GUIDELINES TO SQUEEZE YOUR FINANCE COSTS
While equity, loans from shareholders, bank overdrafts and bank loans are the staple for day to-day company financing, take a closer look at your overall mix of debt and equity and you can lower your overall costs of financing and gain new financial muscle.
CHOOSE THE TYPE OF FINANCE BEST SUITED TO YOUR BUSINESS’S CURRENT STAGE
Your business’s stage of growth provides a good rule of thumb as to the type of finance it is likely to require and the sources available.
HOW MUCH BORROWING SHOULD I USE?
Getting the correct mix of borrowing and equity from retained earnings and owners contributions will lower your finance costs and provide the maximum flexibility to your operations. If your mix is out of balance you may experience excessive risk or under realisation of the potential of the business.
Try to maximise your funding from within the business. This often-forgotten source of finance is the cheapest available and is internally generated by optimising your cash flows and managing working capital correctly. Examples include collecting receivables quickly, taking advantage of prompt payment discounts, negotiating extended payment terms with suppliers and not tying up funds in large holdings of inventory.
Optimise your external borrowing by forming a clear picture of the investment return you want your business to earn. Decide what level of risk you feel comfortable with to earn that return. This will help determine the maximum borrowing or gearing that is acceptable for your business and provides the standard yardstick for comparing different types of finance.
The types of risk associated with financing include:
- Liquidity – the risk that the business will be unable to meet the interest and principal repayments required
- Interest rate – the risk that interest costs are excessive, incorrectly structured or likely to change over time
- Security – the risk the security you have to offer is inadequate due to changes in the market or environment (changes in property values, ability to collect receivables, etc.)
Examining the financing strategies of competitors and other businesses in your industry can help determine some upper and lower boundaries for borrowing.
WHAT OTHER FACTORS SHOULD I CONSIDER?
Debt and company risk have an impact on company directors, who have a duty to manage the business for shareholders, but may be personally liable to some company creditors such as employees should the business become insolvent.
Planning and management control
As increasing your borrowing raises your business risk, robust strategic planning is essential to minimise the chances of unforeseen financing problems dragging your enterprise off-course. Likewise, the benefits of a robust financial plan will be wasted if your management reporting and control procedures are not up to scratch and funds are not used as intended.
Optimising business borrowing is a great way to raise your profitability and profile among the banking community at the same time. But in the long term, the best strategy to lower your external borrowing costs is simply to have higher profits in order to fund the business yourself.
For an extended version of this article and to access the Financing Checklist go to www.clevercompanies.com.au
Clever Companies do not stand still. They are dynamic and constantly challenge the status quo. Our Private Client Service team is committed to helping these private businesses make the most of their opportunities. To learn more about the topic covered in this article please visit our website or call us.
Manoj Santiago 1300 737 938