Don’t rush to borrow money

The saying, “If it is not broken, do not fix it,” is sound advice for the timing of interventions in life, business, and finance. As a philosophy it is about efficiency.

I was thinking about the simplicity of this maxim, and how it could have saved many a dream from eventual ruin while looking back at several applications for loans that I have reviewed over the last 15 years.  In over 40 percent of these cases very little thought was put into why the borrowing was needed or why it is the best option at the time to grow the business. In fact, it became apparent that rather the state of the business a common challenge faced by struggling enterprises are their owners and borrowers.

Here is why.

A loan application should be a long-term strategic decision and not an impulsive stopgap or tactical arrangement. This is evident from how successful, growing and thriving institutions go about arranging credit facilities.  These companies will usually have a view of the requirement to borrow up to a year in advance and follow a well-thought out plan to get there.  This plan will lay out the cost and benefits of borrowing, the means to finance their needs and various scenarios and contingency plans from the activity.

The challenge with many growing enterprises is their expansion plans are heavily reliant on debt financing. Owners and promoters do not consider, for example, other cheaper sources of financing such as equity (including retained earnings over time), supplier credit, or even just phased expansion based on market developments and actual prospects for their product. 

Borrowing pressure

In short, they borrow when they may not need to. This always results in borrowing requirements being urgent, a situation any business should avoid inflicting on itself, and the ensuing highly questionable decision leading inevitably to long application turnaround times. The pressure to borrow lends itself to making even worse decisions such as the diversion of facilities that can create a crisis for the business.

Consider this example. A client may use an overdraft to finance land acquisition. Now an overdraft is renewable annually and interest compounds monthly on the utilised amount on the understanding that the client will be trading and receiving payments with time while accessing funds to continue stocking and meeting recurring expenses.  By using this facility to buy land or machinery, you are tying up working capital. This lowers your potential to meet obligations in time or maintain adequate stock levels or pay utilities inevitably starving the business of cash.

With so much volatility, uncertainty, and complexity, this may create a nightmarish scenario for a businessperson.  

Plan financing

An entrepreneur must take a focused and well-thought out approach to planning their financing, consideration for new equipment, additional staff, costs, diversification of market and off-takers. In other words, they must know what exactly the loan will be used for, when it will be required and what you can do in case the amount is not obtainable. Planning is critical more than ever when dealing with financing options outside of the traditional banks, such as venture capital, private equity, crowdfunding from friends’ family (and strangers), invoice discounting products, contract financing options etc.

A planned intervention is intentional. It makes sense for Okello, for example, to take a term facility or use his savings or equity to acquire land. He can then start developing it into a productive asset that will increase his cash generation capacity enabling him to increase sales and repay his debt.

Providers of finance with greater diligence focus on understanding a business’s potential to generate cash flow (the source of repayment), the credit history (from previous borrowings), length of time an entity has been in business, conditions in the market, how much skin the borrower has in the game. Likewise, a clear view of these concerns while you plan to borrow can help you find the right lender for your business or the right solution.

In an emergency, think about the best options in the strategic plan. Is it an insurable incident for which there will be compensation? Do you have an emergency fund? Contingency plans?  With some of these rushing to the bank will require that you can demonstrate the business application of the borrowed funds and evidence that cash flows to cover the borrowing will be sufficient.

The author is the director credit at Uganda Development Bank.