Notes On High Interest Business Loans For Inventory-Based Businesses
I took on a business loan a few weeks ago. High interest rate. 18% is credit card levels.
I earn a high ROI on the products I sell so this loan should be helpful, but I realize now that re-paying a loan like this actually requires that I earn much higher than an 18% annual return… in fact, I need to earn 118% in order to pay it back.
Why Do I Need To Earn 118% ROI In Order To Pay Back My Loan?
When it hit me, I slapped myself in the forehead.
I run an e-commerce company. I’m going to use this loan money to buy inventory. So long as these products keep selling, I’ll need to remain in stock. This is the loan money, indefinitely tied-up in my inventory!
Now that the money is tied up in inventory, I need to earn back 100% of the loan principle in profits as well as the 18% interest. Unless sell out of all my stock, going back to square 1 again, I need to make a fabulous return. I need to have super-high margins, and most things need to go right.
Even though I buy most of my products for $3 and sell for $20, with large margins in the middle, roughly tripling my money on each inventory turn, I will still feel the pressure to earn 118% ROI over the coming year.
If I can’t earn 118%, I’ll fall into the old trap of “The bank took my business!” when they seize and sell off my inventory.
Interest Rate Is Important But For Short-Term Loans Repaying The Principle Is More Important
Whether your loan is for 5% interest, or 18%, the math is actually quite similar for the first year. You either pay back 105% of the loan, or 118%.
The largest portion of this payment, the repayment of the initial 100% that you sunk into inventory, is unchanged.
I’m 24, so my advice doesn’t come from a place with lots of experience, but I have some ideas or ‘Tips’ for someone considering taking on a business loan, especially if it’s your first business loan and you run a small inventory-based e-commerce shop.
1. Don’t Feel Pressure To Spend The Money
You took on a loan so that you could put the money to work! So you might want to spend it right away on any investment you can find. After all, interest is accruing every second!
Don’t give in to that pressure. Whether your interest rate is 5% or 18%, the bulk of your repayments will be the principle of the loan. If you spend it too quickly, on less-than-worth investments, then you’ll feel the pressure to pay a lot more than just the interest.
Imagine a ‘worst-case’ scenario: You don’t spend any of the money and you pay the interest on the loan. You pay interest for holding unutilized funds. That’s not great, but that’s OK!
This is much better than a totally different ‘worst case’ where you invest the money poorly, don’t make anywhere near the required 100%+ ROI, and find yourself underwater for principle + interest!
2. Don’t Invest In Something You Wouldn’t Have Invested Before
ROI is based on percentages, not hard-numbers. If an investment wasn’t worth it before the loan, it’s not worth it after the loan!
It’s tempting to look for places to spend the money, but don’t let down your guard and don’t start investing in mediocre projects just because you can.
Example: I work with a factory who supplies us with a ‘normal’ size of a product. Sales are good, and for $5,000 we can have them create a mould of a ‘large’ version of this product. It would likely sell well, but margins on these items would be tighter, and we’d need to then sell about 1,000 units just to break even on the mould costs, not to mention inventory orders.
Now, flush with cash, I could easily pay for this mould, but it’s still not a good use of $5,000. The justification would be ‘market domination’, but the hard numbers still don’t work out.
3. Take The Money!
The way I see it, your first loan isn’t about the money. It’s about opening the spigot so that you can get loans in the future. It’s about building your credit.
Your first loan gets you in the game. Even if you don’t utilize the money, and even if you pay interest, and even if your interest rate is high, it clears the way for you to get more money in the future. If you take on a $10,000 loan and pay the interest on time, you will be offered a $20,000 loan soon enough, and probably at a lower interest rate.
Your first loan gets you in the game. It’s OK to pay your dues with a little higher interest rate.
4. Do NOT Change Your Lifestyle At All
If making mediocre business investments is a bad idea, then getting comfortable and spending more on your lifestyle is idiotic.
Taking a loan to buy a bunch of nice things is a clear sign of mental weakness and lack of willpower, patience, and long-term planning capability. Making bad investment decisions is one thing, but purposefully wasting money that is meant to be utilized to generate a return (for you and the lender!) is financial sin.