Before you take a loan – read this!

A comic representation of how loans work.

So here we are, in the midst of a financial crisis. Shops are closing, people are losing their jobs and there is a lot of fear and uncertainty in the air. 

But there is a glimmer of hope! Interest rates in general have fallen. Here in NZ, a quick search of home loan interest rates will show an all-time low of 2.79 to 2.99 percent per annum. It won’t be long before personal and business loans follow suit. Heck, the NZ government is already offering a 3% per annum, non-compounding business loan to eligible businesses!

Now that loans are at bargain prices, it only makes sense that we as business owners should take advantage of them and borrow as much as we can right?


Regardless of how cheap the interest rates are – you are still using money that isn’t yours. Money that you will have to pay back eventually. If you don’t pay back that money on time, then you are in trouble!

But that being said, there are times when having a loan is a good thing. Don’t ‘write off’ (yay for bad accounting puns!) debt as being completely bad, as it can be useful sometimes. Here are three simple questions to ask yourself before you decide to take a loan:

What will you use the loan for?

The first and most important question to ask yourself is this. A loan is borrowed funds that you have to pay back in the future. If you are going to be borrowing, you need to make sure that the money you borrowed is going into making more money which you can then use to pay off the loan. Generally speaking, a business loan should be used for one of two things:

Business expansion/Capital investments

If you are looking to expand your business or purchase new assets/machinery to add to your business, you might need a loan to make the initial investment. Let’s look at an example:

Wei Mun owns a caravan hire company. Due to the renewed interest in domestic tourism, she expects that there will be an increased demand for caravans in the market. She decides to take advantage of this opportunity and purchase three new caravans to add to her fleet which have a total cost of $180,000. Her business does not have the cash on hand to purchase them for cash, so she borrows $180,000 from the bank to finance her purchase.

Now, in Wei Mun’s case, she has a very clear idea of what the loan will be used for. She also has a plan in place to immediately make money from the assets she has purchased (via caravan hire). She is taking a bit of a gamble though, banking on a surge in domestic tourism, but at least she has a plan on how she will pay the loan off in the future.

Working capital/Operating costs

Working capital is a topic I have discussed twice before and if you’ve been following this blog for a while, you will know that working capital is the amount of money you need to keep running your business from day to day.

You will also know what a working capital cycle is and that sometimes, you need a loan to cover your operating expenses just before your next lot of sales comes in. This means that working capital loans are short-term in nature and you want to be able to pay them ASAP. 

Common sources of working capital loans are bank overdrafts and credit cards. If you are based in NZ, the SBC loan that the government is giving is a good source of working capital loan as well. 

Taking a loan for working capital/operating costs is not a bad idea at all – as you will ensure the continued operation of your business and you can easily pay back the loan as long as your business is operating

Those are the two main reasons why you would want a loan.


If you find yourself in a position where you NEED a loan for your business to survive – don’t bother. If your business is already in a position where it could go under or it cannot operate, don’t get a loan. You will not be able to pay it off and you might find yourself having to declare bankruptcy – which believe me, is not a good thing.

How are you going to pay back the loan?

Sort of related to question 1 – but this one makes you think a lot harder about how you are going to pay off the loan. Think of what you are planning to do with the loan – and then immediately start thinking about how you are going to make more money using the loan!

If you are looking at business expansions – then your business expansion needs to make you money! If you are looking at covering your working capital, then you must be sure that your business is running smoothly enough that you can pay back the loan.

In all cases, you will need to forecast your monthly cash flow over the term of the loan. Forecasting is a very tricky process and can be quite flawed. In fact, my good friend Sonnie Bailey from Wealth and Risk NZ likes to call it ‘Flaw-casting’ due to the inherent guesswork that goes into forecasting. 

But that being said, forecasting at least gives you a reasonable estimate that you can use to determine how well your business will perform in the future.

What happens if you can’t pay off your loan?

Worst case scenario – you declare bankruptcy and/or liquidate your company. It’s not pretty, but it is something you need to have at the back of your mind. 

It is also worth having a talk with your bank manager/loan officer about what options you can explore if you find yourself in a position where you cannot service your loan. Banks are only in it for the money, this is true, but because of that, their priority is to get paid. If you file for bankruptcy – they don’t get paid. 9 times out of 10 your bank officer will work with you to make sure you can repay the loan even if it means extending your terms or reducing your monthly payments.

Failing which, bankruptcy can be an option. Unless you’re like my friend, Tracy Hemingway the Debt Free Diva and you decide to pay down 100k worth of commercial debt in 3 years instead of declaring bankruptcy – in which case, GOOD ON YOU!

Whatever it is, have a back up plan. Have that chat with your bank officer and have some cash stashed away in case you can’t repay the loan. It is always better to be prepared when dealing with these situations.

So there you go – three questions to ask yourself before taking out a loan. Remember that you DON’T have to take a loan (despite what the bank officers may say). If you are a small business – equity and revenue funded growth is always the safer and cheaper option. Only take a loan if you are absolutely certain that it will help your business do better in the future.

Stay positive!

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