Business Loans and Debt
In Hamlet, Shakespeare exhorts us to "neither a borrower or lender be". It was another era and time where such activity often led to Shylock type outcomes. In the business climate that has prevailed since the industrial revolution, it is quite commonplace for business big and small to have debt in one form or another.
Is support of growth plans, short or long term cash flow deficits, directors have a few choices:
- Borrow for short or longer term
- Raise additional capital from public or private sources.
- Invest own funds – i.e. the business borrows from shareholders.
This is referred to as gearing or leverage and is measured as Debt to equity ratio i.e. the amount of debt the enterprise has compared to the amount of equity on the balance sheet. The level of debt:equity ratio that is acceptable depends on the industry whether capital intensive or not and indicative ratios abound on the internet. However companies that borrow amounts close to or in excess of their capital are said to be highly geared. Those with little or no debt are said to be lowly geared and have debt capacity – the ability to borrow.
I am a firm believer that the form and type of debt should match the planned cash flow needs of the business. So for example if funds are required for investment in equipment with a life span of 5 years, longer term debt such as lease finance or chattel mortgage is usually appropriate. Whereas if the needs are short term – say a seasonal debtor growth then short term loans such as "a revolving line of credit" is a better fit. The key here is to ensure the Cash plan as discussed in an earlier paper, is robust and gives us a clear indication of the type of funding needed.
The longest-term debt we can get is in fact Capital, funds that shareholders invest and are repaid at the end of the queue of creditors. However more traditional debt is available from Commercial Banks, Leasing companies and a host of investment entities that specialise in supporting new or emerging ventures. They rely on seeing a well thought out business plan with robust cash flow plans. Lenders need to see that there is a good chance of being repaid within the planned time frame of the debt. A mere promise based on luck will not do. It is for that reason that most institutions require some security.
A key question to ask of a business that is in serious cashflow strife is: "If I borrow or lend additional funds to the enterprise, is the payback worthwhile and will this offset the risk of non-achievement?"
It is no use sending “good money after bad money” or in other words borrowing funds or using your own savings to sure uo an enterprise that has a weak chance of survival or success. Those business owners that do that (and there are many) are usually wedded to their product, staff, stature and ego. The wise entrepreneur will know to cut their losses and move forward in a new direction.
If the answer is that borrowing is worthwhile, then check the steps we have talked about before, which include:
- Good business plan
- Good cash flow plan
- Strategic review of operations and potential outcomes
- Decision on best form of funding for cash shortage
Then, kick into gear and sell your need to investors and institutions with passion and commitment.
If you need to discuss these views further contact Your Portal – Plan for success!