When small and medium-sized business SMEs are sourcing for a working capital loan, many businesses always find themselves making common mistakes that can be avoided. This often results due to insufficient knowledge of the available options or lacking enough time to weigh the available options and selecting the best for the specific business need.
Many business needs require different financial solutions and choosing the right ones will not only enable your business to get the most profit out of it but also reduce the strain on your resources. Scarce resources such as time, physical and liquid asses can be lost in case you choose the wrong working capital loan and taking the necessary steps to avoid such mistakes can provide a good solution. These include:
- Choosing a Wrong option for the wrong need
When looking for a working capital loan, there are many available options you can choose as a business. Getting the wrong option, however, might not be good as it might not end up serving its purpose. Invoice finance, for example, has invoice factoring (link to invoice factoring as an article) and invoice discounting (link to invoice discounting article) options.
While the two might be similar they have many distinctive differences. Invoice factoring is a method whereby the business uses its invoices to source for capital. The business, therefore, gives the financier the invoice and the control of its ledgers.
The business customer is now obligated to pay the financier as opposed to the business that delivered the products or conducted business with. This has the advantage of both reduction of risk and the time the business would have used to control credit and manage its ledgers.
Invoice discounting on the other side offers the solutions to this problem while bringing with it its own challenges. This is because it works on allowing the business to have its invoices and control its own credit ledgers but pay an agreed monthly payment.
This is positive as the business has confidentiality as the customers do not have to know the business is using invoice financing methods but the business now has the task of making sure customers make their payments within the timeframes to ensure that the business does not go out of working capital. This might, in the long run, steal the business precious time that could have been used for growth or other business activities.
- Choosing a Wrong Company to work with
Although many companies might be offering working capital solutions, as a business you need to make sure that you get the right company to work with. Banks and other financial institutions might not be a good option if a business that lacks the required collateral in form of physical securities.
Small and medium-sized businesses SMEs might find it challenging to handle banks and bank loans as they might not be in a position to handle the much-required paperwork or have a good credit history that is a requirement. SMEs might also find other institutions challenging since they charge a lot of interest thus reducing profit margins.
- Not reading and understanding the terms of service well
Another common mistake many businesses make is not reading and understanding the company’s terms of contract. This might cost you a big deal as a business. When looking for a working capital loan, it is always advisable to check and counter check the terms of the contract to calculate all the expenses that you undergo as a business and the profit you will remain with. This means that you need to ensure that the option you pick as a business does not interfere with your profit margins.
Planning your expenses give you as a business a head start when deciding the financing option you take as a business. When using invoice discounting, for example, you need to factor in the amount of cash you will have to pay each month and see if it is sustainable. When getting a logbook loan also you should take the necessary steps to ensure that you do not lose your car before finishing the loan. This includes ensuring that you have a solid source of income that guarantees some certain amount of cash to pay the loan each month. Planning also can tell whether you need the working capital loan in the first place. Most businesses do not plan their expenses and are often in chase of financing options when it is not the right time to do so.
- Mismanagement of finances
This goes without saying but since many businesses make this mistake, it is worth repeating over and over again. When working with any loan, a business should ensure that it not only invest in long-term returns but also in short-term options that can provide liquid capital. This might be required to finance daily needs such as running expense, paying utility bills, its suppliers or workers’ wages. Lack of liquid capital also might lead the business to lack the required cash to pay its loan and this could lead to insolvency.
- Other common mistakes
Other common mistakes that a business may make is not to balance on taking loans and repaying them. Many loans can strain a business and this could lead to collapsing of the business. As a business, profit should always be a priority and maximizing it should be the first option. Taking loans can significantly reduce profits in form of interest and a business, therefore, should not prefer to finance its operations on loans as this might be a big expense in the long term. Businesses should also target to get the financing options that are convenient and not costly