5 mistakes should you avoid when financing your SME?

Many SMEs need financing at some point in their life, either at the start of business or later, to overcome a financial downturn or expand their operations. There are different financing options, but they are not all equally valid or advantageous. Choosing the wrong financing can turn out to be a costly mistake that ends up putting the survival of the business at risk .

The five most common mistakes when looking for financing

1. Choose the wrong financing instrument

A common mistake when financing an SME is to choose financing modalities that do not suit the needs of the business. Requesting a short-term loan to cover long-term needs, such as the internationalization process of your SME, will make you have to repay the loan before the investment begins to bear fruit , which will put you in a very delicate situation company finances.

2. Perform excessive leverage

Requesting excessive financing, beyond the possibilities of the SME, is a mistake that is usually paid dearly. As a general rule, the level of indebtedness should not exceed 3 times the EBITDA , the gross operating profit before deducting financial expenses. If the company is growing and you are going to use this financing to promote the expansion of your SME or large-scale projects, the debt may be higher, but still it should not exceed 5 times the EBITDA.

3. Bet on bank concentration

A common mistake when financing SMEs consists of concentrating all the debt in a single bank , generally because it is the one with which it works. The problem is, if the bank reduces its risk levels, you will likely have a difficult time refinancing the debt because interest rates will increase.

In the same way that you adopt strategies to diversify your customers and suppliers to reduce your level of exposure to risk, you must also diversify the banking entities with which you work. Ideally, you have alternative sources of financing to banking, such as crowdlending, private debt or public financing .

4. Not looking for alternatives to financing

In 2018, 28.2% of Spanish SMEs resorted to a credit line and 20.6% to a bank loan to meet their financing needs, according to the VIII Report on SME Financing, carried out by Cesgar . Beyond bank credit, which often charges high interest rates and requires excessively short repayment terms, there are other forms of financing for SMEs that can help them obtain the necessary financing.

Before requesting a loan, it is important to assess the different options and choose the one that best meets the needs of the SME . The leasing and renting, for example, are two options that are growing in popularity among SMEs, as they are excellent alternatives to use certain goods or property without buying them . In addition, since they are not considered bank credit, they do not affect the creditworthiness of your SME.

5. Neglecting the repayment terms

Before signing a loan, it is important that you make sure that you can meet the expected repayment terms. A common mistake of entrepreneurs is to be too optimistic and think that they will be able to pay off the debt quickly . To avoid this situation, it is important that you estimate how long you will need to recover the investment and then add at least six more months to be sure that you can meet the deadlines. Keep in mind that not meeting the deadlines will not only affect the credit history of your SME, making it difficult for them to have future access to other credits, but will also increase the interest to be paid.

by Abdullah Sam
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