It isn’t easy or cheap to start and maintain a business. Costs for starting an SME could run into millions, minus operational costs. Most of the time, SME owners have to borrow money to fund their business; and sometimes, they might not know how to go about it.
Entrepreneurs should be careful when making loan and funding decisions. Taking a loan from the wrong lender, the wrong loan, or even picking the wrong purpose for funding could be a really big mistake. Loans with tight conditions and high interest rates could really eat into your profits.
It’s easy to make business financing mistakes, especially when you aren’t aware of what you should look out for and avoid. On the other hand, you can save yourself by knowing the mistakes you shouldn’t make and their warning signs. You’ll understand the difference between using a loan to fund and grow your business and taking wrong loans that could kill your business before it even has the chance to grow.
- Borrowing more than you need.
It’s tempting to borrow as much money as a lender is willing to loan you, especially when you’re just starting your business and you’re short of funds. But guess what? If you borrow more than your business needs or can afford, you’ll be risking high payments that could eat up your profits over time, and ruin your personal and company credit in the process.
It’s always better to borrow less, because the more you borrow, the more interest you’ll pay. So, only get additional funding when you need it, rather than taking on additional funds that you don’t have an explicit purpose for. This would also help your business credit history because you’ll be able to pay off your loan and it will make it easier for you to get better rates for loans later on.
- Over-relying on external funds
It’s scary to think that you might not make enough money from your business. Even if your business is well funded, that isn’t all that is required for your business to make it past its fifth year of operation.
When you’re about to take a loan, the lender would want to see your debt-to-equity ratio, which compares how much money you invested into your business with how much money you’ve made from it and the amount of debt you’ve incurred so far. Check your debt-to-equity ratio to know how self-reliant your company is. If your ratio doesn’t cut it, then you’re probably over-reliant on loans.
- Taking the wrong loan for the wrong purpose.
Loans vary from each other. Short term loans are different from long term loans. The type of loan you choose to go for can really affect your company’s finances. Here’s a breakdown of loan types, and what they’re best used for so that you can pick the type that suits your purpose.
These loans help you get fast access to cash in exchange for higher interest rates and quick repayment terms. Short term loans are best used to pay for unexpected expenses, to improve your immediate cash flow, or if your credit history disqualifies you from taking other types of loans.
A short term loan is suitable for you if you need money ASAP. The downside is that the loan repayment terms are more aggressive than with long term loans.
These are traditional loans that usually come from financial institutions like banks. You’ll get the financing you need for just about any business purpose in exchange for an interest rate and loan repayment terms set by your lender.
Long term loans provide entrepreneurs with a wider range of loan amounts, lower interest rates and longer loan repayment schedules than short term loans. The only downside is that you need good credit standing to get your loan approved.
Equipment loans are great for SME business owners who need to purchase equipment and machinery for their business. Rather than display good credit history and collateral to get financing, you can ask for a loan that covers the cost of equipment, which serves as the loans collateral. In other words, you get the equipment you need and the bank will take it back if you’re unable to pay back the loan.
With most equipment loan schemes, your business will own the equipment at the end of the agreed period once the last payment has been made and you immediately get access to use the equipment. Repayment options are also flexible to suit your business’ cash flow.
Now this isn’t really a loan per-se, it’s more like a cash advance against outstanding invoices. It lets your business draw money against its sales invoices before the customer has actually paid. Your lender advances you 80-85% of the total value of the invoices, while charging a nominal interest rate until the invoices come through. Once the invoices get paid, your lender provides you with the remaining 15-20% of their value.
Invoice financing helps to make your cash flow a bit steadier, especially when your business is just starting out. It helps you improve your company’s working capital and cash flow so you can achieve your business goals faster.
- Not considering all your options.
Have you thought of getting loans from friends and family? They can help you get your business running without getting neck-deep in debt. Make sure you have a clear repayment plan and contract so that loan repayment wouldn’t cause your relationship with them to go sour.
Look around for other ways to fund your business. Sometimes the best loans don’t come from banks.
- Not repaying loans in good time.
If you fail to pay at the scheduled time, you’ll incur more expenses, penalties and fees that make it harder for you to cover future payments. It could even give you bad credit history. The best thing for you will be to use a loan repayment plan that works for both you and your lender.
- Not looking out for the best offers
Look around and contact different lenders before you take a loan. Some lenders offer better loan repayment terms, smaller closing costs and lower interest rates than others. This extra legwork might save you money in the long run.
Always make sure you have thorough knowledge of your company’s finances so that you can make the best loan and funding decisions and avoid costly mistakes as well.
All the best in your business!