Fundamentals of Borrowing

Debt capital is an amount of money borrowed from a creditor. The amount borrowed is usually evidenced by a note, signed by the borrower, agreeing to repay the principal amount borrowed plus interest on some predetermined basis.

Borrowing Term

The terms under which money is borrowed may vary widely. Short-term notes can be issued for periods as brief as 10 days to fill an immediate need. Long-term notes can be issued for a period of several years.

Payment Schedule

When the terms of a debt are negotiated, a payment schedule is established for both interest obligations and principal repayment.

Discounted Notes

In some cases, particularly in short-term borrowing, the total amount of interest due over the term of the note is deducted from the principal before the proceeds are issued to the borrower. Such a note is called a discounted note.

Short-term Borrowing

Short-term borrowing usually requires repayment within 60 to 90 days. Notes are often renewed, in whole or in part, on the due date, provided that the borrower has lived up to the obligations of the original agreement and the business continues to be a favorable lending risk.

Availability

Commercial banks are the ordinary source of short-term loans for small businesses.

Credit Lines

When a business has established itself as being worthy of short-term credit, and the amount needed fluctuates from time to time, banks will often establish a line of credit with the business. The line of credit is the maximum amount that the business can borrow at any one time. The exact amount borrowed can vary according to the needs of the business but cannot exceed its established credit line.

These arrangements give the business access to its require­ments up to the credit limit, or line. However, it pays interest only on the actual amount borrowed, not the entire line of credit available to it.

Long-term Debt

Long-term debt is borrowing for a period greater than one year. This general classification includes "intermediate debt" which is borrowing for periods of one to 10 years.

Small Business Applications

For small businesses, borrowed capital for periods greater than 10 years is usually available only on real estate mort­gages. Other long-term borrowing usually falls into the "intermediate" classification and is available for periods up to 10 years. Such loans are called "term loans."

Mortgage Payment Schedules

Principal and interest payments on mortgages usually involve uniform monthly payments that include both principal and interest.

Each successive monthly payment reduces the amount of principal outstanding. Therefore, the amount of interest owed decreases and the portion of the monthly payment applicable to principal increases. In the early years of a mortgage, the portion of the monthly payment applied against the principal is relatively small, but grows with each payment.

Term Loan Payment Schedules

For term loans, payment of principal and interest is ordinarily scheduled on an annual, semiannual, or quarterly basis. For example, a 5-year, $50,000 term note bearing 10% interest might have the following payment schedule specified in the note agreement:

Repayment Schedules

The dates on which principal and interest payments are due should be scheduled carefully. For example, a manufacturer with heavy sales just before Christmas and receivables collections through January might best be able to schedule re­payments in February. If a payment were due in October or November, when inventories were high and receivables were climbing, the payment could be crippling.

Collateral

Loans may be secured or unsecured. In a secured loan, the borrower pledges certain assets as collateral (security) to protect the lender in case of default on the loan or failure of the business. If the business defaults on the loan through failure to meet interest obligations or principal repayments, the note-holder (lender) assumes ownership of the collateral. If the business fails, the note-holder claims ownership of those specific assets pledged as collateral before the claims of other creditors are settled.

Typical Collateral

In long-term borrowing, fixed assets such as real estate or equipment are usually pledged as collateral. For short-term borrowing, inventories or accounts receivable are the usual collateral.

Inventory Financing

Inventory financing is most commonly used in automobile and appliance retailing. As each unit is purchased by the re­tailer, the manufacturer is paid by the lender. The lender is repaid by the retailer when the unit is sold. Interest is determined separately for each unit, based upon the actual amount originally paid by the lender and the period between the time the money is paid and the lender is reim­bursed by the retailer.

Accounts Receivable Financing

Basically, accounts receivable financing falls into two categories as follows:

Assignments. The business pledges, or "assigns," its receivables as collateral for a loan.

Factoring. The borrower sells its accounts receivable to a lender ("factor").

Although these arrangements are not loans, in a pure sense, the effect is the same.

Receivables Assignments

When receivables are assigned, the amount of the loan varies according to the volume of receivables outstanding. Normally, the lender will advance some specified percentage of the out­standing accounts receivable up to a specific credit limit. For example, look at the schedule below. The company can borrow up to 80% of assigned receivables, up to a maximum of $100,000.

On the first line, accounts receivable are $100,000 and the amount loaned is 80% of $100,000, or $80,000.

On the second line, outstanding receivables are $125,000. The amount loaned increases to $100,000 ($125,000 x 0.80).

On the third line, accounts receivable are $150,000. Eighty percent of this amount would be $120,000. However, this exceeds the established limit of $100,000. Therefore, bor­rowing is restricted to the $100,000 limit.

In many industries, accounts receivable financing is con­sidered a sign of weakness. However, it is quite common in others. This is particularly true in the garment industry and in personal finance companies.

