Is a short term business loan a good idea?
In this critical moment (i.e. this corona virus era), business owners might run low on cash and might find it very difficult financing their expenses as a result of potential economic recess worldwide. So the predominant question from business people is: “can I finance my business activities through short term loans”?
To begin with, there is no straight forward answer to this question, as there are pros and cons in the use of short-term financing vehicle.
A short term loan is a loan which paid back period is within a year and this is given to business owners who mostly do not qualify for a line of credit from a bank. This type of loan involves lower amounts, less risky and easy to get just because it needs limited paper works for it to be processed.
With these characteristics, a short term loan can be very useful for a startup in this corona virus era. It will solve cash flow issues in the company and it is going to be useful for emergency expenses since revenue is going to be at a standstill for some time. As the month has ended, business owners might need this to pay off workers. A soft loan can be of great help in times of liquidity crisis and can easily be paid back when things normalize. Business owners can now take advantage of the soft loan scheme (six hundred million cedis) government stated in its nationwide speech for micro, small and medium scale businesses. These loans will have a one year moratorium and two year repayment period.
As a result of the lower risk attached to these type of loans, lenders are always willing to lend to those who require it. This help businesses access these funds at cheaper borrowing cost.
Notwithstanding these advantages, a soft loan has disadvantages that you don’t see upfront just because of the urgent need for the funds. The repayment of these loans is sometimes, weekly, monthly or sometimes bi weekly, thereby exerting a lot of liquidity pressure on the business. This sometimes happens at a time the business is cashless, hence putting the business credit worthiness into question.
Secondly, although short term loans are quick to access it is a very expensive type of loan because the monthly repayment is high and can affect the business profits overtime for startups.
Over reliance on short term loan can lead to what is called overtrading, since most of the business’s activities will be funded by these loans without any effort to inject in equity. This puts the business in a vulnerable situation with high credit risk and gearing.
Again, the repayment period may be so short that the maturity period of the project and for that matter the returns may not adequately match with the cash outflows. This can be very discomforting to any business irrespective of the size.
Business owners should always do due diligence on the terms and conditions of these short term loans so as to quantify the effective cost of borrowing to their businesses.
Business owners should take all these into consideration before deciding whether they qualify to take this type of loan. They should also try to match their expenses to their revenue projections. Budgets for revenue and expenditure projections should be adjusted for the first quarter of 2020 to reflect the recent crises. This budget should be realistic and make sure your cash burn rate reduces. For example, utility bills will reduce and so can be channeled to other expense element.
Also, concerning personnel cost, soft loans can be used to defray off these expenses. Some staff will be dormant because of their line of work but this should not call for a layoff, although some business owners might want to consider it. Their salaries can be reduced and this can be discussed with these staffs before the action is taken. All the same, if a lay off is being considered, it should be done cautiously and when it has become necessary.
CEO’s should try to let their personnel be aware of the current situation in the country and let them know that things will come back to normal after this pandemic.