Money Lessons 3: Borrowing for Growth

Raising a family with growing needs, while simultaneously running a business puts rigorous demands on cash flow requirements.

On the business side, our communications agency, Creative Juice, for example, would require us to maintain ample cash flow to sustain financing of projects, plus overhead of manpower, utilities, and sometimes suppliers payments, in between managing accounts receivables. Managing funds may be likened to orchestrating traffic along a busy intersection in Manila sometimes, and ensuring there are no bottlenecks takes a lot of skill and system efficiency from our finance and operations personnel.
On the personal front, on the other hand, requirements would include basic and not-so-basic needs such as but not limited to a safe and cozy home, ample transportation, and of course a good education for all our children. These are only some examples of family needs that take a huge chunk from the family income and resources. On the more minor scale, upgrading appliances at home, or acquiring that latest gadget is something always tempting to do, specially with those 0% interest options now being offered!

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The article published on Inquirer last July 16 entitled, “DEBTS: BLESSING OR CURSE” was insightful as it discussed viewpoints on taking on a loan to fund one’s personal and business requirements. I have a couple friend who I’d say are relatively well to-do, my friend holds a senior corporate position, and her husband a successful entrepreneur. They married around 10 years ago and stayed in an upscale rented condo as they did not believe in taking out a loan to purchase their own home. Instead they had been saving up and investing their money until such time they could buy and build their own home in cash.

When they shared their mindset to me, two things entered my head and struck me: 1) Their ability to delay gratification, and wait till they were really ready and able to buy their own home, and 2) that they must be really disciplined savers and astute investors.

I think I may be right on number two. If you are quite liquid, then putting your money in high yielding investments and delaying purchases for a bit until you raise the required amount, might be a smarter option than taking out a loan, paying for possibly higher interest rates, on something that will even devaluate as soon as it is yours. Perhaps for my money-smart friends, they had a reliable income, combined solid placements that covered not only the savings they put aside for their future home, but also the rental cost of their condo plus all other living expenses. I’d say they played their cards well, specially now that they’ve moved into their brand new townhouse, paid in full.

My own principle regarding debt is that it can be considered as an aid, a blessing or even a lifesaver, but as the article says, one must be very careful and conservative in discernment prior to signing on the dotted line of that loan agreement.

For business requirements, the ability to grow my business is of course always the goal of any entrepreneur, and it more often than not takes funds to grow. For small enterprises, the decision to take out a loan for expansion must be based on the secured projections of revenue, as well as a regular timetable for collections since debt payments demand for regular and timely settlements.

For personal requirements, it takes not only an evaluation of the state of your finances, but also an honest discernment of whether what you are borrowing for is really a necessity and a priority for you and your family, and can you really afford it? That latest car, the newest gadget you can buy on installment, again, go back to your personal values (as advised by Rose Fres Fausto) and decide from there.

All in all, Mr. Moncupa’s insights about “loans multiplying money” is an eye opener. He says in the article:

Let’s say you have P30,000.00 savings in excess of your expenses every month. If you have the equity required by lenders as your participation, you could go to a bank and borrow P3.5 million to buy a house, at 6% interest, re-pricing every year for 15 years. Or buy a car worth P1.350 million payable in 5 years. It’s like magic. Your P30,000.00 is multiplied many times.

In business, financial leverage is normally expressed as the ratio of debts over equity capital. The higher this ratio, the more power it packs. Say, if your return on assets is 5% and you are leveraged 2x, you will have return on your equity capital of 10%. Push the leverage 4x, and with better efficiencies, your ROE can be boosted to 20%. Most of the rich and big businesses, if not all of them, got to their wealth partly due to the power of leverage, in varying degrees, of course.

Bottom line, is we must use these options for leverage carefully and wisely. Decisions on getting financing require commitment and discipline, and can affect you, your family’s and your stakeholders’ future. If there are cases where you need to make smart money decisions, this could be one of the most crucial of all.

Read Tony Moncupa’s column about debt here:

Full disclosure: This post was commissioned by East West Bank. All thoughts and opinions are the writer’s own.

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