Top 5 Reasons Small Businesses Take Out Loans

Small businesses often need extra money to run or grow. They take loans for many reasons. Here are the top 5 reasons why small businesses take out loans.

1. Starting a New Business

Starting a new business is one of the top reasons small businesses take out loans. Launching a business requires significant funds, like renting space, purchasing equipment, hiring staff, and marketing. 

Often, personal savings are not enough to cover these initial costs. A business loan provides the capital to turn an idea into reality, allowing entrepreneurs to focus on growth without immediate financial stress.

Example: Gautam's Startup Journey

Gautam, a 25-year-old aspiring entrepreneur from Bengaluru, dreams of opening a small cafe. He estimates the startup costs as follows:

Gautam applies for a ₹5,00,000 loan under the Pradhan Mantri Mudra Yojana (PMMY) scheme, specifically the 'Kishore' category, which supports businesses needing funding between ₹50,001 and ₹5,00,000. This loan enables him to cover all initial expenses and launch his cafe successfully.

By securing a startup loan, Gautam transforms his vision into a thriving business, illustrating how financial support can empower entrepreneurs to achieve their goals.

2. Expanding Business Operations

Expanding business operations is a common reason small businesses seek loans. Growth often requires significant investment in areas like opening new locations, purchasing equipment, hiring staff, and marketing. 

A business loan provides the necessary funds to support these initiatives, enabling businesses to scale effectively and meet increasing demand.

Example: Harsh's Business Expansion

Harsh, a 30-year-old entrepreneur from Bengaluru, owns a successful bakery. With growing demand, he plans to open a second outlet in the city. He estimates the expansion costs as follows:

Harsh applies for a ₹6,50,000 business expansion loan from a local bank. This funding enables him to cover all necessary expenses for the new outlet. With the additional location, Harsh anticipates a 40% increase in revenue within the next year.

By securing a business expansion loan, Harsh successfully grows his bakery business, meeting customer demand and increasing profitability.

3. Managing Cash Flow Issues

Cash flow problems are a common reason why small businesses take out loans. Even if a business is profitable, it might not have enough cash at the right time to pay bills, salaries, or buy supplies. This mismatch between incoming and outgoing cash can cause serious issues.

Example: Vinesh's Small Business

Vinesh runs a small printing shop. He receives payments from clients 30 days after delivering the work, but he needs to pay his staff and suppliers weekly. This timing difference creates a cash gap.

In the first 3 weeks, Vinesh has no income but must cover ₹50,000 in weekly expenses. By week 4, he receives ₹200,000 from clients, but by then, he has already faced a ₹1,50,000 cash shortfall.

To manage this, Vinesh takes a short-term loan of ₹1,50,000 to cover the initial expenses. When he receives the client's payments in week 4, he repays the loan. This approach helps him keep his business running smoothly.

Loans can be a helpful tool for small businesses to bridge cash flow gaps and ensure operations continue without interruption.

4. Purchasing Equipment or Inventory

Small businesses often need loans to buy equipment or inventory. This helps them grow and meet customer demand. For example, a bakery might need a new oven, or a shop might need more products to sell. Buying these items can be expensive, so a loan can provide the necessary funds.

Example: Tushar's Business

Tushar runs a small electronics store. He wants to expand his product range before the festive season. He plans to buy more inventory, but does not have enough money. So, he considers taking a loan.

Tushar needs ₹7,20,000 to purchase the new inventory. He applies for a loan to cover this amount. With the loan, he can stock up before the festive rush, attract more customers, and increase sales. After selling the products, he plans to repay the loan from the profits.

5. Handling Emergency Expenses

Small businesses often face unexpected expenses, such as equipment breakdowns, urgent repairs, or sudden drops in sales. These emergencies can disrupt operations and strain finances. In such situations, taking a loan can provide immediate funds to address the issue and keep the business running smoothly.

Example: Rahul's Business

Rahul owns a small bakery. One day, his main oven breaks down, and he needs to replace it quickly to continue baking. However, he does not have enough savings to cover the cost. He decides to take a short-term loan to manage this emergency expense.

Rahul applies for a loan of ₹3,50,000 to cover the total emergency expenses. With the new oven installed, he resumes his bakery operations without significant downtime. He plans to repay the loan over the next 12 months from his business profits.

Conclusion

Small businesses take loans to start, expand, manage cash flow, buy stock, or handle emergencies. Loans help them stay strong and succeed when money is tight.

FAQs

1. Why do small businesses need loans?

To fund startup costs, expansion, inventory, or emergencies.

2. Can loans save a struggling business?

Yes, by covering urgent expenses or cash gaps.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?