Yes! But not when you are taking expensive loans that would automatically wipe off your returns. If you are managing operations of a business, it is either you finance it with your fund or you borrow. Occasionally, many businesses often demand capital injections. Entrepreneurs however prefer cheapest one. That’s good but desire to access free funds is not a business language. Please, stop thinking about it; because it cost money to get money. It also cost money to keep money. What happen when you need some quick capital injection into operation of your business?
It could be to close working capital gap or to finance an expansion. One of these things usually happens at that point. You either borrow or bring other interested people into your business to provide additional funds that the business needs.
What happen if you chose to bring people? You just lose absolute control and ownership – you effectively dilute your interest in the business. Someone will start querying your decision henceforth. You may have to open an office for the investor too; sometimes it is part of the deal. Welcome to reality. An owners run businesses often enjoy advantage of quick decision, less bureaucracy safe for the need to sign cheque.
It is not uncommon to hear businessmen saying that their businesses owe no debt. To them, it is an achievement, best finance strategy ever. Yes, they are correct. But debt is not as bad as they often think. There is a secret behind why large businesses leverage. This, to some entrepreneurs is a no-no!
In today business environment, significant numbers of large corporation achieve growth by leveraging. It is a two way situation. Leverage or borrowing funds to push business operations of a business could be disastrous. And, it could be advantageous!
Unlike small scale business owners, large corporations always position to take advantage of available external finance or credit. They understand the rule that many startups, or wannabe entrepreneurs don’t understand. No one can grow beyond level of understanding or knowledge s/he endows with. That goes for business too.
Using debt finance helps reduce your tax liabilities to the extent of the amount your business paid as interest. Your interest payments shelter up to the level of tax rate applied to the profit. Large companies love this advantage. It is not only that debt finance allows a business some leeway in tax liabilities; it could facilitate growth in a manner that could be massive and unprecedented.
Should entrepreneurs borrow to finance their business? Yes! But there is a caveat, don’t do it if you don’t understand how it works. Take local purchase order finance for example, some entrepreneurs don’t factor their interest cost into signing LPO finance with their banks. To them, they have profit in the pipeline if they could fulfill customers order. They always neglect one side. The cost of LPO finance from their banks compare to their returns.
Many entrepreneurs don’t understand how to open LPO line, in spite of the fact that they have serial purchase orders to finance. It is an error to be financing purchase order one by one; it cost more for any business that engages in that approach.
Enough said about short term financing source. Entrepreneurs that have access to external funding at manageable interest will normally grow faster that its peers that is finance with limited capital. Why, the more the capital a business is able to deploy into operation, the higher the probability of its profit performance.
Meanwhile, the concept of leveraging is often anchored on the situation where there are projects or opportunities that ordinarily a company cannot finance. If the return on the project is more than the cost of obtaining funds, that is the interest rate obligation, and then an opportunity for expansion exists.
Geared, companies that have sizeable proportion of debt finance in its financing mix can go down faster if there is miscalculation. That if relationship between finance cost and project benefits is not properly settled.
That means, expected return on investment that a business is borrowing to finance must be more than the cost. It means, business owners or entrepreneurs must do a solid project appraisal without understating cost or overstating revenue.
Assumption must be right about the project because cost of borrowing is always known and constant over the period of the project. So, while there are upside, there is always down side to using debt to support growing business. There are rules; these include
- The project must earn more than it is going to pay
This means, if an entrepreneur see an opportunity to invest certain amount with intention to borrow the money at x-rate, such project must earn more than the interest rate. How do you know a project that will return positively? Then, business managers must always assess project with project appraisal models, as example, using net present value model. Is the present value of net cash flow from the project greater than its initial cost? If your answer is yes, then, invest in it.
- Don’t borrow if your assumptions are based on guess estimates.
You may have done your investment appraisal correctly. But, if your assumptions are based on estimates that may differ greatly, then there is risk; and it will be unbearable if materialize. You are taking too much risk and it may hit you back, hard and fast. If you are certain you are going to make more than what you are paying out, kindly do the business. Be careful of what you assume will happen, uncertainties love the future; and the future loves uncertainties!
- Consider timing, don’t mismatch funds
This is very important. Some entrepreneurs don’t understand impact of timing in business as it relates with project and funding. If you access funds that have short term orientation to support a project that has long term investing outlook, you may likely fail to meet your obligation. If a project fails, it affects the entire business, causes cash drain and liquidity stress. Use long term finance to fund a capital project with similar timing, only.
- Consider currency of flows
It is an error to match funds with different currency base. If your business is receiving revenue in Naira and you go ahead to raise funds in United States dollars, you are on your own. The risk is, it is more likely that one of the pair currencies will appreciate and the other depreciate. Hedging the difference is expensive except for large size companies. Even at that, they have failed in balancing the equation. Remember Etisalat did that; and it backfired on the company.
- Don’t borrow without loans liquidation plan.
It is suicidal for some business owners that love taking credits without putting adequate plan in place. No, you don’t do that. You must have your accountant design a template as to how your business will repay principal as well as meeting periodical interest obligation.
