Indicators in today’s business environment often point to businesses having difficulties obtaining lending from banks. Often times the inability to secure lending can hinder the ability of a business to create jobs while growing.
On the other side of the spectrum, business of today can fall prey to the practice of careless and excessive borrowing.
Borrowing money in today’s business environment when it is not the time to do so could end up being huge determinant to the success of a business.
Still being able to borrow money at the right time can be the difference between a business being able to take a step forward, or being knocked backwards, yet those times are few and far between.
Answering the question, “when it is time to borrow”, can be just as difficult as borrowing the money.
Before moving forward with signs that indicate a true need to borrow money two questions must be answered:
• How profitable actually is the business?
• Will the business have difficulties servicing the debt?
With that being said, the answer to the previous questions is more straightforward than answering the question if there is a need to borrow, because by answering the first question will help to answer the second.
To begin answering the above questions, start by creating a debt- service ratio.
To create a debt – service ratio:
I. Ascertain the gross income of the business. This will include all wages taken from the business earnings, and all other sources of income such as lease or rent payment generated from property.
II. Combine those numbers with earnings before interest, taxes and depreciation of the business.
III. Divide the sum from above by the total of existing debts, and the principal and interest that would be created by the new business debt.
A good business accountant can help with this task if help is needed.
The result will generate what is known as a “global coverage ratio,” which is one or the most important ratios banks use in determining the ability of a smaller business to repay a loan.
The reason why the global coverage ratio is important to banks is because the global coverage ratio takes into account both business and personal incomes of the borrower. For this reason a business owner should refrain from taking unnecessary personal debt as well, as unnecessary business debt.
The ideal number for a global coverage ratio is 3, however a global coverage ratio above 2 is considered to be pretty good if other factors concerning the business are strong. A global coverage ratio below 1.5 normally will result in a higher interest that more than likely would make the loan not worth it for the business.
The above numbers are what the bank will consider. However a business owner may consider a global coverage ratio above 1.5 still too high for the business to borrow money safely.
Banks evaluate ability of a business to repay a loan, but more important is the business owner’s assessment of the business ability to safely repay the debt while keep the profit margin up.
If a business is able to pass the test for the debt-service ratio, now comes the focus question, “should the business borrow money”.
The following considerations should be taken when determining if a business should take on new debt:
• Will the new debt help to generate more profit or more just more debt? It is important for a business to estimate profits before new debt, and profits after new debt. To do this a business owner must be clear on if the money is being spent in an area that will increase profits. For an example if a business wants to borrow money to replace business vehicles, the owner must determine if replacing the vehicles would generate more profits. In this situation a transportation business would see a more direct link to higher profits and new vehicles, than a cleaning service. As well construction business may need larger vehicles to compensate for larger jobs. But a business looking to take on debt for a new vehicle for strictly appearance than the business should not put as high of a value on the new vehicle purchase, because the purchase more than likely will do little to increase profits or lower the cost of doing business.
• Determine if the debt is actually to grow the business or to keep the business afloat. There is a huge difference in the two. If the need is to grow the business than the business must factor in how growing the business will increase profits. If the reason is to keep the business afloat, than it may be more help for the business to review the cost of doing business for cuts that would help to increase profits over time.
• Consider the type of credit. There is a huge difference in taken on debt in the form of a line of credit to get through a slow season, and repaying a loan over a long period of time. The business environment is ever changing and money borrowed today may become difficult to repay at a later date.
Analyzing the need to borrow money will take an investment of time. It is wise for a business to create conservative, optimistic, and moderate projections concerning borrowing money. Running an investment analysis will help to see just how much borrowing money will actually help the business.
One overlooked perspective is how borrowing money will result in deductions taken by business at the end of the year. Often business owners fail to see how borrowing money will lower the year’s end profits of the business. Lowering profits could make it more difficult for the business to borrow money if an actual need to borrow money to grow the business should surface after the profits have been lowered.
Finally, if all signs point to the need to borrow money, and the proper analysis show the debt can safely be repaid while protecting profits, then a business should consider a certified business loan. Certified business loans offers diverse solutions that are better suited for the business unique needs such as fixed and flexible repayment options, loans for smaller denominations, shorter approval on loans for lesser amounts (sometimes with in one business day), and the ability to leverage larger loans against future sales.