ₹15 lakh and you plan to borrow ₹10 lakh, you need to know how the remaining ₹5 lakh will be arranged.
Calculate your own contribution before finalising the loan amount.
This gives you a clearer picture of the total financial commitment involved and also helps you understand how much of your own funds will be locked into the project.
- Calculate the Monthly Loan Repayment
The loan amount alone does not tell you how expensive the borrowing will be.
Consider the interest rate and repayment period and calculate the expected monthly instalment.
Then compare this with the cash that the business normally generates after paying its regular operating expenses.
For example, if your business normally has ₹80,000 available after monthly operating expenses and the proposed loan repayment is ₹50,000, you should examine whether the remaining amount is sufficient for other financial needs.
Do not base this calculation only on your best sales month.
Use realistic figures based on your regular business performance.
- Calculate Your Monthly Business Expenses
Before adding a new loan repayment, understand your existing expenses.
These may include:
- Rent
- Employee salaries
- Electricity and other utilities
- Raw materials or inventory
- Transportation
- Marketing expenses
- Existing loan repayments
- Taxes and statutory payments
- Maintenance and other regular costs
Once these are listed, you can see how much money is actually available for a new repayment.
It is also useful to separate regular operating expenses from occasional or one-time expenses, so that the repayment calculation is based on a realistic picture of the business.
- Check Your Cash Flow
A business can show a profit on paper and still face difficulty paying its monthly bills.
This can happen when customers take a long time to pay, inventory remains unsold or large expenses have to be paid before receiving sales income.
Therefore, look at when money comes into the business and when it goes out.
Your expected loan repayment should fit within this cash flow pattern.
A simple monthly cash flow projection can help identify periods when the business may face a cash shortage, even if the business is profitable overall.
Cash flow projections are also an important part of financial planning for a business loan because they help demonstrate how the business expects to manage its financial commitments.
- Calculate Your Break-Even Point
Break-even is the point where the business generates enough revenue to cover its operating costs, without making a profit or a loss.
Knowing your break-even point can help you understand how much you need to sell before the business starts generating an operating surplus.
This becomes particularly important when taking a loan for a new business or expansion.
If the expected sales required to cover the business’s costs are unrealistic, the proposed borrowing deserves a closer look.
Remember, however, that breaking even does not automatically mean that the business has enough cash to service a loan. Loan repayments also need to be considered separately in the cash flow assessment.
- Calculate the Effect of the Loan on Your Existing Debt
Already paying another business or personal loan?
Include those repayments in your calculation.
For example, a business may appear capable of handling a new ₹30,000 monthly repayment when considered separately. But if there is already another ₹25,000 repayment, the total monthly commitment becomes ₹55,000.
Look at all existing financial commitments together rather than evaluating the new loan in isolation.
This is also where a business owner should look at the debt-servicing capacity of the business — in simple terms, whether the business is generating enough cash to comfortably meet all its loan repayments.
- Prepare Realistic Future Projections
Before approaching a lender, prepare an estimate of your expected sales, expenses, profit and cash flow for the coming years.
Do not simply assume that sales will increase sharply every year.
Consider your present customer base, pricing, competition, operating capacity and likely expenses.
It is also useful to prepare different scenarios:
- What if sales grow as expected?
- What if sales are lower than expected?
- What if expenses increase?
- What if customer collections are delayed?
A project report commonly brings these figures together through projected financial statements, project cost, funding sources, cash flow and repayment-related calculations.
- Calculate How Much the Loan Will Cost Overall
A ₹10 lakh loan does not mean you will repay only ₹10 lakh.
Interest over the repayment period adds to the total amount paid back.
Depending on the loan, there may also be processing charges and other applicable costs.
Before signing the agreement, check the repayment schedule and understand the total financial commitment, rather than looking only at the monthly instalment.
A lower monthly instalment may sometimes simply mean a longer repayment period and therefore a higher total interest cost.
- Prepare a Simple Loan Feasibility Check
Once you have the numbers, put them together.
Ask yourself:
- How much does the project actually cost?
- How much money can I contribute?
- How much do I need to borrow?
- What will the monthly repayment be?
- What are my existing loan commitments?
- How much does my business normally generate after operating expenses?
- When will customers actually pay?
- What happens if sales are lower than expected for a few months?
- Will the business still have enough cash for regular operations?
- Can the business comfortably service the total debt?
These questions can give you a much clearer picture before you take on additional debt.
Why a Project Report Can Help
For many business loan applications, a project report brings the business plan and financial calculations into one place.
It can include the proposed investment, sources of finance, expected revenue, expenses, profitability, cash flow, repayment plan and other financial information relevant to the proposal.
But a project report should not be prepared only because the bank has asked for one.
The process of preparing the numbers itself can help the business owner test the proposal, identify funding gaps, understand the repayment burden and assess whether the proposed borrowing makes financial sense.
In that sense, a good project report is not just a document for the lender.
It is also a financial planning tool for the business owner.
Before You Borrow, Understand the Numbers
Taking a business loan is a financial decision that should be based on numbers rather than simply on the loan amount offered.
Calculate the actual requirement, your own contribution, monthly expenses, repayment amount, cash flow, break-even point and existing commitments.
Then prepare realistic projections for the coming years and test what happens if the business does not perform exactly as expected.
A loan can provide the funds needed to grow a business. But the objective should not be simply to obtain the maximum funding available.
The objective should be to borrow an amount that the business can use productively and service comfortably.
A properly prepared financial plan can help you understand whether the proposed borrowing fits your business and how the funds can be used effectively.
At 2ndinnings, we help businesses bring these numbers together through financial planning, project reports and related business support, so that the promoter has a clearer picture of the proposed investment, funding requirement, repayment capacity and projected financial position.
Before asking, “How much loan can I get?” it is worth asking, “How much loan can my business comfortably handle?”
