A Big thank you to our colleagues at Counts Consulting, LLC for giving us permission to post their previously published article. Permission granted VIA email 10/13/11. All articles are reprinted in their entirety as originally published.
When is it a good idea to Borrow Money?
A good rule to remember when considering a loan is: Never borrow money without first having a budget and business plan that shows how the loan will accomplish your goal(s) and provide the funds to repay the loan.
One of the biggest fears I hear when people consider borrowing money is they won’t be able to repay the loan. Usually this is because of past experience. They got behind in paying bills and didn’t have the money to buy inventory so they went to the bank and took out a loan. Some of them had to put their business or home up as collateral. They thought that if they could just get past this “slow period” business would bounce back.
The bulk of the borrowed money usually went to catching up on bills or inventory without reducing the overhead, which is probably what got them in trouble in the first place. Then they were not able to pay the loan as planned, and they are worse off than before the loan. Reason: Their expenses are too high for the sales they generate and in consistent buying.
The idea that you can back oft on buying tor a month is similar to pulling back on the throttle on a plane and expecting it to stay at the same altitude. Then, sales fall but payroll and other expenses don’t. This situation just keeps getting worse and worse like a leaf in a whirlpool.
Let’s focus on when it may be a good idea to borrow money.
Since you usually purchase inventory with what is left after you pay the bills, it is vital that you keep as much money as possible in our “car buying account”. Forty (40) to fifty (50) percent of your sales come from the vehicles (inventory) purchased in the last 3-4 months. The balance comes primarily from your warehouse and last, and least, from the dismantled hulls “out back”. Therefore, it is critical that you maintain consistent buying. Because of this, I make the following recommendation: Never pay for major equipment purchases out of cash on-hand if it will reduce your ability to buy inventory. Buying is the most important job in our industry so having the money to buy EVERY month is critical to the health of the company. If you slow up on buying, you can expect sales to drop and then spend even more money getting back to where you were before. So, if you decide to buy a new delivery truck, upgrade your computer, etc., I strongly recommend that you consider financing the purchase and keep investing your “car buying money” in inventory. I assure you that the profits on good inventory will be much greater than the payments on the money, if you finance for three years or more.
Now let’s take a minute to discuss buying equipment. I occasionally see recyclers buying the latest in a rollback vehicle haulers or an oversized loader when they don’t have the money to buy inventory. Unless you own a u-pull-it business or have an insurance contract, you probably don’t need a rollback. Investing that money in inventory will make you a lot more than you will ever save towing your own vehicles. Besides, if you can’t buy vehicles, what are you going to haul?
Another piece of equipment that very few recyclers need is a vehicle crusher. The experts tell me that you need to crush 80+ vehicles per day to make it economical to own one of these high dollar machines. Again, investing the money in inventory will make you a lot more money in the long run.
Now back to when to borrow money:
Another time to consider borrowing money is when you want to increase sales more than 10%. As a rule, you can grow sales between 5-10% annually without borrowing money, provided you keep overhead under control. If your sales goal is higher than 10%, you may run out of money and not be able to buy the inventory needed to sustain the desired sales increase. Realistically, it takes between 3 to 4.5 times your average monthly sales, invested in inventory and receivables, to maintain your sales increase. Example: If your average sales are $50,000 per month, from your inventory, it normally takes between $120,000 and $175,000 (invested in inventory and receivables) to maintain those sales. Therefore, if you want to increase sales from $50,000 to $60,000 ($10,000 per month), you probably need between $20,000 and $30,000 in additional monies to attain and maintain that increase. If you do not have the needed cash reserves to support the increase in sales, you might consider a loan or line or credit. Properly invested, this loan can usually be paid back in less than two years.
You may also need access to a line of credit while you are waiting for customers to pay for the parts they bought last month. Recyclers tend to run out of “car buying money” near the middle of each month, so this money can help bridge the gap. The reason for this is pretty simple. If a shop owes you $5,000, at the end of the month, they will probably owe you $9,000 by the time they pay you the $5,000. We need to be able to continue buying during this delay.
It is difficult to grow a business quickly without an extra source of money. We seem to be very quick and comfortable borrowing money for a new boat, home, car, etc., but we often hesitate to feed the very entity that pays for all of these things, our business. I hope you find this information helpful.