Borrowing can help a business grow, but only if the loan costs less than the profit it earns, and only if you can repay it from cash flow. Before you sign, work out the real cost and the effect on your tax.

Common sources

  • Banks offer term loans and overdrafts, usually with security and a clear schedule.
  • SACCOs lend to members at rates that are often lower than banks, based on your savings.
  • Mobile and digital lenders give quick small loans at higher costs.
  • Chamas and merry-go-rounds lend to members, with interest agreed by the group; see the chama contributions and loans tracker.
  • Suppliers may give credit terms, which is a loan in effect.
  • Government and development funds offer special programmes, with conditions.

Work out the real cost

Ask for the annual interest rate, the fees (processing, insurance, legal and valuation), the term and the repayment schedule. The monthly payment and total interest come from those. The loan affordability checker and schedule shows the monthly payment, total interest and a month-by-month schedule, and the loan repayment and amortisation schedule handles a loan you already hold.

Can you afford it?

As a rule of thumb, total loan repayments should stay well below a third of your income; a business should be able to meet the payment even in a weak month. Test it against your forecast; see how to build a cash flow forecast and the 12-month cash flow forecast.

Tax treatment

  • Interest on a business loan is deductible if the loan was used for the business; see expenses small businesses can deduct. Keep the loan statements, and the agreement showing the purpose.
  • Repayment of the principal is not deductible, because it is not a cost.
  • Loan proceeds are not income. Do not include them in sales.
  • Fees are generally deductible, though large arrangement fees may be spread over the loan.
  • Interest on a loan for your own home is a separate relief; see mortgage interest relief for homeowners.

Record the loan properly

Record the loan in your books: cash received on one side and the loan owed on the other. Each repayment splits into interest, which is an expense, and principal, which reduces the loan. A journal book or the chart of accounts and general ledger makes this easy.

Security and risk

Many loans need security, such as property, a vehicle or a guarantor. Understand what you stand to lose before you offer it. A sole trader is personally liable; a limited company's directors may be asked for personal guarantees, which removes the protection. See sole trader or limited company.

Things to ask the lender

  1. What is the total cost of the loan in shillings?
  2. Is the rate fixed or variable?
  3. What happens if I repay early?
  4. What are the penalties for late payment?

Compare at least two lenders, and read the agreement, not just the summary.

This is general information, not financial advice. Ask a qualified adviser about your own situation.

Common questions

Is loan interest tax deductible? Interest on a business loan used for business purposes is generally deductible, while the repayment of the capital is not. Keep the loan agreement and statements.

How do I compare two loans? Compare the total cost, including interest, fees and insurance, over the whole term, not just the monthly instalment or the quoted rate.

What if I cannot repay on time? Talk to the lender before missing a payment. Restructuring is usually cheaper than penalties and a damaged credit record.