Why Do Business Owners Need To Borrow? – Part 2
In last week’s blog I asked the question: why do business owners need to borrow?
The answer is, that there are of course many reasons why a business needs to borrow. I mentioned last time that in a British Business Bank survey carried out in 2016, they discovered that 60% of SME businesses (small and medium sized enterprises are defined as businesses with between 0 and 249 employees) sought some form of external funding at some point over the previous three years.
What’s interesting, is that there are some common reasons why most businesses need to raise funding.
And the 5 most common reasons that most businesses apply for finance are these:
- Working capital
- Asset purchase
- Start a business
- Expansion
- Refinance of existing debt
Last week I examined the first three, and this week I’ll go through the other two reasons in more detail.
- Expansion
If you are looking to grow your business, then you need to understand the difference between operational expenditure (OpEx) and capital expenditure (CapEx).
In running a business, there are costs involved in the day to day running of the business such as rent, rates, heating, lighting, payroll, telephones and so on. These costs fall into the category of OpEx – in other words there are costs required to cover the day-to-day operation of the business.
CapEx on the other hand, is usually what is required to grow and expand the business. Whether you are looking to move into a new premises, take on a new sales team, expand the range of products or services you sell or expand into international markets, you are going to require funds to cover these capital costs – CapEx.
Where many business owners make a mistake is they treat CapEx as OpEx, and try to fund capital expenditure from the day-to-day operational income of the business. That usually leads to cash flow issues because the business simply cannot grow and expand effectively by using operational expenditure. It will be a slow growth and as I say, ultimately lead to cash flow issues – see last week’s blog when I talked about working capital.
As a result, some kind of funding is usually required to fund growth and expansion, in other words CapEx.
2. Refinance of existing debt
I often come across business owners who have taken out loans on an ‘ad hoc’ basis as the requirements of the business has changed.
The result is they have several different loans and facilities within the business, each of which could be structured in a much more efficient way.
For instance, the business may have an overdraft which instead of being a trading facility has a significant level of ‘hard core’ borrowing. This is an expensive way to borrow bearing in mind the interest rates and fees charged on an overdraft when compared to a business loan.
Also, I often see short term loans with higher monthly repayments, than would be the case if the loan was re-structured over a longer term.
When I am asked to look at the financial re-structuring of a business, usually it’s about putting the debt on to a longer-term basis, thereby reducing the monthly repayments and so improving the cash flow of the business.
I see many businesses who would benefit from a review of their current borrowing, as there are usually significant advantages to be had, particularly from a cash flow perspective, by carrying out a restructuring of the existing debt.
Now might be a good time to review your current funding arrangements. Could there be more effectively structured at a better rate of interest or over a longer term? Alternatively, you may have some CapEx requirements right now.
If you’d like to talk to us about how we can help you fund your business, then email us at keith.park@fundingtrack.com or give us a call on 020 8949 2122 and let’s see how we can help.
