Insolvency Risk: The Dangers of Taking Out Loans in Response to COVID-19

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While small business loans are great in the right circumstances, however, there are some serious dangers companies could face when taking out a loan that could lead to insolvency risk, especially during the pandemic. Government backed schemes such as CBILS, CLBILS & BBLS are still “LOANS” not grants.

Countries around the world have been thrust into unprecedented uncertainty due to COVID-19 and the probability of recession threatens as marketplaces stumble, manufacturing plunges and stock markets crash.

Besides the health emergency, there are severe financial implications caused by coronavirus for companies. One of the biggest is an organisation’s risk of insolvency. While it may be tempting to take out a small business loan to access the funds needed during COVID-19, there are major risks associated with taking one out.

Taking out a loan is a great way for companies to borrow money when needed. And thankfully, most loans offer fixed payment schedules meaning there are no unexpected surprises – and interest rates are usually well under the rates charged by credit card companies.

However, there are some serious dangers companies could face when taking out a loan that could lead to insolvency risk.

A company is insolvent when:

  • It fails to pay its bills when due
  • Liabilities surpass assets.

Essentially, any organisation needs adequate funds to meet its responsibilities. The nearer a company is to being unable to do this, the nearer it is to insolvency.

A company can reduce its risk of insolvency by carrying out practical management strategies as well as critical action when difficult decisions are needed.

Instead of taking out a loan, consider using an insolvency firm who specialises in business recovery and corporate financial solutions. Their main intention is to ease financial pressures and offer recovery strategies.

Here are some of the risks companies should know about before applying for a loan, so they know if it’s the right decision for them.

Failure to Make Payments

One of the biggest risks a company faces when taking out a loan during COVID-19 is not having enough money to keep its commitment to the lender.

If an organisation can’t afford to pay its monthly loan repayment and defaults on it, it’ll have to deal with severe financial penalties. Not only is this damaging to a company’s credit score, but it could also lead to legal action.

To prevent this from happening, a business must find out how much the loan payment is and how it tallies with its budget. If it seems impossible to meet this monthly payment, avoid borrowing money at all costs.

Avoid Taking on Too Much Debt

 If a business takes on a loan and commits to making monthly repayments, this liability could hinder its ability to achieve other company objectives. Ultimately, revenue will now be spent on paying off the loan rather than doing other things with the money, such as investing in larger projects.

Prior to taking out a loan, consider whether it’s really worth borrowing it all.

Less Chance of Borrowing in Future

If a lender believes a company has too much outstanding debt relative to revenue, it won’t authorise a loan.

If a loan is taken out, the payment on it will be taken into account when the debt-to-revenue ratio is ascertained.

For instance, if a company borrows immediately to pay off bills or personal expenses then needs to take a loan out for something else later before the current loan is paid off, this results in a huge problem. If that loan is too great in relation to revenue, a company’s debt-to-revenue ratio could be too high for it to be eligible for a loan the following year.

A company should avoid borrowing anything unless absolutely necessary. If an organisation must borrow, it’s worth keeping its loan balance as small as possible to guarantee the over-all remaining amount of debt owed – including credit card payments and loans – remains fairly comparative to its revenue.

Whenever a company considers borrowing money, it’s worth knowing the risks associated with taking out a loan. By fully understanding the potential dangers of taking one out, a business will hopefully take steps to reduce these risks, so its decision to borrow doesn’t have adverse effects on its future.

Hudson Weir are an established firm of Insolvency Practitioners who specialise in
business recovery and corporate financial solutions. Hudson Weir provides industry
leading, nationwide services for its clients with the intention of easing financial
pressures and providing recovery strategies for struggling businesses.
https://www.hudsonweir.co.uk/

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