Tips For Borrowing Causes Part 2

The following is the final part of this article. In part 1, I discussed borrowing need caused by accounts receivable and inventory slowdowns, short and long-term growth and increase in working investment. In this final part, I discuss the remaining borrowing causes.

• Fixed assets renewals and expansion

Fixed assets wear out with use or become obsolete, requiring replacement. It is expected that the cost of new fixed asset will be recovered or converted to cash over its useful time. This is known as capital investment cycle. Fixed assets are needed to support a series of operating cycles. It is logical, therefore, to spread the cost over several cycles, but certainly not beyond their useful lives. A company that opts to buy an expensive fixed asset out of its cash flow will most likely run out of cash subsequently. Fixed assets require long term financing. As a rule of thumb, a company whose fixed asset usage ratio is rising and at least 60% should start planning to replace equipment. It is prudent to make a comparison of industry average of the sales/net fixed assets ratio which is a useful indicator of funding needs for expansion of production capacity.

• Outlays for fixed assets

Excessive growth in other assets such as investments, prepaid expenses, deferred charges, intangibles and goodwill can be borrowing causes. However, these expenses should constitute a significant proportion of total assets over time in order to cause a concern. Financing of these assets may be short or long depending on the intended use of the assets.

• Low profitability or losses

Companies fund themselves internally from profits. If profits drop significantly or a company operates unprofitably for a long period, cash shortages are likely to occur. Cash shortages may cause other borrowing causes such as slowed sales growth. Normally lenders will not finance losses or declining profitability. A prudent lender will endeavor to investigate the cause of losses or declining profitability by analyzing sales and expenses trends. Temporary losses and decline in profitability may be financed with short term loans while long term losses or decline in profitability may be financed with long term funds.

• Distributions or dividend payments

If dividend payments or distributions are higher than profit, a borrowing need may arise. Payout ratio may help to identify distributions or dividends payment trend. A high or rising ratio in relation to profits is an indicator of imminent danger of cash shortages. The borrowing need arising thereof may be short-term or long-term and may be financed as such. However, many lenders tend to avoid financing of dividend payments.

• Debt restructuring

Debt restructuring is a borrowing need but does not result to new funds to the borrower. It is merely a replacement of another creditor, often to improve debt service ability. The commonest reasons for debt restructuring are to replace maxed trade creditor debts, loan mismatches, expensive and poorly structured debt. Financing of restructured debt will depend on the need. For example, trade creditors will be financed with short term debt per the length of the operating cycle and liabilities will be financed with long term debt to provide improved debt service. Low profitability over a prolonged period may cause a borrowing need as well. Temporary losses may need short-term loans but persistently low profitability or losses may require long-term funding.

• Unexpected expenses

These are usually one-off expenses incurred to cover litigation, installations and uninsured losses, to name but just a few. Large unexpected expenses can cause a company’s failure to meet regular expenses. In such circumstances, therefore, these expenses may be financed with bank debt. The primary source of repayment will determine the term of the loan.

Source by Franc Jo

Leave a Reply