Why do SME Businesses Over-borrow ?

There are different reasons for over-borrowing by SMEs: over- optimism, availability of finance, stage of the business cycle in addition to simple business reasons such as misguided business decision or new market development. In general, these factors can be shown to be both on the supply side and demand side:

Supply Side
Availability of financing: there are many programs offering access to finance for SMEs, aiming at reducing the barriers to access to finance. Many of such programs are not able to distinguish between the credit constrained business and an opportunistic borrower who may be induced to take on unnecessary debt only because it is available at a favorable rate.
Unfair lending practices: similarly to households, SME businesses may face unscrupulous lenders selling too much debt or inappropriate toxic products which may cause the borrowers to experience financial difficulties.

Demand Side
Over-confidence: many entrepreneurs exhibit overconfidence and will borrow beyond their needs only because they believe that they will be successful. While optimism plays an important role in entrepreneurial success, it may also lead to over-indebtedness.

Myopic decision-making: as already mentioned, small business owners may not always act rationally and in their best interest, they may accumulate too much debt based on their biased assessment of the market potential or become a victim of a herding behavior of other businesses which are borrowing money. Financial skills of borrowers may play an important role as well.
Innovation and growth: many SMEs borrow funds to finance growth and expansion of their operations, and borrowing is highly correlated with high growth if the expected growth is realized. If not, the excessive borrowing based on faulty expectations may lead to over-indebtedness of the business. The interplay between the supply and demand factors determines the actual borrowing behavior of businesses, and its potential for indebtedness.

Therefore, it is critical to analyze both types of reasons for indebtedness.


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SME Debt or equity finance?

Many forms of finance can be relevant for SMEs. In the broadest terms, SMEs can access two key sources of business finance: debt or equity.

Debt finance requires a steady income stream to meet interest payments, and often requires “collateral” to be provided, against which the loan is secured. Providers of debt financing face a risk that borrowers will not pay them back in full. If borrowers do pay them back in full, they receive a fixed return as agreed at the outset of the loan, with no further upside from outperformance. Providers of debt finance are therefore only willing to bear a certain level of risk when financing businesses.

Equity finance does not demand the meeting of regular interest repayments. Equity investors are instead exposed to potential open-ended capital growth (i.e. they have unlimited upside potential, unlike a debt financer), but may equally lose some, or all, of their investment. Equity finance is therefore better suited to higher risk situations.

Businesses with limited certainty over future cashflow or short or non-existent track-records of delivering profits typically carry more risk (particularly if they have no assets to offer as security) and therefore are less suited to high levels of debt financing. However, even businesses that have a good track record may not be as suited to debt finance as they may think.

For example, in the run-up to the recent financial crisis, rising property prices were used to justify high levels of debt where an injection of equity would often have been more appropriate. The collapse of property values has wiped out much of the equity that was on SME balance sheets pre crisis. Many SMEs who borrowed against properties valued at the peak of the market have found themselves with loans that they are struggling to refinance, as the value of the property has decreased so much. Banks are no longer prepared to finance at high Loan-To-Value ratios, and expectations of SMEs therefore need to be re-set.

Working capital provides another example. Working capital is defined as equity used to finance the operational needs of the business. The level of working capital that a firm holds is one of the most important strategic decisions that it has to make. SME owners that invest equity into their businesses to cover seasonal peaks and troughs can be more confident that the business will survive, as the business will not have any problems with liquidity. However, this safety comes at a cost: short term borrowing would normally be cheaper than the “cost” of equity to fund the troughs.

Banks looking to lend prudently, as well as SME owners looking to borrow prudently, should do so with a full understanding of the risks and trade-offs such as those outlined above. This requires a higher quality dialogue between the lender and borrower than that which has been the norm in the market to date.

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Meet a Certified Financial Consultant ®: Costas Stabolas

Financial consulting is a service provided by Certified Financial Consultants® to large corporations, government agencies, SMEs/ Micro businesses and individual clients. The role of a financial consultant is to provide an independent, expert opinion on a proposed business plan or decision.

There are two main types of financial consulting: business and personal

In a business financial consulting arrangement, the client has a specific plan or concept they want an independent opinion about. The role of the consultant is to review the proposed plan and identify strengths and weaknesses. They are also expected to provide advice on risk management, industry trends, long-term viability, etc.

Personal financial consulting is usually a service required by people with significant financial resources and a complex investment portfolio. These services include investment advice, taxation planning, income management, risk assessment and long-term planning. These issues must be actively managed by a professional to obtain maximum benefit with the lowest amount of risk possible.

This type of work requires a background in banking & finance and business management. Consultants usually have 15+ years of working experience. This experience add value and perspective.

A Certified Financial Consultant® (CFC®) is a professional designation obtained from The Institute of Financial Consultants®, USA.
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Meet a Certified Expert in Risk Management : Costas Stabolas

Risk management is about coping with the challenges of growth, complexity and competition in a sustainable manner. Risk managers identify and assess threats, put plans in place for if things go wrong and decide how to avoid, reduce or transfer risks. Specific tasks depend on the industry in which you are working.

