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The Business Financing Prime Rate Is A Bit of An Illusion
Most everything we here about the prime lending rates being kept at historically low levels by their respective country administrators to keep the global economy from stalling out during the recession is a bit of a farce for the small and medium sized business that contribute to driving the economy.
Yes, if you’re a well established company with a senior bank credit facility, your cost of operating has gone down due to historically low interest rates. But in many cases, the cost saving that are realized wouldn’t make or break established companies with the balance sheets to qualify for low interest rate debt.
If a company gets offside of their balance sheet and income statement covenants with a bank, they either get their interest rate jacked up nullifying any savings, or end up with a special loans tag which can lead to a forced payout that is even more expensive if not fatal in some cases.
For all other businesses that are looking to start, expand, grow, replace assets, and so on, interest rates near prime are mostly a myth.
Unfortunately, no one told business owners who are frantically in search of business capital right now, working off their long term conditioning of what should be available to them based on where the prime rate is sitting, that things are not what they seem.
Whether this is good or bad, fair or unfair isn’t really the issue. Prime plus rates are difficult to secure because the economic risk is higher and lenders are being more cautious until the recessionary impacts work themselves out.
The key learning is that things are not what they seem and as a result, business owners need to reassess their ability to access incremental capital and the related cost that comes with it.
Failure to adjust to the current environment can not only waste valuable time and money searching for something that isn’t there, but it can also put basic business operations and incremental sales opportunities at risk.
The solution may be to forgo expansion or new business endeavors in the short term, or focus on lower levels of potential profit to cash flow a higher cost of capital.
For businesses offside on their financial covenants that have received a demand for repayment from their senior lender, it could be very unlikely that a similar senior lender is going to be available to replace the existing one and an extended search for money that has a low probability of being there could run the business out of time for structured and civilized refinancing.
Adjusting financing expectations sooner than later can have a profound impact on the long term health of the business.
Click Here To Speak To Brent Finlay About Your Business Financing Requirements.
Business Financing Tradeoff – Lower Taxes Versus More Borrowing Power
I’ve written a fair bit lately about the importance of financial statements and their importance to business financing activities, especially after the year end.
One of the biggest challenges with getting the most financing power out of your financial statements is to have a tax planning strategy that is in line with your business financing strategy.
Too often, accountants will go through tax planning strategies in a bit of a vacuum, not having any knowledge or appreciation of what the business will require for capital or what if any refinancing will need to take place in the year ahead. Even if there isn’t an immediate capital need that’s planned, there still is the consideration of things that could unfold and allowing for their potential capital requirements.
And when financial statements are optimized for tax purposes only, they can reduce and potentially destroy your ability to borrow incremental capital in the process.
Effective tax strategies can lower net income which is required for debt servicing and lower retained earnings, which will reduce the amount of equity on the balance sheet available for financial leverage.
What confounds the whole process even further is that each lender will have their own series of add backs and adjustments to income and cash flow that may or may not be impacted by certain tax strategies.
In reality, paying taxes can be viewed as a cost of borrowing in that if the business is not in a taxable position, it won’t have the financial results necessary to acquire and service debt.
So how do you optimize the financial statements for both taxation and financing at the same time? This is a bit of a difficult question to answer due to all the unknown variables involved on the business financing side.
One approach to consider when the business is actively seeking capital prior to the completion of the year end financial statements is for the accountants to prepare a draft version based on the collective best guess work of the business owner and their third party accountant as to what level of earnings would be acceptable to the target lender or investor.
The draft version can be put forth with the financing application and if an approval can be secured based on these numbers, the statements can be finalized as written. If financing can’t be obtained for the sought after terms and condition, the draft financials can be further adjusted to optimize the tax position of the business if appropriate and finalized via a revision.
There are other approaches to consider. Just keep in mind that in order to get the best result for both taxation and capital procurement potential, the business owner and manager need to make sure that they provide their taxation expert with their forward looking plans and capital requirements so that some effort can be made to allow for both requirements if necessary.