Last Updated On January 2023

Debt Financing for SMEs: How to Manage Loans Effectively

A common concern among people engaged in a business is funding their operations. Not everyone has enough money in the bank to make a dream business come true. This is where debt financing may come in. The term “debt” may scare some businesspeople, but not all debts are bad. In this case, debt financing can truly be helpful, especially for small businesses.

What is debt financing?

Debt financing is a type of funding that involves borrowing money from a lender and repaying it over time with interest. Small businesses can use debt financing to obtain the capital they need to start or grow their operations, make necessary investments, or finance other expenses.

Debt financing typically comes in the form of loans or lines of credit, which can be secured or unsecured. Secured loans require collateral, such as property or equipment, which the lender can seize if the borrower fails to repay the loan. Unsecured loans do not require collateral but often have higher interest rates and stricter eligibility requirement.

Small businesses can obtain debt financing from a variety of sources, including banks, online lenders, and government programs. Some small businesses may also obtain debt financing from family and friends or through crowdfunding.

Read more at: What are sources of small business loan in the Philippines?

One of the advantages of debt financing for small businesses is that it allows them to maintain control of their operations, as lenders do not typically require equity in the business. Additionally, the interest payments on debt financing are tax deductible, which can provide some relief from the cost of borrowing.

However, debt financing also has some potential drawbacks. Small businesses that take on debt financing must make regular payments, which can strain cash flow and reduce the amount of capital available for other expenses. Therefore, debt management is important.

What are the debt financing options for small businesses?

Businesses looking for debt financing in the Philippines have a lot of options, depending on what they need the money for. Here are some debt financing examples. 

Working Capital Loans

A working capital loan is a type of loan that businesses use to finance their day-to-day operations. This type of loan is designed to provide businesses with the money they need to cover short-term expenses such as payroll, inventory, and accounts payable.

Working capital loans are what businesses typically use for temporary cash flow shortages or need additional funds to cover expenses during growth or expansion. These loans are typically unsecured, meaning they do not require collateral and can have a relatively short repayment period of a few months to a few years.

Invoice Factoring Loans

An invoice factoring loan is a type of financing where a business sells its outstanding invoices or accounts receivables to a third-party company, known as a factor, at a discount. In exchange for the invoices, the factor provides the business with an upfront cash advance, typically around 80-90% of the value of the invoices. The factor then collects payments directly from the customers who owe the invoices and deducts their fees before returning the remaining balance to the business.

Invoice factoring loans can be a useful financing option for businesses that need immediate cash flow to cover their expenses. By selling their invoices to a factor, businesses can receive cash up front instead of waiting for their customers to pay, which can help them cover their expenses and reinvest in their operations.

However, it's important to carefully consider the costs and risks involved before taking on an invoice factoring loan. Factors typically charge fees for their services, which can range from 1 to 5% of the value of the invoices, and the discount rate can be higher for invoices with longer payment terms or higher-risk customers. Additionally, some customers may view the use of invoice factoring as a negative sign, which can potentially damage the relationship between the business and its customers.

Business Overdraft Loans

A business overdraft loan is a flexible type of loan that allows businesses to withdraw more money than they have in their account, up to a predetermined limit. Small and medium enterprises (SMEs) can benefit from a business overdraft loan in three ways:

One, business overdraft loans provide SMEs with a flexible source of working capital that can be used to manage their day-to-day cash flow needs. SMEs can draw on the overdraft facility as needed and repay the funds when their cash flow improves, without having to reapply for a new loan each time.

Two, business overdraft loans are typically short-term financing options that can help SMEs bridge temporary gaps in their cash flow. SMEs can use the overdraft facility to cover unexpected expenses or take advantage of short-term opportunities, such as purchasing inventory or meeting payroll obligations.

Three, business overdraft loans typically have lower interest rates than credit cards or other short-term financing options. This can help SMEs save money on interest charges and reduce their overall cost of financing.

Hire-purchase loans

A hire-purchase loan is a type of financing that allows someone to buy something, such as a car or equipment, and pay for it over time in installments. Instead of paying for the item upfront, the buyer makes a down payment and then makes regular payments, typically monthly, until the full amount of the purchase price plus interest is paid off.

During the hire-purchase period, the buyer possesses and uses the item, but legal ownership remains with the lender. Once the buyer has made all the required payments, ownership of the item is transferred to them.

Hire-purchase loans can be a useful financing option for businesses that need to purchase an expensive item but don't have the cash up front. However, it's important to consider the interest rates and terms of the loan before entering into a hire-purchase agreement to ensure that it's a good financial decision.

Small Business Debt Management Tips

When availing of a business loan in the Philippines, it is important to ensure that you can manage it to avoid defaulting and getting into more problems. Here are some ways to manage your debt financing.

Find Safe and Secure Working Capital Loans with EFI

If you are looking for a business loan in the Philippines for debt financing, particularly as working capital, Esquire Financing Inc. or EFI is here for you.

EFI specially caters to SMEs, which have unique needs. Unlike banks or other non-bank financial institutions, EFI requires only minimal documents. Also, it offers business loans without collateral. Its fast turnaround time is also unrivaled—only 3 days or less as long as all requirements are in order. With EFI, you can borrow up to P10 million to improve your working capital. Visit our loan applications page today to start fueling your business dream!

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