The business needs financing that comes from owners as capital and lenders as loans
Which one takes place at the first stage – financing or collection?
The answer is the same as for the old problems – egg or chicken.
Businesses need financing that comes from homeowners in the form of capital and lenders in the form of loans.
The owner is paid back as a dividend or profit, the lender by interest and principal. These two items include the sources of funds for the operation of the business with the expenses incurred within the framework of operating expenses and the purchase of capital goods.
Covering operational expenses is called working capital. The purchase of capital goods, on the other hand, is term financing.
Working capital is like foreign exchange financing that is used for the production of goods and services, the payment of which is settled from current cash flows.
Settlement of working capital financing depends on the operating cycle, from the production process to the completion of sales.
Delay in achieving the sale proceeds on time and unsold production can create problems in eliminating working capital loans.
This funding is normally taken into account when calculating the cost of the goods / services produced.
The loan for the purchase of capital goods requires a long repayment period with interest.
In this case, the borrowers must have a satisfactory profitability to allow the payment of interest with good liquidity through a flow of cash inflows for regular repayment during the term of the loan. The volatility of cash flow leads to hamper repayment.
The repayment of loan maturities and interest on current transactions is called hedge financing. It will be speculative finance if only interest can be paid on current transactions.
For the payment of the deposit, a new loan is required. Down payments and interest cannot be paid from open transactions under ponzi schemes.
In this case, a new loan is required for repayment and operation of the business.
The working capital loan is inevitable for the purchase of goods and services, including wages, to produce output before sales. The regularity of sales and cash flow guarantees the repayment of working capital loans, as these loans are recorded in the day-to-day operations of the business as an expense, with interest as a non-operating expense.
The loan for capital goods is payable for periods exceeding one year.
The cost of the loan is presented in regular operations as non-operating expenses, but it is not allowed for the installment payment which depends on the cash flows accumulated through amortization and the after-tax portion of the profit retained. without disbursement as dividend / profit. The regularity of the repayment depends on an amount of deposit compatible with the depreciation charges charged in the operating expenses of the company.
Otherwise, it is only possible to make installments. Non-payment of the deposit results in default of payment.
The excess of income over expenses, including depreciation, brings an operating surplus into a business entity.
The excess does not represent a strong position to erase the repayment. The liquidity position should be measured by adjusting the surplus for sales / cash payments, net receivables / payables, non-cash outflows for depreciation and related provisions. A net profit after payment of an acceptable dividend guarantees a smooth repayment of loan principal.
Business entities are faced with uncertainty due to technological change, substitute products in the market, external demand shock, change in taste, etc.
Such a situation creates survival issues for the business entity. As a result, excess liquidity may come under pressure due to tight sales.
Thus, term loans based on forecasts of future cash flows do not eliminate debts. Prudential regulations for granting loans at the end of lenders or regulators are ineffective in the situation.
Ultimate effect of recalling the collateral to realize the proceeds of the outstanding loan.
Prudential regulations for lending are formulated by the central banks of nation states.
Central banks formulate regulations but have no practical experience in business operations or lending activities.
They deal with guaranteed instruments like treasury bills / bonds. In addition, they have unique experiences in lending activities.
They grant loan facilities to their staff on the basis of internal regulations. In this case, they consider the present value of their employee pension rights.
These loans are settled until retirement based on retirement benefits.
During their lifetime, the current cash flows are not sufficient to repay the loans. Such secured loan operations are not sufficient to adapt to the practical situations of the loan markets.
As stated earlier, the term loan is used for the purchase of capital goods. This means that a loan achieves current benefits at the expense of future cash flow.
Bank staff take advances with capitalization of future profits on money creation out of thin air or through a so-called fractional reserve system.
People who are currently using their future income can lead quality lives, others cannot.
Such opportunities for some people are an effective tool for inequality in society!
But these lucky people are few in society.
The main jobs in the company are generated by private business entities for which long-term capital is needed to procure capital goods.
The commodities of banks are deposits ranging from short to medium term. But they sell products with a long maturity.
They are said to face a timeline mismatch to exploit these capital market products.
As stated in the previous paragraphs, business entities are in uncertainty about the future, their term financing is also on a risky path.
Capitalizing future cash flows for current use is a way to move from low income to middle income, to higher income, to high income bracket.
Loan is one way in which individuals can move forward. At the individual level, we see such progress from a few classes of people working with the financial system and a few organized societies.
The job itself creates the right to have millions of loans for big purchases like home.
The entire duration of their fixed tenure is capitalized by granting loans from scratch. Beneficiaries have the chance to take wealth to the next level. The calculation of the loans is organized so that the monthly income remains free, the future flows are concentrated for an adjustment at the end of the services.
Such flows of fixed income securities are seldom possible for individuals in the real sector. Their income depends on the proper functioning of the entity in which they work.
In a real situation of uncertainty, term loans are always at risk.
Loans for capital goods should be negotiated for periods when the capital goods are capable of generating expected income streams to be used to repay principal and interest.
The amount of repayment of the principal amount should be set in such a way that a fund withheld from the relevant capital goods is able to make this payment.
Otherwise, payment of the principal is rarely possible.
Hence, the loans become an event of default.
But a sinking fund does not guarantee repayment if the sales are not the same as expected due to different shocks.
In such a case, should we call guarantees? Reality!
But we see in the previous discussion, that the individual loans granted by the banking sectors are cleaned thanks to the terminal services of the individuals.
So why ask questions to call collateral to come to cases of non-payment in real sectors. Shouldn’t he be bailed out?
In real situations, the flow of sales is not the same as expected. Thus, term loans are rarely repayable. So, is there an alternative without bailout?
The author works in the development sector and can be reached at [email protected]