Do established businesses borrow? Or is that a business practice reserved for start-ups and first-timers?
When thinking about commercial loans, business owners sometimes forget how valuable these loans can be even long after they’ve started their business and gotten it up and running. As we’ve discussed in previous articles, borrowing for business is not for new businesses only.
Borrowing for business can be key in your organization’s growth strategy.
Let’s look back at Philip Campbell’s Achievable Ten-Step Plan for Winning Financial Success in Business. Steps 1-4 deal with confronting reality. You need to build up a cash balance, put aside enough cash to pay income taxes, diagnose and fix profitability and cash flow weaknesses, and create a reliable financial forecast.
In Steps 5-7, the plan focuses on creating a safety net for your business, and Steps 8-10 center on how to grow and enjoy your business.
Do you know the role debt can play in the final two phases of this financial roadmap? Take a look at Steps 5 and 8: pay your bank line down to zero and use existing cash flow for capital expenditures and growth capitals, respectively. These steps will give you some insight into how you can use debt to grow your business—responsibly.
Smart Business Owners Use Debt to Grow
Smart business owners no longer need to borrow money to become a business, they borrow money to improve the business. Depending on how well you manage your financials, this may be using a line of credit. As your company matures and gets a solid working line of capital, you still need a deposit line in the bank.
As companies grow, they desire to improve and expand. That may look like better equipment, a new building, or hiring additional staff. Expanding fixed assets is a goal for growing businesses—and a commercial loan is one way to help businesses reach that goal.
Borrow Against Your Bank Line
First, business owners want to pay their bank line down to zero, even if temporarily. This revolving line of credit is meant for movement. Borrowing against your own line of credit is a good practice for businesses with
- Seasonal demands or cash flow fluctuations
- Short-term cash needs (i.e., when accounts receivable is high)
- Goals to expand fixed assets
To optimize the use of your bank line, borrow against it as demands rise, then pay the line back down to zero (at least once a year or more, if possible). Not only is this a smart and responsible business practice, but also one that will teach you discipline for paying off the line. Another advantage to borrowing against your bank line is you will not need to report receivables to the bank like you would if you secured the loan through another type of collateral.
Utilize Sweep Accounts
A smart strategy to help you pay your bank line down to zero is to utilize sweep accounts. A sweep account is a type of bank account that, at the close of each business day, automatically transfers amounts over or under a certain amount into another account or option that has a higher interest-earning investment option.
Business owners utilize this approach to sweeping in their checking account to pay down their line of credit. By having a sweep setup on your checking account, you will save on interest.
It’s also common for business owners to sweep into a money-market account (internal sweep if under $250,000) about two to three times a month from a checking account.
Borrow Money to Save Money
Now we know that a line of credit can help businesses with irregularities in cash flow, let’s discuss an example of how this can actually save your business money.
Let’s say you have a supplier who offers you a 1% discount for early payment, and you pay the supplier on a monthly basis. By the end of one year, you’ve saved enough through the early-pay discount to earn the equivalent of 12% annual interest rate. You may need to borrow in order to make that early payment, but if your cost of credit is less than that interest rate of 12%, your business saves money—and that can add up over the course of a year and year-over-year.
Why borrow money for a 1% discount? Let’s take a look at this scenario: you have to pay a supplier an invoice of $100,000. If you pay the invoice early, that 1% discount would you save your business $1,000. You have a 6% rate on your line of credit and borrow the full $100,000. With these figures, the cost of interest you pay after 30 days is only $500. Now think about those savings over the entire year, added to your business’ bottom line. Not to mention you’ll be in good standing with your suppliers for paying early.
This is just one example of how you can use debt to grow your business responsibly. Responsibly is key. It can be easy to borrow here and there to pay for what you want for your business, then find yourself struggling to pay back the debt later. That’s why it’s important to follow the other steps of the financial roadmap including creating a financial forecast for your business.
When you know where your business is headed—goals, potential roadblocks, and accelerators—you can better map out how to reach those goals. Borrowing to grow your business takes discipline, but the payoff is big.
Have you ever used debt to grow your business?
Does your business need to borrow to grow? Learn more about borrowing for business in this free ebook.