I received a question some time back on a matter that applies even today.
Would it be wise to borrow to grow our catering business?
Ten years ago, my husband and I took over his mother’s catering business. Although the business has been around for 50 years and has built a solid reputation for quality food and exceptional service, we soon realized it needed a lot of improvement. We had to spend most of our savings to build a new kitchen, get a new service vehicle, buy new equipment and utensils, design a new logo, etc. We also had to re-introduce the business to the market because most of its old customers were gone. In this kind of business, we always have to change outdated equipment and design to keep up with the changing trends and keep the competition at bay.
Most of our revenues go into these improvements. However, since we only rely on our sales from the bookings that we get, we realize that it will take several more years before we can take our business to a whole new level.
We have contemplated on taking out a business loan, at least P1M but kept postponing it because we were too afraid of the monthly amortization. But I think it’s about time we did this while we are still young, have the energy and enthusiasm, and while we’re still bursting with ideas on how to run this business effectively. I can’t wait for another 10 years while we see our competition take off.
My reply:
Based on the information you gave, it seems that you are in a perfect position to make your business dreams come true. You both have the passion for your food and catering business, a main ingredient in any business. You have started building up your productive assets to support your catering business and you need a process to validate your plan to borrow to grow your business. Borrowing is leverage and properly used, the most powerful tool to build capital and grow a business. Since both of you are still of prime age, you can still be more aggressive as clearly, you can still recover from any mistakes you might make.
Your immediate need is to make your actual Financial Statements for your business, that is, Cash Flow, Profit and Loss Statement and Balance Sheet as of the end of the latest month to understand the real condition and the true net worth of your business. I strongly advise that you seek professional assistance to make these financial statements for you. Any prospective lender will require the information from you anyway before they even start evaluating your loan application.
After you have established your true financial condition, think out your business plan in detail: what market you will sell to, what product and/or services you will sell and your best estimates as to how much it will cost you to produce and deliver these products and services. The most important projection is your Cash Flow, which provides the true and total amount of cash (capital and debt) required to sustain the profitability of your business. You need to make your monthly projections for the next few years. These must be based on your most realistic set of assumptions pertaining to all aspects of the business requiring cash (cash out) or producing cash (cash in).
Make as many projections as you want using different assumptions for each item. These include all the cash that you receive and all the amounts you need to spend for. For each item, use different assumptions. On one sheet, you can have optimistic assumptions. On another sheet, you can use the pessimistic assumptions. Then, choose what assumption in each item is the most realistic and come out with a working financial plan, which will be a combination of all the scenarios you make. Some items can change monthly and some can be the same all throughout. You have to put some thought to each amount you use.
The negative amounts in your Net monthly Cash Flow represent the Equity and/or temporary funding (loan) needed by your business during those months. If you see the need for a loan based on your initial projections, your inflows and outflow projections will change with the benefit of the improved operations from your loan and the cash flows related to the loan. Go back and forth with all these changes until you arrive at what in your best judgment truly represents the most likely and conservative outcome. This will determine whether or not you can afford to take out a loan; how much; what payment terms and the interest rate you can absorb.
In taking out a loan, the most critical ingredient is your source of repayment and the cost or interest rate of the loan. Note that a loan is a definite and firm obligation for you to repay specific amounts at specific dates in the future. You must pay this obligation whether or not you achieve your business projections. To lower your borrowing rates, you may need to put up some collateral (most likely real estate). As a matter of fact, while the borrowing cost is important, what is more important is that you understand your true financial burden. As a final note, don’t rush into getting any loan until you have determined (from various cash flow projections) the amount of temporary borrowing you will need and the amount of amortization your business can comfortably service on a periodic basis (i.e., monthly quarterly, or even yearly).
You must make sure that under the worst conditions, you will have real and sufficient source for repayment.
Remember that your business financials should be separate from your personal financial statements. Your business should pay you and your husband a salary. If you are using your home and vehicles for your business, your business should pay you for the use of these assets. This will give you a true picture of what your business profitability really is.