Favorable loan – how to get a loan and not lose money.
To begin, I would like to return to the definition of a bank loan. The simplest, and most common definition, loan is the amount of money borrowed by the borrower. Well, a profitable loan is either a sum of money borrowed, or property or funds acquired for this amount, begin to work for the borrower and bring him profit.
And before making a decision on a loan, a businessman must determine whether he is profitable or not. Profitable loan must meet certain conditions. Consider these conditions.
A profitable loan should have a clear purpose.
I already wrote, and I want to repeat again. A loan should be taken only when there is a clear plan for its use, there is an idea what effect will be from the investment of credit money.
Banks often advertise their soft loans. And businessmen, without thinking carefully, take a loan, naively believing that free money will never hurt. But nobody just needs money. They are quickly spent, and the loan must be paid. Just using credit funds does not automatically guarantee benefits to anyone. In contrast, misused credit can undermine the financial position of a business.
There is an immutable law of business – money must work, money must make money. If a business does not have a development plan, there are no conditions for growth, there is no idea of what its growth translates into – a profitable loan quickly turns into a burden for the business, reduces the profit of the business.
You should not take a loan for business development, for example, to buy equipment, a tool for increasing production capacities, without having clear guarantees on how the customer base will grow, or without preliminary agreements with customers. If injections into the business do not attract the required number of additional customers, then the loan money is thrown away.
Profitable loan – the return on business assets is higher than bank interest.
But far from always increasing the customer base leads to an increase in business profits. For example, a business has seen a steady increase in customers. Customer growth is so great that businesses need to significantly increase production capacity to meet demand.
The businessman takes, it seems to him, a profitable loan from the bank for the purchase of additional equipment, the creation of new jobs. But the expansion of the business did not lead to a percentage increase in profits. Why? Yes, because the interest rate on loans turned out to be higher than the profitability of business assets. In this case, loan servicing is carried out at the expense of the business’s own finances, and not at the expense of increasing profits and paying interest on the loan, eating up business profits.
Business assets are all that a business owns for the production and sale of its products – the total value of its property, cash, stocks of raw materials, semi-finished products, finished products, receivables, fixed assets.
The rate of return on assets is determined by the ratio of business profit before interest on loans for a certain period of time (for example, for a year) to the total value of its assets.
ROA = Profit / Assets.
Consider an example. Imagine a business producing some simple product. The owner decided to expand it and for this purpose took a loan at 15% per annum.
I put them in the case and prepared a big bag for money. Time passes – output increased, but profit does not increase, but decreases.
It turned out that the return on business assets is below 15%. Those. business earned on borrowed money less than it gave to the bank as payment for the use of a loan.
So that borrowed money does not start to eat its own profit, the return on business assets should be higher than the percentage of the loan.
You must have a margin of assets. Profitability should significantly exceed the percentage of the loan. Profitability depends on many factors, both internal and external. And it can fluctuate significantly. And if it drops sharply, loan payments will only increase the negative of this.
I believe (and always did) that a loan can be taken if the return on assets exceeds the interest on the loan more than twice.
Two examples to confirm what was said.
I will give two examples, two cases that I myself have observed.
Both of them occurred in Ukraine at about the same time, about 8 years ago. I opened a furniture factory in Ukraine. Imported some components from Israel, as in Ukraine at that time they were not produced. I had to import springs from Israel, despite the costs of their transportation, customs clearance, loading and unloading. Despite these costs, their price was lower than in Ukraine. Moreover, in Israel, springs were made from wire supplied from Ukraine. For a long time I could not understand how this could be.