Managing Cash Flow

Borrowing for Cash Shortfalls 259
INTEREST IS ONLY ONE OF THE LOAN COSTS
TO CONSIDER.
The company’s overall banking relationships should also be considered. It may
look attractive to get a cheap loan from a new financial institution, but what if
the company has an emergency? Will the new and “cheaper” lender stand
behind the company when needed? Consider whether it might be worth paying
a little more to maintain a solid, ongoing relationship with the company’s lead
bank, particularly if that bank has stood behind the company in past times of
difficulty.
An additional consideration is what should be financed by short- rather than
longer-term debt. The preferred capital structure of a business is one in which
short-term needs are financed by short-term debt and its long-term or “permanent”
needs are financed by long-term sources—long-term debt or equity. Certain
short-term assets (e.g., permanent working capital needs) can legitimately be
financed with long-term funds since they represent permanent requirements of
the growing business. Seasonal financing should not be financed by use of longterm
moneys—seasonal borrowing should be cleaned up seasonally to be sure
that the business is being properly managed from a financial perspective.
However, it would be better to finance a piece of equipment or a project having
multiple-year lives with long-term money than with a short-term loan, since the
funds to repay the loan will presumably come from the profits generated by the
equipment or project.
The company must recognize that many, particularly smaller, businesses are
able to obtain only short-term loans because banks are unwilling to commit to
longer term financing. If this is the case, the company must do whatever it must
to keep operations going, and theoretical models of how a business capital structure
should be built are necessarily tossed aside. As a practical matter, this means
that many long-term projects can only be financed by short-term financing. This
raises the financial risk of the project to the company, since the loan may have to
be repaid or renegotiated before the project generates enough cash to pay it off. If
money is not available to roll over the loan or if interest rates rise sharply, it could
cause serious financial problems for the company. Nevertheless, the goal of balancing
long-term needs with long-term financing and short-term needs with
short-term financing should be retained for future application whenever it
becomes possible to do so.
Leverage
A major financial advantage of borrowing is the leverage that can be generated as
a result of using borrowed funds. Leverage is essentially the economic advantage
gained from using someone else’s money. A simplified example of the effect or