Generally, a debt is any amount which one party known as the debtor, owes a second party, referred to as the creditor. It is usually regarded in accounting as assets owed, and it is created when a creditor agrees to lend a sum or assets to a debtor.
In finance, debt is usually granted with expected repayment in modern society and in most cases, of the original sum plus interest.
It is also a means of using anticipated future purchasing power in the present before it has actually been earned, and most companies and corporations use it as part of their overall corporate finance strategy.
A debt can either be secured, if it is collaterised or unsecured, where no collateral is available and it allows individuals and businesses to engage in transactions that they would, ordinarily, not able to do. For instance, while corporate firms in industrialised countries use it to expand their operations, it is, often times, used by individuals to purchase houses, cars and many other valuables.
Even countries incur debt from multinational institutions and governments to embark on infrastructural projects. However, when debts are massively accumulated, they could, if not properly serviced have a ravaging effect on one’s reputation.
Experts say borrowing money for a business is a big decision with long-lasting financial consequences. They contend that before an entrepreneur applies for a business loan or signs a loan agreement, there is need to be sure they are not making some of the common business borrowing mistakes.
Some these mistakes are:
Not having a firm grip on your business’ financial situation:
This is the number one business borrowing mistake from which all others stem. Experts say an entrepreneur should keep good financial records, manage his cashflow carefully, and at least learn the basics of bookkeeping.
A Chartered Accountant, Mr Afeez Balogun says, “By regularly reviewing his financials, an entrepreneur would be able to make accurate financial forecasts and develop a long-term financial plan for his business. All of these would enable him to borrow wisely.”
Getting the wrong type of business loan:
An entrepreneur should always match the type of loan to the business purpose. Balogun added, “If you need to finance commercial real estate, for example, you would not take out a business loan with a 12-month term. However, many small business owners take out long-term loans to pay short-term expenses, such as meeting payroll or buying inventory for a big order from a new client.”
He says there is need to look for a lender that offers the specific type of financing the entrepreneur needs.
Choosing the wrong lender:
Experts also say there are more borrowing options for small businesses than ever before, from the traditional sources such as banks and credit unions to alternative lenders and crowd funding websites.
A Management Consultant, Mr Segun Muyiwa says, “Don’t rush into the borrowing decision. Take the time to assess all of your options before you apply for loans. Then, if you receive loan approval from multiple lenders, carefully compare the offers to make sure you are getting the best possible terms.”
Not knowing how much the business loan will cost you in the long run:
With so many different financing options, experts say it can be complicated to work out what various loan terms, interest rates, and payment plans will mean for your day-to-day budget.
Balogun says if necessary, there is need for an entrepreneur to have an accountant that will help review the options before making a decision.
Borrowing more than you can comfortably pay back:
It’s tempting to borrow extra money just to have a cushion, but it’s not always wise. Make sure you can easily pay back any loan you take out by using your most conservative sales estimates. This knowledge not only gives you peace of mind, but also makes lenders more comfortable lending you funds.
Borrowing less than you need:
When you don’t borrow enough money, before long, you will have to come back to the lender for more money because you have run out of cash. The lender will rightly be concerned that you don’t know how to manage money and will be less likely to lend to you again. If you don’t develop accurate financial forecasts, you are more likely to borrow too little.
Borrowing for things you don’t actually need:
Many small business owners borrow money in order to purchase the latest equipment, lease a bigger location, or upgrade their technology. That is smart if these investments will actually pay off financially, but not so smart if you are going into debt just to finance an extravagant lifestyle. It’s important to consider every business expense or investment carefully. Use your financial projections, run the numbers and make sure you’re confident a loan has good return on investment before you apply.
Waiting until you are desperate:
It’s often said that banks only want to lend money to people who don’t need it, and there’s definitely a grain of truth in that when it comes to small business owners. If your business is struggling financially, banks will be concerned about your ability to manage money, and that makes it more difficult to get a loan.
By managing your business finances correctly, staying on top of cash flow, and developing and using financial projections, you will be able to predict any need for capital well ahead of time, and apply for a loan before you are in dire straits.