Key activities may include:

Planning, designing and implementing an overall risk management process;

Risk assessment (identifying, describing and estimating the risks);

Risk evaluation (comparing risks with criteria like costs, legal requirements, etc.);

Quantifying the organisation's 'risk appetite' (i.e. the level of acceptable risk);

Risk reporting (to the board of directors so they understand the most significant risks, to business heads to ensure they are aware of risks relevant to their parts and to individuals to understand their accountability for individual risks);

Corporate governance, involving external risk reporting to stakeholders;

Conducting audits of policy and compliance to standards, including liaison with internal and external auditors;

Providing support, education and training to staff. 

(*) Certified Expert in Risk Management is a professional certification obtained from The Frankfurt School of Finance & Management, Frankfurt am Main, Germany.

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Meet a Greek Certified Expert in Microfinance : Costas Stabolas

A Microfinance consultant contributes to facilitating financial institutions in providing loans, deposits and insurance services to their (micro)clients. 

He assists commercial banks in downscaling or establishing microfinance business units, in order to support them in servicing microenterprises and low-income clients with a large array of tailor-made financial products. 

He supports institutional transformation of various kinds, by supporting microfinance organisations on different levels in their organisational upscaling.

Additionally, the Microfinance consultant (1) develops and implements innovative microfinance products in the field of credit and savings, (2) improves product costing (3) evaluates credit scoring systems and (4) promotes innovative delivery channels to improve operational efficiency (i.e. branchless banking).
The provision of training courses on a large range of topics is also a crucial part of his services. 

(*) Certified Expert in Microfinance (CEMF), is a professional certification obtained from The Frankfurt School of Finance & Management, Frankfurt am Main, Germany.
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The power of Questions in Sales

Here are some reasons why you need to ask your potential customers more questions in your sales effort:
 
Questions engage: When a question is asked (a closed question in this case) we naturally answer (we agree, disagree or form an opinion). When this happens, your potential customer will want to see if you share the same opinion, have an interesting point, or can provide the solution to the issue. 

Questions challenge: A well-posed question can help you challenge your potential customers’ beliefs and help them uncover needs they don’t know they have. These questions are particularly important when people have “heard it all before…” or when you are launching a new product, service or concept and need to educate people on why they need your business.

Questions break down perceptions:
A lot of times potential customers bring perceptions to your business. They make assumptions about what you do and how you do it based on their level of understanding and experience with competitors. While this can work in your favor (the education is done for you), it can also work against you and fuel their objections if they have had negative past experiences. When you pose a question based on your point of difference, it can change your potential customer’s perceptions of you and separate you from competitors. 

Questions can make sales: Leading questions (where you ask your potential customer a series of questions you know they will say ‘yes’) have been proven to increase sales.


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The Pareto Principle in management or how to work smart on the right things

In the early 1900’s, an Italian economist, Vilfredo Pareto created a mathematical formula describing the unequal distribution of wealth he observed and measured in his country: Pareto observed that roughly 20 percent of the people controlled or owned 80 percent of the wealth.  After Pareto made his observation and published his findings and formula, many others (in both science and business) observed similar phenomena in their own areas of expertise. This observation (the principle that 20 percent of a set is generally responsible for 80 percent of a related result), became known as Pareto's Principle or the 80/20 Rule, and can be a very useful and effective tool of modern-day business management. 

What It Means To Business People?

The 80/20 Rule means that in any set of things (workers, customers, etc.) a few (20 percent) are vital and many (80 percent) are considered trivial. In Pareto's case, he found that roughly 20 percent of the people in his country dominated with 80 percent of the wealth. Project Managers know that 20 percent of work (usually the first 10 percent and the last 10 percent) consume 80 percent of the time and resources. The 80/20 Rule can be applied to almost anything! You know 20 percent of your inventory occupies 80 percent of your warehouse space. Similarly, 80 percent of your inventory items come from 20 percent of your suppliers. At the same time, it’s likely that 80 percent of your revenues will be the result of sales made by 20 percent of your sales staff.  And 20 percent of your workers will cause 80 percent of your problems, while another 20 percent of your staff will deliver 80 percent of your entire production. 

How Pareto’s Principle Can Help Us?

The Pareto Principle in management reminds us to stay focused on the “20 percent that matters”. Of all the tasks performed throughout the day, one could say that only 20 percent really matter.  Those tasks in the 20 percent very likely will produce 80 percent of our results.  Thus, it’s critical that we identify and focus on those things.  

Since 20 percent of your employees likely produce 80 percent of your results you should focus your limited time in management of only that 20 percent. However, this proposed implementation of Pareto’s Principle to management is flawed, because it overlooks the fact that 80 percent of your time should be spent doing what is really important, or most likely to deliver the greatest return.  By helping your “good” salespeople become better, you are more likely to reap greater results than by dedicating the same management effort to helping the fewer “great” salespeople become terrific. Thus, it’s wise to evaluate various management situations and apply the Pareto Principle appropriately – and wisely. 

Pareto's Principle should serve as a reminder to us to stay focused on investing 80 percent of our time and energy on the 20 percent of work that’s really important.  It’s not just important to “work hard” and “work smart”, but also to work smart on the right things.

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