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Is this a good time to take out a loan to expand?
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Location: Blogs Speaking of business..." |
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| Posted by: Dr. Philip R. Geist |
8/8/2007 12:49 PM |
If only we had hindsight beforehand! Things to consider about borrowing money to expand your business include the state of the economy, the role your business plays in that economy, the cost of capital, the expected rate of return, and missed opportunities....
In any given economy, there are always sectors that will perform better than others at any given time. Remember the old westerns where the customers all ran out the back while the rival gangs had a gunfight in the street? The storekeepers lost business while incurring the cost of repairs to their windows from stray shots. The glaziers had extra business replacing windows, the gunsmith presumably sold replacement ammunition to the winners, and the undertaker sold his services to whoever looked after the losers.
After natural disasters contractors have extra work cleaning up and rebuilding the affected areas. When the economic cycle shifts from expansion to contraction, opportunities are created for some businesses as well. Families may shift from eating out and a movie to take-home and a video rental; instead of going away for vacation people may stay closer to home and add home improvements like home theatres, swimming pools, or new landscaping that they can enjoy on an on-going basis.
If you are lucky enough to have a business that is adding customers in this part of the economic cycle, you may be asking yourself, "Is this a good time to take out a loan to expand?" Here are some issues you should consider in making your decision:
- State of the Economy - Does the economic cycle that is sending more customers to your business appear to be self-sustaining and long-term? In other words, is this a temporary situation or a condition that will last long enough for you to make a return on your investment? You can get some insight from statements of the Federal Reserve Board at www.federalreserve.gov which forecast future economic conditions. Watching television news on any of the financial networks or reading business publications will help you identify trends as well. DON'T make a long-term committment to a short-term situation. If the change is expected to be short-lived, perhaps due to a change in traffic flow due to road construction - use a short-term fix like extended hours instead.
- Role Your Business Plays - Is your business one that will prosper in the current cycle? In order to be one, it has to maintain its current customers and provide an alternative for new customers who are transferring their purchases from another business. The video store in the second paragraph is a good example where transfers from movies adds to current business. DO make sure that you know where any increases in business are coming from: ask or survey new customers .
- Cost of Capital - How much will the money you need to borrow cost you, both today and in the long-term? If you are getting a variable rate loan you will have to consider that rates may increase. If you can get a fixed-rate loan, looking at interest rate history can give you an insight into whether rates are currently "low" or "high." Ten year treasury bill rates are at 4.72% as of August 6, 2007. This rate is slightly above where rates were in 1962, and substantially lower than the 16% they were in 1982. They have fallen every year since 1982 and have bottomed out in 2006 and are now on the way up again. According to the St. Louis Federal Reserve Bank (http://research.stlouisfed. org/fred2) these rates are a good indicator of lending rate trends.
- Expected Rate of Return - You should never borrow money for your business without making a business plan first. The plan should show projected sales and expenses in order to determine profitability. Your profit from the investment you make with the borrowed money will have to cover the cost of the loan as well as give you additional profit in order for the loan to make good financial sense. DON'T react! DO make a business plan!
- Missed Opportunities - You should always be aware of who your competion are and what they are doing. This is especially true in times of economic shift. If there is an increase of customers in your market segment and you do not expand to meet that increase and your competion does, you will risk losing the transfer customers. DON't be "asleep at the switch." DO know what your competion is doing.
Remember... when opportunity knocks you have to open the door to take advantage of it. |
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