When customers must pay invoices directly to a factor, it may create doubts about the company's financial stability and, therefore, its ability to deliver.

When accounts receivable are assigned, the borrower is still responsible for collection. Upon collection of any receivable, the amount borrowed should be repaid. Interest is based upon the amount borrowed and the time between receipt of proceeds by the borrower and repayment.

If you Operate a factory, wholesale outlet, retail store, Service shop, or are a builder, you'll need to sell. No matter how great
your product is, regardless of what customers think of it, you need to sell to survive.

Direct selling methods are through personal sales efforts, Advertising and, for many businesses, display - like the styling and
packaging of this product itself - in kitchens, in the institution, or even both. Establishing a fantastic reputation with the
general public through courtesy and distinctive services is a direct method of selling. While the latter shouldn't be neglected,
this brief discussion will be restricted to direct selling methods.

To establish your business on a firm footing requires a Whole Lot Of competitive personal selling. You may have established
competition to overcome. Or, if your thought is fresh with little or no competition, you've got the extra difficulty of convincing
people of the value of this new thought. Personal selling work is almost always necessary to achieve this. If you aren't a
fantastic salesperson, seek a worker or asociate who's.

Another way to create sales is by advertising. This may be done Through papers, shopping papers, the yellow pages section of the
telephone directory, and other published periodicals; radio and television; handbills, and direct mail. The media you select, in
addition to the message and style of presentation, depends upon the particular customers you wish to reach. Plan and prepare
advertisements with care or it will be unsuccessful. Most media are going to have the ability to describe the features of their
audience (readers, listeners, etc.). Ever since your first planning described the qualities of your potential clients, you need to
match these characteristics with the media crowd. If you are selling expensive jewelry, don't advertise in high school papers.
Should you fix bicycles, you probably need to.

Advertising can be very costly. It is wise to place a limitation upon An amount to invest, then stay within that limitation. To
assist you in deciding how much to invest, study the working ratios of similar companies. Media advertising salespeople can help
you plan and even prepare advertisements for you. Be sure to tell them your budget limitations.

A third method of stimulating sales is effective displays both in Your place of company and outside it. If you've had no prior
expertise in display work, you will want to study the subject or turn the job over to someone else. Watch screens of other
businesses and read novels, trade magazines, and the literature provided by equipment makers. It may be wise to employ a screen
expert for your opening display and special occasions, or you may obtain the help of one on a part time basis. Much is dependent
on your kind of business and what it takes.

The proper number and types of selling effort to utilize vary from business to business and from owner to owner. Some companies
prosper with low-key revenue attempts. Others, such as the used-car lots, flourish on aggressive, hoop-la promotions. In any case,
the significance of effective selling can't be over-emphasized.

On the other hand, don't lose sight of your Key objective - to Make a profit. Anyone can generate a large sales volume selling
dollar bills for ninety bucks. But that will not last long. So keep control of your own expenses, and price your product
carefully.

Record Keeping. 1 essential element of business management is the keeping of adequate records. Study after study shows that many
supervisor failures can result from insufficient records or the owner's failure to use what information was accessible to him.
Without records, the businessperson can't see in advance that way the business is going. Up-to-date records may predict impending
disaster, forewarning one to take steps to prevent it. While additional work is required to keep a decent set of documents, you
will be more than paid for the effort and cost.

If You Aren't prepared to keep adequate records - or have somebody Keep them - you shouldn't attempt to run a small business. At a
minimum, records are Required to substantiate:

1. Your yields under tax legislation, including income tax and social Safety laws;

2. Your request for credit from equipment manufacturers or a loan From a lender;

3. Your claims about the business, in case you would like to sell it.

However, most important, you need them to run Your Company successfully And to raise your profits. Having a decent. Yet simple,
bookkeeping system you can answer these questions as:

How much company I doing? What are my costs? Which seem to be too high? What's my gross Profit margin? My net profit? How much am
I collecting in my charge enterprise? What is the state of my working capital? How much cash do I have available? How much in the
bank? How much do I owe my Providers? What is my net worth? That is, what is the value of my ownership of The business? What are
the trends in my Receipts, expenses, profits, and net value? Is my financial situation improving Or growing worse? How do my
resources compare with what I owe? What's the Percentage of return on my investment? How many cents from each dollar of Earnings
are net gain? Answer these and other questions by preparing and studying balance sheets and profit-and-loss statements. To do
this, it's Important to record information regarding transactions as they happen. Maintain This data in a detailed and orderly
fashion and you'll be able to answer the above questions. You'll Also possess the answers to such other vital questions About your
business as: What services or products do my customers enjoy best? Next best? Not at all? Do I take the product most frequently
requested? Am I Qualified to render the professional services that they demand most? Just how many of my charge Customers are slow
payers? Shall I switch to money only, or use a credit card Bill plan?

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