During the last economic downturn, debt got a bad name. And no wonder; too much debt and the subsequent decrease in asset values caused many people and businesses to get hurt or worse. But since that trauma, we’ve overreacted.
Now, more than ever, (prudent) financial leverage makes sense. Rates have never been so low. For one of the few times in our lifetimes one can achieve positive leverage. Positive leverage is when the unleveraged rate of return on an investment is more than the cost of borrowing. Borrowing at, for example, six percent when the unleveraged rate of return is ten percent, creates positive leverage and increases the return on invested capital. This hasn’t been possible very often in the last five decades.
Of course, taking on debt or leveraging an asset is the classic double-edged sword. As we saw, a significant downturn can result in underwater assets. So smart and prudent use of debt is in order.
Making it Easy for Bankers to Give You Money
Most banks have plenty of money to lend. Nevertheless, they are being very careful about lending it out. How can you be one of those borrowers who get the funds you’re looking for?
First, you need to borrow for good reasons. Borrowing to cover losses or to pay off the hole you’ve dug for yourself is not going to warm the heart of your banker. Borrowing to grow or to fund payroll until receivables are collected makes sense. Borrowing to buy a piece of equipment that will result in more business or make you more efficient makes sense too.
Next, remember the “Three Cs” of banking that gives the bank three potential forms of repayment. First, Cash Flow needs to be sufficient to service the debt and pay back the principle when due. Cash Flow and profit are different but profitability is a great source of cash flow. Second, the bank needs to remain “Collateral Whole.” That means that the bank’s collateral, if foreclosed on, needs to be worth more than the amount of debt outstanding. The third C is Credit, meaning the borrower’s guarantee needs to be strong in case the first two Cs are insufficient.
Anyone who loans money wants to be kept up-to-date on the business’s progress and performance. Your banker wants to know whether the business is profitable. S/he wants to know if you’re hitting your sales goals and whether you’re on budget. The best way to keep a lender informed is to provide them with accurate and timely financial statements, usually prepared on an accrual basis. That same information is important for management of the business. Not having good information is like driving a car with the windshield covered.
Finally, find a banker who will get to know you and your business. If you’ve had a year or two in the last five that were not profitable, be prepared to explain what you did to correct the situation and why you are well prepared going forward. Have the banker visit your office or plant to see your operation. Make sure your banker can explain your value proposition. Consider providing monthly financial statements, particularly if they demonstrate a trend toward improved profitability. Tell your story and make sure your banker can tell it to the credit officer within the bank. Your banker needs to sell your loan to the decision makers within their organization.
There is no guarantee you’ll be able to borrow the money you want but following the above advice will certainly enhance the chances of your success.
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