How much money should you borrow for a small business loan?

You want to apply for a business loan—but just how much should you actually borrow? While its easy to think that more capital equates to more profit potential, that’s not always the case. 

The amount you borrow for a business loan doesn’t just influence your business’s growth trajectory; it also affects your cash flow, operations, and future financing opportunities. 

That’s why, as a borrower, it’s critical to understand how much money you’ll need to reach your goals and how much you can realistically afford to borrow. 

Finding your borrowing sweet spot

When it comes to getting financing, Goldilocks’s rules apply: you don’t want too little or too much—you want just enough. Let’s explore a few possible scenarios. 

What happens if you borrow too much money?

If you overstate your financing needs in your loan application, there are two likely outcomes. The first possibility is that you don’t qualify to borrow the amount of money you ask for, in which case you might be denied your loan. You may have to start the application process over or find a new lender, both of which take time and resources you may not have to spare. 

The second possibility is that you do qualify for the amount you ask for, but it’s still more than you can afford. If your business doesn’t bring in enough revenue or sales to outweigh your loan repayments, you might be strapped for cash for daily operations. As a result, you might struggle to make payments on time or plan for long-term growth. 

What happens if you don’t borrow enough money? 

If you err on the side of caution and downplay your funding needs—or if you don’t get approved for the full amount you want—you might find yourself in a compromising position. Maybe your growth projects stall, for example, or your cash flow runs out. 

You might not get the capital you need to maintain inventory levels, hire additional help, or follow through with your business commitments, all of which can set you back with your goals and finances. 

What happens if you borrow just enough money? 

If you take the time to figure out how much money you need and where your current finances stand, you’re more likely to ask for a reasonable amount of capital. Ideally, that sweet spot lets you execute your goals to completion, have a small cash cushion in case you encounter obstacles, reap the profits from your investments, and make loan payments in a way that feels manageable to you. 

4 factors to consider when determining how much money is just enough

This process requires research and forward thinking. Here are four factors to consider when evaluating how much capital you need: 

1. Your loan purpose 

The first step to determining how much money to borrow is deciding what you want to use a loan for—and why. Maybe you want to expand your customer base with a storefront renovation or new marketing campaign. Or maybe you need to hire seasonal employees or restock inventory to keep up with demand. In some cases, you might even have a handful of different projects or tasks to check off your list. 

Once you identify your purpose, its time to reach out to vendors for quotes, review your business’s financial data, and conduct research online. You need to figure out exactly what your loan would go toward. Instead of saying you need $50,000 for new inventory, for example, you might figure out you need $20,000 for new materials, $10,000 for shipping, $15,000 for labor, and $5,000 for storage. 

2. Your business finances 

Before you ask for money, it’s important to understand the current state of your finances. Your business’s financial health doesn’t just dictate whether or not you qualify for a loan—it also affects the debt load you can afford to carry. 

Externally, many lenders want to see that you have a strong repayment history, enough cash flow to maintain operations, and a history of profits—or at least considerable profit potential. Internally, you need to ensure you’re taking on enough debt to free you up, but not so much that you get bogged down with repayments. 

Take the following steps to gauge your business finances: 

• Review your business’s cash flow statements and forecasts to assess how much money you have coming in and whether or not you’re likely to experience an upcoming cash drought. 
• Review your profit and loss statement from the past year to get a better idea of your profit margins and how well you’re meeting your goals.  
• Review your sales or revenue forecasts for the next year to see if things look steady—or if you need help boosting your numbers. 
• Calculate your debt service coverage ratio (DSCR) to figure out how much debt you can afford. 
• Meet with your business accountant to discuss your options. 

3. Your growth potential 

It can be hard to quantify your business’s growth potential, but it’s important to assess how much—if at all—a loan will help propel your business forward. Ideally, you want to use a loan to invest in your business’s growth, but sometimes you might need help surviving a rough period or stabilizing operations. 

In some cases a higher borrowing amount gets you further ahead, while other times it can set you back. It all depends on where you’re starting from, what your goals are, and how strategically you deploy your funds. 

Ask the following questions when considering your business’s growth possibilities:

• What’s your goal with the loan? Let’s say you need capital for inventory. Is your goal to meet customer demand more easily, or do you want to use new inventory to raise your prices? If you borrow more money, will you make more money? 
• What’s the best case scenario with the loan? Is it realistic? Consider the best possible outcome of using a loan—whether it’s doubling your revenue or signing on 10 new clients—then ask yourself how realistic that outcome is given your resources and the state of the market. 
• What’s the worst case scenario? Is it likely? Consider the worst outcome of getting a loan—and how likely it is to play out. Depending on your business and industry, the worst outcome could be anything from losing customers as a result of growing inflation to missing multiple loan payments because you’re out of cash flow. 
• What do you need to do with the loan in order to achieve your goal? Write out all the big and small steps you’d have to take in order to meet your goal for the loan. If you want to open a second location, for example, you have to scout out spots; order new furniture, equipment, and materials; hire new staff; run a marketing campaign; and plan a launch day—and that’s just to get started. Once you outline what’s involved, consider whether or not you have the time and resources to execute the steps necessary to reach your goal. 
• What are your long-term business plans? The amount of money you borrow now should support your goals in the future. On the one hand, borrowing money you can’t pay off on time can hurt your credit score and limit your financing opportunities down the line. On the other hand, taking too small a loan may not give you the momentum you need to set your business up for continued success.

4. The loan’s full cost

The amount you borrow is just one part of the total amount you’re actually paying for your loan. In addition to a principal loan payment, you’ll also have to pay either variable or fixed interest rates, closing or origination fees, servicing or processing fees, and potentially prepayment penalties. 

Every lender has different fees, costs, and annual percentage rates (APR) so it’s a good idea to do your homework before applying for a loan. Understanding the differences in total costs can give you more clarity about which loan option is more affordable for you. 

So, how much money can you actually borrow? 

Landing on the right number isn’t a perfect science. After you add up the amount you’ll need, you also have to review your business finances to see what’s feasible for you to pay off. 

Fortunately, you can use our handy business loan calculator to estimate your monthly loan payments and plug them into your bigger financial picture. All you have to do is input the amount of money you need and the length of time you’d like to make repayments, and you can see roughly what you’d end up paying each month. 

Keep in mind this number is just a rough estimate; it ultimately depends on a variety of different factors, including the interest rate you qualify for.  

Getting a loan with Funding Circle

At Funding Circle, we want to help you get the funding you need to reach your goals—and pay back your loan with ease. That’s why we pair all our loan applicants with a dedicated Account Manager who can answer your questions, walk you through your options, and make sure you’re set up with a borrowing structure and amount that works for you. 

If you qualify, our business term loans let you borrow anywhere from $25,000 to $500,000 with repayment periods from six months to five years. We also have affordable interest rates, predictable monthly payments, and no prepayment penalties. 

Learn more about our term loans or apply today. 

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