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Web posted
Monday, February 14, 2005
A loan for the right reason benefits all
By Ron Kukes
For the Journal
Borrowing money can be appropriate when the purpose is productive and the use of the money will cause liquidation of the loan. Here are a few examples of when it is appropriate to borrow money:
To purchase a piece of equipment used to make a product that will sell at a profit. The increased profits result from the additional equipment, which repay the loan.
To purchase inventory that is then re-sold, either in the raw form or as a finished good. The proceeds from sale then repay the loan.
To purchase a facility to house a business. The profits generated from the business being housed will repay the loan.
In each of these examples, there is an additional source of repayment resulting from the loan proceeds, either through the sale of equipment, the liquidation of the inventory or the sale of the facility.
Here are a few examples of risky loans that a borrower or lender should normally avoid:
To pay taxes. Taxes are a part of doing business. There is no repayment source derived from a loan for taxes. A business owner should be planning for this "expense" and holding back the cash needed.
To cover payroll. There are few instances that a loan should pay for normal operations, such as salaries, supplies and rent. Unless salaries are used to generate well-defined revenue, the cash provided from the business should support normal operating expenses. A business owner should ask the question, "Does this salary benefit the business's bottom line?" One of the few instances could be when a business is seasonal or service-related. Nevertheless, borrowing for operating expenses is risky.
To purchase personal assets or cover the cost of a vacation. Both of these reasons for borrowing suggest a lack of planning resources for future desires.
There are exceptions for borrowing money for the above purposes, such as money from operations is used to purchase equipment and subsequently the business is short of cash for taxes. A lender will take this into consideration when reviewing the loan request.
When the banker requests collateral and will loan less than 100 percent of the value of the collateral, it's to assure a repayment source is available to cover the full outstanding debt even if the primary source is lost. Neither the borrower nor lender succeed when a secondary source of repayment - (the collateral) - is insufficient to repay an outstanding obligation.
The approach a lender takes to a loan request is exactly the same approach a potential borrower should take.
Do I have the means to repay the loan within the terms provided?
If my plan fails, can I still repay the loan from other sources?
Will the loan increase revenues or improve production, thereby reducing expenses?
Borrowers are optimistic or they wouldn't be requesting the loan. Justification can be easy if a borrower only reviews the positive elements in the request. A quality lender does a better job for a prospective borrower by measuring the positive elements and comparing them to the risks associated with the loan.
Bankers want to make loans when everyone gains from the credit extended.
If you are considering borrowing money, even if it's from Cousin Bob or Uncle Ralph, I encourage you to present your package to a banker and see what he thinks about your project. I can assure you the banker is the "ultimate sounding board" who will help you see the risks, and thereby determine if the rewards are worth it.
Ron Kukes is president and chief executive officer of Alaska First Community Bank & Trust. He can be reached via e-mail at ron@fibank.com.
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