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Small businesses relying too heavily on credit

Small businesses relying too heavily on credit

Category: Business

Updated: 08/10/2014
First Published: 08/10/2014

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This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

Small businesses rely on having suitable funding streams to grow effectively, but unfortunately, it seems that far too few have a stable mechanism to ensure this. Average incomes are low and finances often rely on credit, which means many SMEs have significant funding concerns as a result.

According to research from AXA Business Insurance, this is a growing problem for many fledgling companies. The figures show that around a third of small businesses take home less than £10,000 a year from their business, and 28% don't even take a regular salary – instead, they take out lump sums as and when cash flow allows. A fifth (20%) earn £32,000 or more, but just 2% of small firms are in the upper echelons of £150,000+.

The fact that the majority of small businesses earn £32,000 or less – and a worrying proportion take home less than £10,000 each year – could perhaps explain the increasing reliance on credit.

The figures show that 45% of small businesses use credit cards and overdrafts to cover cash flow fluctuations, while many also use these mechanisms when seeking funding for growth. Of the 12% that sought funding in the first six months of the year, just 8% received it through Funding for Lending and 11% received a Government grant or loan, while 24% turned to their credit card and 27% used their overdraft.

Few have a substantial financial buffer either, with 26% of small businesses having less than £1,000 in savings and a further 24% having less than £5,000. This is particularly concerning given that most don't have suitable insurance, which could leave them wide open to financial shocks should things go wrong.

Over half (53%) of SMEs that are required, by law, to have employers liability insurance fail to have it in place, while 43% of those that should have public liability insurance don't have such a policy. Only half of those who provide advice are covered against negligence claims, and just a quarter have personal accident or business interruption included in their policy.

Given that most have such scarce savings to protect their finances should things go wrong, not to mention the over-reliance on credit, the fact that so few have suitable insurance in place is a worrying trend. So, too, is the lack of desire to seek alternative funding arrangements – it may seem difficult to secure sufficient funding, but it could be a far better way to balance the books than turning to credit cards or overdrafts.

Darrell Sansom, managing director at AXA Business Insurance, commented on the findings: "Small businesses are the future: sole traders and entrepreneurs with just a handful of staff now make up 95% of the private business sector. [But] our findings suggest that many face a daily struggle with uncertain cash flow and lack of funding availability. They're also lacking the vital safety nets that will see them through setbacks… overdrafts and credit cards should not be the only fall-back they have.

"Businesses need to know that there are Government funding schemes they can benefit from, what kind of insurance they need and why it's needed, as well as getting information on the financial practices and tools available to tackle common risks."

So, just what can you do if you want to fund your business? Well, there are plenty of different avenues to consider. Government funding schemes are a key option, but you might also like to consider the likes of specialist business loans, invoice factoring, commercial mortgages or bridging loans.

They're still forms of credit but, unlike credit cards and overdrafts, they have set end dates in sight and can be a lot more manageable. They could prove to be a great way to help grow your business and help manage cash flow fluctuations, so check out our best buys and business guides to see if they could work for you.

What next?

Compare business loans

Find out more about invoice factoring

Read our business finance guides

Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.

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