Using debt wisely

Debt is misunderstood by large portion of our populace. Many think borrowing is shameful and proudly announce that they do not owe anyone a kobo. Who could blame them? The first rule in my secondary school was “neither lend nor borrow.’’ That may work for teenagers butcould be a hindrance in adulthood. However, some people go to the other extreme and amass more debt than they can manage, leading to sleepless nights and financial ruin. How then can we use debt wisely?

Debt involves buying goods or services with someone else’s money. This includes taking an actual loan, using a credit card, collecting goods without paying upfront and so on. There is a price to pay for the advantage – that price is either built into the price of the goods ab initio or spelt out as interest payable. Those of us who buy goods from “car boot” vendors should not be deceived into believing it is interest free. There are no free lunches, nothing like zero interest.

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Borrowing can help one take advantage of a time bound opportunity, which if one were to wait to generate the funds by oneself, the window of opportunity would close. Borrowing helps to fast track growth by making funds available to do bigger transactions and so enjoy economies of scale. This means a trader who borrows to buy additional merchandise would enjoy higher discounts/ lower costs for buying in bulk and be able to make a wider margin than her colleagues in the same market.

Some of us have taken loans from our employers for which deductions are made from our monthly salaries, this reduces our already insufficient take-home pay and makes us susceptible to integrity lapses to “make ends meet.”Such loans should only be taken for medical emergencies. We should strive to maintain a rainy-day savings account for unplanned expenses like car repairs.I do not recommend taking consumer debt (for buying clothes, TV, smartphone etc.). Debt is best used to generate income, that’s the only way the interest element would not become a heavy burden.

When borrowing, consider the following factors. 1) Cost of funds – what is the interest rate payable on this loan? Sometimes the interest rate may be high but if the tenure of borrowing is short, it might still be worth exploring. 2) Market price – what is the price of the items to be purchased by the loan and the margin to be made from the transaction? 3) Price stability – how stable are the prices? If they are volatile and fluctuate like company shares on the stock exchange – you cannot guarantee that you would make a positive return to pay the principal talk less of the interest accrued. 4) Ease of exit – how easily can you exit the loan? Since banks can change their interest rate at will, can you easily back out of the loan when your transactions can no longer accommodate the interest obligation?

Entrepreneurs who borrow for their business need to confirm that the cash accruing from the business can service the debt (repay principal and interest as and when due); make a comfortable margin that covers all business expenses; and deliver a worthwhile profit to them at the end of the business cycle. That requires careful computation of revenue expectations based on historical data from the business. This underscores the importance of proper record keeping. Please note that debt servicing should never be more than 33% of Income. Because startups do not have historical data to base borrowing (especially repayment) decisions on, I do not recommend that they borrow at the initial stages. They do not understand the cash flow patterns of their new businesses, so they should not be committing to rigidly fixed repayment plans – this is a mismatch. It’s best to do crowd funding from friends and family to finance startups.

A debt is itself a commodity – so do adequate due diligence. Shop around for best rates, conditions, repayment terms and so on. Watch out for loans with low interest rate but with additional fees. These flat fees make the loan expensive; because they are usually paid upfront, their value is higher than backend payments. Repay loans as quickly as possible – the longer the tenure, the more naira you pay as interest.

Debt is very beneficial if managed properly. Let’s be prudent debt managers.