Do not rush to borrow money

The saying “If it ain’t broke, don’t fix it” is good advice for the timing of interventions in life, business, and finance. As a philosophy, it is about efficiency.

I thought about the simplicity of that maxim and how it could have saved many dreams from eventual ruin while thinking back to several loan applications I have reviewed over the past 15 years. In over 40% of these cases, little thought was given to why the loan was needed or why it was the best option at the time to grow the business. In fact, it has become apparent that rather the state of the business, a common challenge faced by struggling businesses are their owners and their borrowers.

Applying for a loan should be a long-term strategic decision and not an impulsive stopgap or tactical arrangement. This is evident in the way successful, growing, successful institutions go about arranging credit facilities. These companies will typically have a vision of the requirement to borrow up to a year in advance and follow a well-thought-out plan to get there. This plan will outline the cost and benefits of borrowing, ways to finance their needs, and various scenarios and business contingency plans.

The challenge with many growing businesses is that their expansion plans rely heavily on debt financing. Owners and developers do not consider, for example, other cheaper sources of finance such as equity (including retained earnings over time), supplier credit or even simple incremental expansion based on the evolution of the market and the real perspectives of their product.

In short, they borrow when they don’t need it. This always translates into urgent borrowing needs, a situation any business should avoid self-inflicting, and the ensuing highly questionable decision inevitably results in long application processing times. The pressure to borrow lends itself to making even worse decisions such as hijacking facilities that can create a crisis for the business.

Consider this example. A customer can use an overdraft to finance the acquisition of land. Now, an overdraft is renewable annually and interest is compounded monthly on the amount used, with the understanding that the customer will negotiate and receive payments over time while accessing the funds to continue storing and meeting recurring expenses. By using this facility to purchase land or machinery, you are tying up working capital. This reduces your ability to meet your obligations on time or maintain adequate inventory levels or pay for utilities, inevitably depriving the business of cash.

With so much volatility, uncertainty and complexity, it can create a nightmare scenario for a businessman.

An entrepreneur must take a focused and well-thought-out approach to planning their financing, taking into account new equipment, additional staff, costs, market and buyer diversification. In other words, they need to know exactly what the loan will be used for, when it will be needed, and what you can do if the amount is not available. Planning is more essential than ever when it comes to financing options outside of traditional banks, such as venture capital, private equity, crowdfunding from family of friends (and strangers ), invoice discounting products, contract financing options, etc.

A planned intervention is intentional. It makes sense for Okello, for example, to take out a term facility or use his savings or equity to acquire land. He can then begin to develop it into a productive asset that will increase his ability to generate cash allowing him to increase sales and repay his debt.

Financing providers with greater diligence focus on understanding a business’s potential to generate cash flow (the source of repayment), credit history (of previous borrowings), length of time in business entity, market conditions, how much skin the borrower has in play. Likewise, having a clear view of these concerns while you are considering borrowing can help you find the right lender for your business or the good solution.

In an emergency, think about the best options in the strategic plan. Is this an insurable loss for which there will be compensation? Do you have an emergency fund? Contingency plans? With some of them, the rush to the bank will require you to be able to demonstrate the business application of the borrowed funds and proof that the cash flow to cover the borrowing will be sufficient.

The author is credit manager at the Uganda Development Bank.

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