Ways to Manage Credit Obligations to Prevent Default Risk
Understanding credit obligations is key to attracting financial support. Getting financial support through loans is perfectly normal for SMEs. While there is absolutely nothing wrong in taking loans to support business financing, paying these loans back as at when due can make all the difference between the loans working for you and you getting into some trouble.
Default risk is a term used to refer to the possibility of a lender incurring a loss due to the borrower’s failure to repay as promised. As a company taking out a loan, there are practical ways to ensure that you efficiently manage your credit obligations to prevent default risk and the resultant crisis that could arise. Some of these include:
1. Carefully consider credit terms
Before signing an agreement to take out a loan, it is essential that you carefully read through the terms of agreement to understand what you’re signing up for. Ensure that you meticulously note the interest rate, the loan repayment date, and other important elements of the contract.
This will help you keep these important details at heart and not default in your payment. Credit terms are as important as the loan itself and should be carefully assessed.
2. Build accurate revenue projections to justify borrowing
The major reason most companies take out loans is in order to finance expansion and cause a level of growth in the organisation. It could be to purchase more stocks for sales or expand the business’s capacity in one way or another.
One common mistake is making awfully optimistic projections. Your revenue projections must be accurate, attainable, and must give room for certain margins of error. You must also have a laid-down practical strategy in place to attain the set goals. Setting idealistic goals is one sure way to shoot yourself in the leg.
3. Ensure you stick to the budget
Defaulting on your credit is not something any company wants to have on their profile, and one of the sure ways to default is to use the money for things it was not intended for. If you have been able to build accurate revenue projections, the next thing you need to do is stick to the set budget. Don’t spend more than you stipulated, and don’t spend on items not included in the budget.
This might prove hard as there might be emergency needs. However, no matter what comes up, remind yourself that the funds in question were not yours in the first place, and your creditors will need their money in full once your repayment date is up. Sticking to the budget prevents overspending, underspending, or extra-budgetary spending. It also helps you ensure that the funds are used optimally.
4. Cut down your costs
The best time to spend huge amounts of money on your business is not when you have taken out a loan. When your company takes out a loan, you might be tempted to spend as much as your eyes can see. But it is crucial that you tame your spending and cut down your costs, particularly in this period. Spend on only the most important items, and you will be able to stay accountable for the loan taken as at when required of you.
5. Have a dialogue with your lender
Suppose after doing all you can do by cutting down costs, sticking to budgets, and doing everything within your means; you still cannot meet up with your credit obligations. In that case, the best thing to do might be to have a dialogue with your lender before the due date. Naturally, this isn’t the most pleasing alternative, but it surely beats waiting for your repayment date to be due and then defaulting on it.
By having a dialogue with your lender, you will prove that you’re truly accountable with the loan and that you are conscious of the terms of your credit obligations. You also prove that your company has integrity and that you can be trusted with more funds in the future. A dialogue with your lender can either lead to an extension of the loan tenure, conversion of the loan into equity, or even nothing at all – but it is always a better option than defaulting.
Having stated all these, your priority as a company should be to ensure that you prevent a default risk. Your company needs to meet up what is required, and as aforementioned, the first step to achieving this is to ensure that you understand what is required. You can only achieve this by carefully going through the terms of agreement, preferably with a lawyer, so you are up to date on what you are signing to.
After clearly understanding the terms of agreement, create a revenue projection and stick to your budget. Cut down your costs and prevent unnecessary spending. If all else fails, have a dialogue with your lender to communicate the present situation of things. This is how you stay ahead of your credit obligations.