Loans for small food businesses: what to ask

Before you take a loan for your food business, find out how much money actually reaches your account, how much you repay in total and what each monthly payment is. Then compare those numbers with your margin: whatever you buy with the loan has to produce more contribution each month than the repayment, with room to spare in case sales are lower than you hope. If the maths only works when everything goes perfectly, the loan is too big or too expensive for you.

Questions to ask before you sign

Get the answers in writing, in money:

1. How much lands in my account? If fees are taken off at the start, you receive less than you borrowed.
2. What is the repayment and how many are there? Ask whether the payment is fixed or can change.
3. How much do I repay in total? Repayment × number of payments, plus any other charges.
4. What is the annual cost including all fees and insurance? The interest rate alone does not tell the whole story. Ask for the all-in annual cost so you can compare offers side by side.
5. What happens if I pay late? Penalty fees, extra interest, effects on your credit record.
6. Can I repay early without a penalty? If things go well, you will want to finish sooner.
7. What security do you want? If it is your home, your salary or a relative's guarantee, the risk is no longer only the business's.

Also check that the lender is authorised by your country's financial regulator. If anything is unclear, keep asking until someone explains it with numbers.

The cost of the money, in money

The real cost of a loan is what you repay in total minus what you received. That is the figure to compare with your margin.

cost of the loan = total repaid − amount received

If you receive $2,920 and repay $3,420, the money cost you $500. Put another way, you pay back about $1.17 for every dollar you got.

Compare the cost with your margin

A loan is repaid out of contribution margin, not out of sales. If a product leaves you $4.80 per unit, every $4.80 of loan cost is one unit you sell for the lender. There are two sums to do:

• Units to cover the repayment: (repayment + extra monthly running costs) ÷ contribution per unit. That is how many extra units you must sell each month just to cover the loan.
• Units eaten by the cost of money: total loan cost ÷ contribution per unit. That is how much of your extra work ends up paying interest and fees.

Then run a stress test: work out what happens if you sell 80% of what you expect. If you can still make the repayment, the loan is manageable. If not, you will be topping it up from somewhere else in exactly the bad months.

Worked example: a second oven for more loaves

You sell sourdough loaves for $7.50. Their variable cost (flour, salt, starter feed, bag, label) is $2.70, so each loaf leaves $4.80. Your oven is full and you want a second-hand second oven. A lender offers $3,000 with an $80 arrangement fee taken off at the start.

Option A: 12 payments of $285

• You receive: 3,000 − 80 = $2,920.
• You repay in total: 12 × 285 = $3,420.
• Cost of the loan: 3,420 − 2,920 = $500, or 500 ÷ 2,920 = 17.1% of what you received.

Option B: 24 payments of $155

• You repay in total: 24 × 155 = $3,720.
• Cost of the loan: 3,720 − 2,920 = $800, or 800 ÷ 2,920 = 27.4% of what you received.

What the oven brings in. You expect to sell 90 more loaves a month. The second oven adds $40 a month in energy.

Stress test on option A. If you sell only 80% of the plan, that is 72 extra loaves: 72 × 4.80 = $345.60, minus 40, minus 285 = $20.60 a month. You can still pay, but with almost no room.

Reading it. Option B leaves more each month and copes better with a slow month, but the money costs you 62 more loaves (167 − 105). Option A is cheaper but needs at least 68 extra loaves every month for a year. If you already have orders that would fill the second oven, A makes sense. If the extra sales are a hope, neither option is a good idea yet: try selling more from the oven you have first, with an extra bake.

Loans for stock and working capital

A short loan to buy ingredients, for example for a large café order, works the same way over a shorter period. Say you borrow $1,500 for two months and it costs $90 in total. If ingredients are 30% of your price, that $1,500 turns into 1,500 ÷ 0.30 = $5,000 of sales. Taking off the ingredients and $500 of packaging, the contribution is 5,000 − 1,500 − 500 = $3,000. The cost of money is 90 ÷ 3,000 = 3% of that contribution: reasonable.

The risk here is timing. If the café pays at 60 days and your first repayment is due at 30, you will be paying with money you do not have yet. Before borrowing, check how many days pass between buying and getting paid; the guide to working capital shows how to work out that cycle, and the one on how inventory ties up cash shows how to free money without borrowing at all.

When borrowing makes sense, and when it does not

It makes sense when what you buy adds capacity for a product that already sells and leaves a good margin, or when it funds a confirmed order that is paid before the repayment is due.

It does not make sense to cover losses on a product that does not pay its way, to pay ordinary monthly fixed costs, or to buy stock in bulk just because it is cheap. In those cases the loan makes the problem you already have bigger.

Before any loan, be clear on how money comes in and goes out of your business each week. The guide to cash flow for small food businesses helps you see whether the repayment fits.

Do it with the calculator

Put your product into the food cost calculator to get its exact contribution margin per unit. With that number you can do both sums in this guide: how many units cover the repayment and how many the cost of money takes.