It’s important to secure the best type of financing to suit your business goals—but that’s impossible to do if you don’t understand the language of the industry.
We’re here to break down some of the industry-specific terms, so you don’t have to decipher the lending jargon and can focus on what really matters: the future of your business! Here is a continuation of our lending term resource post, which we hope will shed some light on the jargon-dense lending process.
Though this might seem self-explanatory, the federal government has a strict definition of what constitutes a small business. The Small Business Administration has small business size standards which can be viewed in the Electronic Code of Federal Regulations. The SBA also provides a useful tool for entrepreneurs to find out of their business is considered small and therefore eligible for SBA funding.
Term loans are a traditional type of funding for small businesses which are usually used for long-term investments. Term loans include a lump sum payment which is paid back with fixed amounts over a period of time. Term loans usually feature lower monthly payments than short-term loans, although the repayment terms are longer. This type of financing varies in interest rate, term length and loan size.
A company’s working capital can be boiled down to the difference between its current assets and current liabilities. Working capital does not account for long-term assets or liabilities.
Debt Service Coverage Ratio (DSCR)
This measure is a telling component of a loan application because it determines the potential risk to the lender. It does so by highlighting a business’ ability to pay back the loan with interest. A business’ DSCR can be calculated by dividing its annual net operating income by its annual debt payments. DSCR values greater than 1.25 have a better chance of getting approved for a loan.
Paying back your small business loan early may sound ideal, but that’s not necessarily a good move. When you pay the full amount of the loan back early, it hurts the lender by reducing the amount of interest owed to them. Because of this, early repayment can result in additional charges. Not all lenders charge these types of fees, but it’s important to be aware of potential prepayment penalty clauses before taking out a loan.
We hope this glossary will simplify the dizzying lending language and allow you to navigate the loan process with ease.