Leveraging with debt

THIS is a personal finance column, so we hardly discuss business finance. However, the lockdown has brought with it a deluge of credit offers. Governments trying to restart national economies are dangling credits with mouth-watering conditions before the public. Caution and wisdom are required.

Whilst in theory, business finances are separate from personal finances, in reality, business losses impinge personal finances, health and well-being. The recently announced Central Bank of Nigeria Global Standing Instruction (GSI) policy underscores this. The GSI policy authorizes a lending bank to use the funds of borrowers (linked to their BVNs) held in any other bank to offset outstanding loan and interest repayments. There is therefore a need to appraise all borrowing needs thoroughly and calmly before incurring any debt.

No doubt, there are numerous benefits of borrowing to finance a business. Firstly, the increased funding enables you to run a bigger operation and achieve economies of scale.

This should ultimately lead to an increase in the rate of return (profit margin). Borrowing for large assets acquisition helps to fast track growth. Instead of waiting to save money to buy an equipment, the equipment is acquired immediately and the money that should have been used for savings would be channeled towards loan repayment. Loan repayment would even be easier than saving because the new equipment would be generating additional revenue. Therefore, borrowing for investment is generally a good decision.

What should we consider before we borrow? Firstly, the loan amount – never borrow more than the business needs because the business would not be able to generate the loan repayment and you would be forced to look elsewhere to repay or you would default on repayment. Consider when to draw on the loan. Interest is only paid on the amount withdrawn. So, draw only what you need at any time – the means that you should negotiate payment terms with your own suppliers and avoid paying up front for goods and services. A 48 hours delay in payment means you do not pay interest on that amount for two days. It all adds up. Most borrowers do not pay sufficient attention to the effects of compound interest – the concept of paying interest on interest. The longer the tenure of a loan, the more compound interest accrues on the principal amount. Therefore, always choose the shortest possible tenure for every loan. Do your projections and simulations carefully. Go for a short but realistic tenure. Avoid going to the other extreme and making payment projections you cannot meet; this could lead to payment defaults.

Another very important consideration is the price of the loan- the interest rate and other fees. The surplus accruable from the business must cover all the fees and leave a comfortable and motivating profit for you. Breaking even may be acceptable at the beginning of a project, but as it matures, the returns must be sufficient to motivate you to continue working at it. Otherwise, there might be a temptation to take out what you believe you are entitled to even before you give the bank their share. This of course, would lead to default.

The timing of a loan is another crucial consideration. Can the market absorb your increased production? Are the macro-economical conditions favorable? If you borrow to increase production but are unable to sell the additional goods, you will find it difficult to repay your loan.

Always explore alternatives to borrowing and any avenue to reduce your total borrowing. An equipment vendor may be willing to allow you to take an equipment and pay for it over a few months. This kind of arrangement is usually interest-free. The amount for the equipment can then be deducted from your bank loan request. You could even do trade by barter. Or ask family and friends to donate unused furniture and equipment which you refurbish for a fraction of the price of new ones. All these would significantly reduce the amount of loan you need and consequently the loan tenure and interest payable. Explore these alternatives. Nothing ventured, nothing gained.

Never borrow for a new project because it essentially an experiment. Borrowing for an experiment is unwise. Use interest-free money to execute the Proof of Concept. Only after the business concept (business model and other conditions) has been proven to be viable and profitable should you use expensive funds to finance the business.

Business finance impacts our personal finances. It can make us very wealthy or otherwise. The richest people in the world are business owners, not salary earners. Business is empowering but we must carefully navigate the waters.

Happy investing.

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