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| Beyond Survival-Using an Overdarft |
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Beyond Survial #2
Westpac Beyond Survival #6
Business survival in the 21st Century - Seven key areas of failure
by David Dandie - Westpac Bank
Use your overdraft correctly
Of all the different types of products offered by financial institutions it is my opinion that the overdraft facility is the most commonly abused. Have you ever looked at the balance of the overdraft and thought to yourself I’ll just write the cheque out and worry about it later? If you are purchasing large ticket items with your overdraft facility you are bound to experience cash flow problems.
In some countries the overdraft facility doesn’t exist and its equivalent is a short term loan that has to be repaid in full within a given time frame. Here in Australia and New Zealand we issue an overdraft facility limit. This is like a car speed limit, unfortunately there is no licence issued at the same time to drive the facility. I have had customers purchase houses, a helicopter, forklift and an aeroplane with their overdraft facility. It is important to understand that there are different types of finance facilities for a reason. The purpose of the overdraft is to help meet every day expenses, pay the rent, wages, stock, utilities and help carry the business in line with its seasonal requirements. The overdraft is not there to finance long term assets.
Assume that in order to run your business your seasonal requirement is an overdraft limit of $100,000.00. If you used your overdraft to purchase a new car for $80,000.00, the available portion of the overdraft facility now becomes $20,000. This is not enough to manage your business, cash flow is tight and you find you can’t meet every day expenses. At this point most people turn to the Bank to source more funds. The common solution is to refinance the core debt component of $80,000.00 paying this off monthly as a long term loan. This effectively frees up the cash available under the overdraft limit of $100,000.00 and repairs the damage.
The business continues to operate well until you purchase a second car for $80,000.00. Once again the available cash is not enough to meet commitments with only $20,000.00 available. Cash becomes tight, you contact the Bank but this time they can’t help you. How many times can you go back to the Bank to refinance core debt in an overdraft? The answer is that the debt never goes away it is restructured. The business needs to be able to service both the long term debt of $80,000.00 and the overdraft of $100,000.00 which is the working facility required to carry your business through the season. Unfortunately the business can’t service the overdraft and two cars at $80,000.00.
This is a common problem with the overdraft facility. It is perceived that the cash is available to pay out but in reality it is already committed to cover the running expenses of the business. It is best to speak with the Bank first, they will confirm serviceability of the loan and suggest what loan options are available. The key is to match the life of the loan with the life of the asset. A long term asset requires a long term loan.
In the above case it would be best to sell at least one of the cars to inject cash back into the business. Should you find yourself in a similar position the overall process involves two steps. The first is to refinance the core debt component as a long term loan. The second step is the hardest and it is to change the management skills that created the problem in the first place. If this never changes then the problem will only continue and eventually reach the point where the debt can’t be refinanced because you can’t meet the repayments.
Planning
This re-emphasises the need to complete a plan for your business. A cash flow budget will allow you to assess the impact of term repayments on cash flow. If this shows that you can’t afford the repayments then alternative solutions can be addressed. If you write the cheque out first you will be worrying about it later.
Westpac Beyond Survival Workshops address the impact of borrowing properly in your business. The purpose of the overdraft facility is to provide the funds to meet seasonal requirements not to purchase long term assets. Building a cash flow budget emphasises the impact these decisions can have on your cash flow.
Please call 1300-769-441; +61 3 9802-5288; email or fax: +61 3 9803-8296
for finance and leasing assistance.
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