It’s not an understatement to say Africans fear debt, even in business. And we are not wrong to given all the evidence we have seen of lives falling apart because if debt. We all have that one relative who was doing well, or so it seemed until the revelation that it was all debt-financed and the collector came. None the less debt is incredibly useful in financing businesses and wealth creation. However, there are principles that you just follow to do so effectively and I’ve gathered 5 really important ones for you to learn about using debt to make money.
This is a very simple principle; borrow the long term for long term purposes, short term for short term purposes and never mix the two. The Asian financial crisis of the early 2000s was in part caused by a heavy reliance on short term debt for long term projects. You wouldn’t borrow over 30 years for a car, well the banks wouldn’t allow you. The loan will remain long after the useful life of the asset. How will you repay the loan without the assets productive capacity? The inverse is also dangerous, using short term finance for a long term project will lead to the loan demanding payback before the project has recouped investment.
It’s all about cash flow
Debt, like much of finance if not all of it is all about cash flow. What matters most to lenders is cash flow. What matters most to borrowers is cash flow. Lenders want to know that their cash flow is guaranteed and will generally prefer a borrower whose cash flow is not tied to the success of the project they are borrowing for. That’s not to say such projects don’t get funding, it’s just less likely. Collateral only serves as a last resort guarantee.
Don’t borrow to start
One of the most frequent complaints is how people will often be turned down when they are applying for debt finance for their new venture. There are a couple of important things to consider here. Firstly debt providers are not risk-takers, that is to say, they like their money and on time. New ventures have an unforeseeable amount of risk. Going back to the last point the cash flow potential of a new project is simply unknown and that’s something these risk-averse types cannot stomach.
Borrow for growth
What you can borrow for is the expansion of your business. If you have a going concern that has proven cash flow you can firstly, show that there is a positive cash flow in the venture and secondly prove that you can turn the loan into consistent cash flow. Borrowing works well to expand a business. Expansion is not without risk but the cash flow risk is greatly reduced when borrowing for expansion. Working Capital loans are a really good example of borrowing for expansion.
Every point counts
As I said earlier it’s all about cash flow. One number matters more than any other in debt and that is the interest rate. Well, the repayment but that is calculated from the interest rate. Every percentage point of interest counts in debt financing. The difference between 2.5 and 3.5% could be $500 depending on the size of the project. What makes matters worse is the state of the economy. Borrowing in any form is expensive and only made worse in the inflationary environment. You may feel like you don’t have many options but it’s best you leave no stone unturned when looking for debt financing. While you’re scrutinizing the interest rates check every other detail in that loan contract.
Debt finance can do great things for you. You will need to study, understand and apply the principles outlined here when it comes to debt to make the best of it for you.