Dr Jana Matthews | 5 minute read | To borrow or not to borrow
In this pandemic-affected business environment some companies are facing cashflow problems not experienced previously. Others might be short on cash due to rapid growth, as they take advantage of favourable conditions. One way or the other, if you’re in the position of needing more cash in your company, an option is to borrow via a bank loan.
If you’ve read and acted on the advice in my previous article Respond to your company’s warning light, then you will know whether and what month your expenses will be more than your income. And whether your cash flow problem is going to last for one month or for the foreseeable future. If you decide to borrow, you will need to take those financial statements (Profit & Loss, Balance Sheet and Cash Flow) with you when you visit with the banker to talk about your company and apply for the loan.
Business loan vs ‘overdraft’ vs credit card
The size and type of loan will depend on how much you need. Whether you need it immediately. Or if you need to have access to cash to cover a shortfall now and then. With a business loan you get the money immediately. It begins to accrue interest the moment it’s transferred to your company’s bank account.
But if you only need a loan to cover a cash shortfall in a month when customers pay late, or you have an exceptional expenditure, you may be better off with an “overdraft”. This is a line of credit to borrow from when you need the cash, then pay back in the months when you have extra cash. This will minimise any interest you will need to pay on the money borrowed. Different banks offer different features and benefits around these two types of loans, so do your research on what’s available.
Inexperienced CEOs may be tempted to borrow against their credit card. Although it’s quicker, easier and you don’t have to worry about being turned down (assuming you stay within your credit limit), I don’t advise doing that. The interest rate is about 20%, and you get charged from the moment you take the money out. It’s much better to go see a banker and develop a banking relationship.
What determines whether you are eligible?
Bankers look at 4 C’s to determine eligibility for a loan. Before you apply, run your company through the 4 C‘s and look at your company through the eyes of your banker. Don’t be discouraged – very few companies ever score a perfect 10 on every element, and especially now when many companies’ capacity to pay their bills has been severely impaired.
Character to borrow – What is the character of the business (and the owners)?
How big is the business? How long has it been operating? When did it become a customer of the bank? Where is it located? How many employees does it have? How is it structured? Does it have lawsuits, liens, or negative media? What are customers saying about it? What’s its credit history and has it paid its bills on time? Is the CEO or owner(s) willing to share information about the business? Has the CEO or owner(s) ever filed bankruptcy or gone into liquidation? All this information provides the banker with insights into the “character” and “trustworthiness” of the business owner.
Capacity to borrow – Does the company have the capacity to pay its bills?
How healthy is the company’s cash flow, and profit and loss statement? How many lines of credit are outstanding? Any defaults? How strong is its balance sheet, i.e., does it have more assets than liabilities? How much debt does it have and who does it owe, e.g., owners, other banks, or other entities?
Capital to borrow – Will the company have the capital to pay back the loan when it comes due?
Under normal circumstances, the banker would be trying to determine how much your company can afford to borrow. How could the bank be repaid, if your company were to go under? You would need to demonstrate to the banker that, at the end of six months, there would be enough cash flowing into the company to begin making payments on the loan. If that looks questionable – as it does when you are a new company with no track record, or a company that’s in financial difficulty – the bank will ask for some collateral or “security” for the loan. For example, you would need to agree to secure the loan with money from your savings account, stocks, bonds, property – and that could include your house or your farm.
The banker will expect to see your business plan, your financial plan and need to understand how and when you expect to be able to pay back the loan.
Conditions to borrow – What are the conditions facing the business?
The final C has to do with the externalities impacting the business. All companies are being impacted by CoVID-19. But as the old saying goes, “It’s not what happens to you that matters, but how you respond to what’s happening.” Some companies are doing well and actually need more cash for growth. For example grocery stores, companies doing video streaming, those making protective gear for hospital workers, and manufacturing camper vans! But most companies are in financial pain. Whether that’s temporary or long-term will depend on how you respond and whether your company already has the basic business building blocks in place that will support the survival and future growth of your company.
Be prepared for these questions the banker may ask. Describe how you are using this “down time” to take a hard look at the business. Identify where changes need to be made and your timetable for making them. Show the banker how a loan will enable the company to come through this crisis as a much stronger company. And how your new “lean, mean fighting machine” company will be able to pay back the loan and interest, bring back employees, and get back on the growth path.
Remember that while a loan may help you get through a rough patch, it will not, in and of itself, solve your problems.
The government, Reserve Bank, the banks – all of us want you to stay in business. So if your problems persist, explore the many state and federal grant programs that are being offered, including some that are outright cash grants, that could help your company survive these challenging times.