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How to avoid too much debt in your business

Financial health is one of the pillars of the proper functioning of SMEs. Organizations that regularly analyze their debt ratio are less dependent on external financing. And they show a better ability to balance their accounts, reducing or increasing sources of financing outside the business.

The debt ratio measures the level of debt in relation to equity. The companies that maintain an optimal debt ratio avoid damaging their financial health.

In general terms, as long as debt is kept at adequate levels, loans provide flexibility and control to the company. first because the conditions of financial products are usually elastic. And they usually support customizations to suit specific business needs.

And, second, because resorting to a financial institution to request financing does not imply giving up part of the control of the business to said entity. The same does not happen if the financing comes from a capital increase by external partners or investors. In that case, the shareholder composition could change. And generate a loss of control over business operations and strategy.

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Going into debt with the bank gives the company a broader margin of action without having to give up part of the business. But, excessive indebtedness increases the risk of incurring the dreaded leverage. That is, that the debt excessively influences the performance of the business.

Use of financial ERP

Pablo Couso, commercial director of Datisa says that “Using a financial ERP helps SMEs to control their debt ratio. It will allow them to have precise information about the forms of financing their business. Know what or who you depend on financially. Or know the relationship between own financial resources and external ones. In other words, a financial ERP will help SMEs to control the situation of their financial debt. And, with it, to make informed decisions.”

To avoid excessive indebtedness, it is advisable not only to look within the organization, but also identify industry standards in which it operates. Some sectors such as energy or construction tend to have a high level of indebtedness because their projects require high investments. However, other environments such as those in which service companies operate, for example, do not require large volumes of initial investment.

Pablo Couso insists on the importance of analyzing financial information. The commercial director of Datisa says that “It will be necessary to be aware of the interest rate paid for the acquired debt, as well as the profitability obtained from the financing.” And he illustrates it with the following example: If an SME asks for a loan and pays 10% interest, but gets a 20% return on the investment it makes with the money they have lent, the debt favors the financial health of the business .

In short, these are the three keys to avoid excessive indebtedness of SMEs:

  1. Control the debt ratio and always keep it at optimal levels
  2. Know the direct relationship between own and external financial resources
  3. Analyze operating margins

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