09 Nov 8 reasons why business borrowing is smart
Responsible business borrowing can in many instances be the smartest option for your business. Obtaining extra funds to support growth, supplement working capital and enhance your processes is a fundamental part of a flexible, growth-focused financial strategy.
When we talk about business borrowing here, we are concentrating on the taking out of debt, rather than selling equity in the business. Business borrowing can come in many forms, from traditional bank overdrafts and loans, to more flexible, growth-centered working capital credit solutions such as invoice finance or revolving credit facilities for supplier payments.
Is business borrowing a sensible option for you?
Of course, all debt carries some form of risk. Knowing whether business borrowing is right for you is a fundamental part of developing the financial strategy for your business. You should ask yourself two essential questions before deciding to borrow money:
1. Is your business attractive to a lender?
2. Can you service the debt without too much trouble?
Understanding your debt to service coverage ratio (DSCR) is crucial to assessing whether your business can afford to borrow.
DSCR = Net Operating Income / Total Debt Service
A DSCR greater than 1 means your business has sufficient net income (revenue minus operating expenses) to pay its current debt obligations. A DSCR less than 1 means it does not. If your business has a DSCR of less than 1, then you are experiencing negative cash flow and will find it more difficult to secure borrowing.
When considering business borrowing, don’t confuse needing capital to stay in business with needing capital to grow your business. Borrowing to enhance working capital, make additional profits and grow your business is different to borrowing to keep above water.
Good debt and bad debt
Contrary to popular belief, not all debt is bad. There are many instances where debt can be the best option for your business. Good debt is a sensible investment in your business’s financial future, should leave it better off in the long-term and should not have a negative impact on its overall financial position. When used for the benefit of the business, it can be part of a secure and balanced financial strategy.
The key to using debt for the benefit of your business lies in leverage. Leveraging debt is using borrowing for investment purposes, to multiply your profits or returns. Every successful company around the world has used leverage to grow their business, and become the success they are today. Companies use debt to finance their business operations. By doing this, they increase their leverage as they can invest in operations without increasing their equity. They get good return on their borrowing investment, and debt becomes a healthy part of their financial strategy.
The trick is to recognise and understand the circumstances and opportunities for when leveraging debt through business borrowing is the right thing to do for your business.
When business borrowing is smart
1. Facilitating growth
When a business is experiencing rapid growth, paying suppliers on time to ensure order fulfilment can leave it low on cash before receiving customer payments. Working capital gaps can then appear, putting pressure on the business and inhibiting its growth. This is where borrowing through a supplier payments finance solution such as Pay4’s revolving credit facility can take the pressure off. Borrowing in the short term as a regular, controlled element of a well-rounded financial strategy will help your growth trajectory continue, unimpeded by gaps in working capital.
Business borrowing can also fund the purchase of assets in the short term, when for example, emergency situations should appear. Being able to call upon debt-based solutions such as revolving credit facilities in times of immediate need is an essential part of a modern, flexible and well-prepared financial strategy.
2. Seizing opportunities
Successful businesses spot opportunities in the market and borrow the funds they need to seize the moment. Whether it’s a large order following an industry event, or a potential new product enhancement, the ability to borrow money in the short term to grab the opportunity with both hands can be the difference between stagnation and success.
This is where the speed, efficiency and streamlined application processes of alternative finance companies really come into their own. Securing access to funding from alternative providers can be as quick as just a few days, allowing businesses to jump on opportunities when they appear.
The cost of business borrowing should always be assessed against the opportunity cost (cost of missing the opportunity). Often the short term borrowing cost can prove far cheaper than the lost revenue potential from a missed customer, order, or business deal.
3. Managing seasonal fluctuations
If your business experiences seasonal fluctuations in demand, and profits peak and trough throughout the year, hoarding cash generated in the good months to cover the cash shortage in leaner times can hinder the growth of your business. Your profits are effectively going unused for the majority of the year, when they could be reinvested for growth. Borrowing through a working capital solution (preferably with no non-usage charges) over the short term to cover preparation for peak periods can help you to reinvest those profits more effectively throughout the entire year.
4. Optimising your supply chain
If your business experiences seasonal variations in demand, then optimising your supply chain to align with these variations will increase efficiency, reduce waste, and improve profitability. With the right borrowing arrangement, seasonal businesses can spread out paying for peak period necessities over a longer period. This allows them to stock key items in advance, increase efficiency through larger orders, and respond faster to industry trends.
Business borrowing also allows you to pay your suppliers early, without creating or exacerbating gaps in your working capital. Your business can therefore approach suppliers from a position of strength, securing preferential terms and discounts that will further enhance profitability.
5. Improving customer terms
With the pressure eased on your working capital, not only will your business be able to secure preferential terms with your suppliers, but will also be able to offer optimum terms to your customers, improving your competitiveness without leaving your cash flow stretched.
6. Helping to secure future credit
If your business is experiencing good growth, and profitability is healthy, then you should still consider business borrowing as a strategic element of a longer term plan. Even if on the surface, your business does not appear to require it. Companies such as Google and Amazon are ‘debt-free’, thanks to their strong cashflow and profits, yet this is still considered inefficient – they finance the company with retained earnings. As companies such as these mature and their growth inevitably slows down, debt will likely become an increasingly important source of funding.
This is where having a strong credit history of well-managed debt will help your business to secure borrowing should it become necessary once growth slows.
7. Keeping equity in your business
When raising funds for your business, relinquishing equity is almost always more expensive in the longer-run than taking on debt. Sacrificing equity costs you a share of your business, forever.
As equity investors take on higher risk, (debt is much less risky for the investor because the firm is legally obligated to pay it) they demand more return on their investment. This means giving up both current and potential value, often to fill a shorter term requirement. If you expect your business to be successful, and are averse to relinquishing control to other investors, then business borrowing is likely more suited to your needs.
In short, business borrowing to finance growth will likely bring greater rewards for the company founder than if the founder decides to share the profits among many owners.
8. Clearer, more disciplined financial focus
With a focus on maximising the value of all resources, incorporating business borrowing into your financial strategy encourages you to maintain good financial discipline. In contrast to a business with excess cash floating around, a business that utilises debt keeps focus across the organisation on justifying each and every purchase, process and production method.
This is not necessarily a reason to enter into borrowing per se, rather a positive side effect of incorporating business borrowing into your financial strategy and company culture.
A business that utilises a flexible, growth-focused working capital debt solution may also enjoy a clearer picture of their finances and forecasting. With the right finance solution in place, the cost of debt is usually clear and easy to understand. With peaks and troughs in expenditure levelled out, debt obligations fixed and working capital gaps closed, a business can maintain a sharper, more efficient financial focus.
Sensible borrowing for a smart strategy
With smart, flexible business borrowing as part of your financial strategy you can improve your business’s stability, competitiveness, and bottom line. Using debt constructively to purchase assets, enhance processes or invest in your business, thereby creating enough profit to make your repayments, will ensure your business is financially optimised for maximum growth.
The trick to securing smart, sensible business borrowing is first exploring your funding options. Be sure to do this long before you can’t make your obligations. Due to the competitive finance market today, choosing the most cost-effective, flexible, and suitable arrangement requires some research. If you’re a growth-focused business looking for a flexible way to enhance your working capital, pay your suppliers and optimise your processes, Pay4’s unsecured supplier payment finance facility offers up to 120 days credit, no non-usage fees, and credit limits from £50,000 to £1m.