Bank loans as a financial instrument (1 of 18)
Access to capital is often reported by micro-enterprises across Europe as a key constraint: as a result of the recent financial and economic crisis, almost every micro-enterprise needs fresh capital.
Bank loans as a financial instrument (2 of 18)
The most used financial instrument for micro-enterprises to sustain their business is a bank loan. This financial instrument is used all over the world and is the fastest way to get a fresh financial injection for realizing new projects or ideas.
Bank loans as a financial instrument (3 of 18)
The terms for using bank loans are very rigorous and because of that managers and the owners of companies should be very careful when using them. Every decision for using a bank loan should be made following a deep analysis from the manager’s side.
Bank loans as a financial instrument (4 of 18)
The analysis should indicate a strong justification for taking out a loan. These ought to demonstrate that the project or idea which is to be financed by the loan will be more cost-effective than the loan.
Bank loans as a financial instrument (5 of 18)
In general, micro-enterprises need financing for their current operations or to expand, for instance to develop new products, purchase of raw materials, upgrading or renovating equipment and machines, retrofitting or expanding premises, etc.
Bank loans as a financial instrument (6 of 18)
Bank loans are tailored to the specific purpose of the micro-enterprise and are divided into:
• loans for fixed assets
• loans for variable assets
• mixed loans (combination of fixed and variable)
Bank loans as a financial instrument (7 of 18)
Bank loans as a financial instrument (8 of 18)
Maturity of the loan, in essence, depends on many conditions such as: type of business, activity, market, products, etc. Interest rate is the “cost of money”, meaning the extra amount that the borrower needs to return to the lender (the bank).
Bank loans as a financial instrument (9 of 18)
In addition to the interest rate, micro-enterprises should be aware of other elements that contribute to the so called “cost of financing”.
Bank loans as a financial instrument (10 of 18)
There are many other costs such as: payment commission, administrative costs for collateral, maintenance costs of the loan, costs for early loan repayment, etc.
Bank loans as a financial instrument (11 of 18)
Also, the costs which do not originate directly from the loan should be taken in consideration. For example: the bank can give the company a smaller interest rate, but charge higher costs for bank payments from that company.
Bank loans as a financial instrument (12 of 18)
Because of that, managers should take into consideration, all costs associated with the loan (application, evaluation process, issuance of the loan, repayment, management fees, etc.)
Bank loans as a financial instrument (13 of 18)
Entrepreneurs should consider all the costs involved and associated with taking the loan to make informed and sound financial decisions.
Bank loans as a financial instrument (14 of 18)
Following the decision to take out a loan, managers of micro-enterprises should take in consideration many conditions when planning payment of the instalments.
Bank loans as a financial instrument (15 of 18)
The biggest impact when planning of payment instalments will be the effects of: sales of products, seasonality of the business, business cycle, period of procurement of raw materials, etc. Instalments can be organized depending on the business cycle.
Bank loans as a financial instrument (16 of 18)
These mean that instalments can be organized on a monthly or quarterly basis depending on the business cycle for that enterprise (regular or irregular instalment plan). Monthly instalment should not exceed 60 % of monthly income of the company.
Bank loans as a financial instrument (17 of 18)
Irrespective of the loan type and maturity, banks often require collateral to reduce the risk of the loan. Collateral-based lending is one of the main obstacles to access to finance, especially for micro-enterprises that typically have limited resources or fixed assets.
Bank loans as a financial instrument (18 of 18)
For smaller loans or loans that have a small risk the collateral can be secured in alternative ways (state guarantee funds, other company as guarantor, money deposit, etc.).