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The benefits of a loan for small businesses.

For a small business, there are several ways to determine the benefits of a loan.

The easiest, but also the most approximate way. Rather, it’s not even a way, but simply a condition for those entrepreneurs who do not want to consider the economy of their business. The condition is quite simple. The net profit of small businesses should significantly exceed all payments on the loan. The fulfillment of this condition must be indispensable. To some extent, this will allow the business to avoid bankruptcy. But only that. It is unclear whether there is a benefit from the loan or not.

To accurately determine the benefits of a loan, you should turn to the concepts of profitability. To do this, I recommend reading an article on profitability.

You can recommend several options for determining the profitability of borrowing using profitability. For example, the definition and comparison of return on assets before and after lending.

The effectiveness of business lending is also determined by capitalization, determined by a simple formula:

Capitalization = Assets / Net Assets.

Where: – assets – this is the sum of the values ​​of business property, cash, inventories, receivables, fixed assets;

– net assets is the difference between the value of all assets and the sum of debt obligations, or liabilities.

To more accurately determine the attractiveness and effectiveness of lending, the effectiveness of the use of borrowed capital in relation to its own, it is necessary to determine the so-called leverage. Again, the formula is very simple:
Leverage = Borrowed funds / Net assets.

As can be seen from the formula, leverage (in the economic literature there are other names, for example, financial leverage, leverage, leverage) is the ratio of borrowed capital to own funds. The effect of leverage arises only if the percentage value of borrowed funds is significantly lower than the profit from their use, which, in turn, allows you to increase profitability.

Leverage effect.
The benefit of the loan is measured in how much the loan will increase the return on equity. The leverage effect, expressed as a percentage, can be determined by a simplified formula:

ECP = (1 – SNP) * (RA – Rsk) * ЗК / СК

Where:

– SNP – income tax rate;

– RA – return on assets (profit before tax and interest on loans divided by the value of assets).

– Rsk – the estimated interest rate on loans (preferably in terms of taking into account all costs of the loan).

– ЗК- loan amount.

– SK – equity.

Leverage (financial leverage) shows how the use of loans affects the amount of net profit.

An example of the effect of leverage on business profitability.
For example, let us calculate the effect of leverage for two arbitrary small businesses, one of which produces a product – business “X”, and the second is engaged in the sale of a product – business “U”. For convenience, all the calculations are summarized in a table.

 

Indicators Unit Measurement Business X Business U
Equity 1,000,000 100,000
Borrowed capital 500,000 60,000
Total capital 1500000 160,000
Operating profit cu 210,000 60,000
Income tax rate% 25 25
Return on equity% 21 60
Return on assets% 14 37.5
Loan interest rate% 15 15
EPC% -0.375 5.625
Return on equity, taking into account ECP% 20.625 65.625
Let me remind you that return on equity shows how efficiently the business capital works. This is one of the key indicators of business performance.

Return on equity = profit before interest on loans and taxes / equity.

So what we got as a result of calculations. The benefit from the loan in business “X” turned out to be practically zero, even somewhat negative. Those. borrowed funds eat up part of the business profit.

The benefits of a business loan “U” is obvious. Borrowed funds bring additional profit to the business, work for the business.

small business loan_credit benefits

The benefits of a loan can be deceiving.
Financial leverage, if used correctly, can improve the return on equity and, consequently, the profit of the business. However, there is a flip side to the coin.The benefits of a loan for small businesses.

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