‘About Debt’ Q&A Series: Debt or Equity — Which is Best to Grow Your Business? (Part 4)

Last week in the ‘About Debt’ Q&A Series, we learned that debt could be used to help profitable businesses grow. So what are the important factors a business needs to consider before applying for a loan? Let’s find out together in this article!

Q Sandra: “We discussed a case where an agricultural company produces coconut sugar. The business is cash flow positive. However to serve bigger clients the company may need bigger working capital as foreign buyers usually input 30-days terms of payment. She may also need an additional machine to increase capacity.

Would you say this is a good use of borrowing? What are the important things for a company to consider before applying for a loan in general?”

A Chi-Ling: “Increasing capacity by buying extra machines is a really good reason for your friend’s company to use debt, as long as that company doesn’t already have too much existing debt. But it sounds like: her company is cash flow positive, the business and operations model are all proven, and she is really confident there is unmet demand for her product and it just requires extra capacity for her to fulfill that unmet demand. Those factors sound very positive for your friend to consider debt as a solution. Factors that all entrepreneurs should consider before they take out a loan:

• If you are going to buy an asset, is that asset expected to go up in value or produce income?
• How sizable is that loan relative to the company’s revenues, will loan repayments represent a big portion of the monthly revenues for the company?
• Terms and conditions of the loan. When people think of terms and conditions of a loan the first and only thing they focus on is interest rates (how much is the loan going to cost). But there are obviously much more terms and conditions in and about the loan, and those really need to be understood before signing on the dotted line to take out the debt.
• Do the entrepreneurs understand the risks and what could happen if things go wrong?
• Will borrowing this money improve the company’s finances in the long run?

So it is very important for businesses to assess whether the loan will improve the company’s finances over time and how much repayment as compared to income that the company can afford.”

It is very important for businesses to assess whether the loan will improve the company’s finances over time and how much repayment as compared to income that the company can afford.

<to be continued>