Does your business need to borrow, and can it?

Top signs your business has to borrow, and what the lenders to your business are looking for.

The most common catalysts that cause a business to begin considering borrowing are normally relatively simple, and not at all necessarily negative.

A business may be driven to borrow due to long debtor payment terms and limited supplier trading terms can force a business into a cash-flow position where it needs to borrow money. If managed poorly, terms can really negatively affect your businesses cash flow.

Suppliers who service SME’s often want a deposit or full payment prior to the shipping of the goods, and quite frankly, most SME’s don’t have that kind cash available. Both domestic and international suppliers may do this until they feel comfortable with the relationship and are comfortable extending trading terms. In the interim, businesses are left scraping for every dollar just to maintain the turnover they have, leaving no room or cash for growth.

On the flip side, debtors seem to want to push hard for drawn out terms multiplying the hurt on your businesses cash-flow and inducing a huge need for a cash injection just to keep your head above water. There are only really a few ways to go about remedying these issues and ultimately if you don’t do one, a pair or all three it’s unlikely any business will reach its full potential.

Business growth, too, creates cash-flow strains and needs on a business, creating a need for borrowing. Every business owner starts out wanting their business to succeed and to do so you need to grow. However, not every business is ready to do so. Often, the cash and profitability benefits of growing go unrealised for a significant period of time, and while you’re waiting to enjoy the upside, you need to invest in new products, bring in new stock and staff. All of these additional costs are incurred while your business is growing and often long before you or your business has been able to realise the financial benefits from the growth.

SME’s are usually fantastic at what they do but may not be as adept at cash-flow management, and when it comes time to grow they struggle to fund the aforementioned expenses that are needed to be able to service lucrative larger contracts they win. If the business is not funded correctly during the growth phase, it can often cause things like tax arrears, wage payment pressure, and late supplier payments, which are indicators of a business in trouble!

Finally, a business may seek finance if it is in the final stage of the business cycle – when they are in trouble. They may be financially struggling to meet standard business expenses or statutory payments on time due to cash flow constraints. Often at this stage it is too late for many financiers to assist their plight. It’s far more sensible to address the problem proactively, before it actually becomes a problem. Plug the hole, identify why your business is losing money, and make the hard decisions which fix the problem.

Just because your business needs money, unfortunately doesn’t necessarily mean you’ll be able to obtain it.

We often hear and read that banks aren’t lending to SME’s, and that SME’s can’t get the money they need to grow, create employment and stimulate the economy. Whether that’s true or related to the above remains somewhat murky, but is does lead us to ask: when is the appropriate time for SME’s to borrow money? We’ve discussed why a business might need to borrow earlier, but needing to borrow and being able to are unfortunately not necessarily the same thing.

It’s important for a business to qualify itself before even asking when it should borrow money. It should be able to answer “yes” to both of the following questions:

– Is my underlying business profitable, or going to be profitable?

– Can I service the debt easily?

Answering the first question is straightforward – if I stopped growing today, would I be making money? Answering the second should be just as straight forward – do I generate enough cash to cover my interest bills?

Banks ask and answer these questions themselves by calculating your debt-service ratio. Let’s assume your business has no current debt the following formula would apply;

(EBITDA + Gross Income + Wages you’re taking from your business + other sources of income)

Divided By

(Existing personal debt + Principal & Interest you would owe on the new business debt)

The resulting “global coverage ratio,” which banks may examine when they are considering lending to an SME, takes into account your personal finances and those of your business. For you to safely be able to service the debt, the resulting ratio should be more than 3. If it’s above 2, you’re in a relatively respectable state as far as the banks are concerned. Banks won’t tend to lend against ratios below 1.5 without exorbitant interest rates that ‘cover the risk’, and are probably detrimental to the growth you are trying to achieve. According to Reserve Bank of Australia data from 2014 the average interest rate charged on outstanding SME debt is 215 basis points higher (2.15%) than for larger businesses. As the government continues to explore ways to develop a better ecosystem for innovative sources of finance, and the above reiterates how expensive and intrusive lending from banks can be, it’s important to understand the alternatives.

And there are alternatives to the banks for SME’s, namely:

– Non-bank lenders (cash-flow lending providers, for example Trade or Debtor Finance);

– Capital Markets;

– Private Equity; and

– Individuals (family and friends).

When you go and speak to your bank, or any finance provider, understand what products they can offer you and make sure you understand what products the other non-traditional lenders listed above, can offer you. Make an informed decision on which way to go financially for your business, and it will ultimately help you!

 

Moneytech is an Australian commercial finance organisation specialising in Trade Finance (Credit Express) and Debtor Finance (Confirmed Capital). We aspire to become trusted partners of our customers. We support their growth by both understanding their business, and creating innovative financial products based on their feedback which fulfils their needs. Continue to our web site to learn more, or call us on 1300 858 904.