The Article below was assigned to one of our experienced Associates in the Banking & Restructuring Department, Mrs. Christina Kekkou Phella, and was written with the help and close supervision of our Team. The Article emphasises on pinpointing recurring mistakes relating to Business Financing, with examples of common errors and misconceptions either stemming from the side of the lender (often a banking institution), the side of the borrower (businesses – companies), or both in each case. It forms a short, simple piece of writing, which highlights critical malpractices of previous years, with the aim to facilitate better decision-making and actions from all stakeholders in the present and future.
Most businesses wishing to grow will need to borrow at some point to finance transactions such as an increase in working capital, the purchase of assets such as new machinery, or an office building.
Applying for business financing is always a very serious decision and can be crucial for the success or failure of any business. It is of utmost importance that a company borrows only as much as it can afford and is necessary at the correct time.
In the years preceding 2013, both Cyprus bankers and businessmen approached the matter in a very simplified manner. In their eagerness to increase their market share and to unload the excess liquidity, Cyprus banks only asked for a mortgage as a collateral and, if that was available, no further questions were asked. A business could therefore borrow up to the value of the mortgage and all other parameters were being ignored.
In a blooming economy all went well and businesses flourished, keeping everyone happy.
But during the economic crisis which followed, all the above mistakes made when borrowing money haunted numerous businesses that were not prepared for the sudden wave of changes in the economy and, as a result of the pressure of banking institutions for repayments, lots of businesses failed. This created a domino effect, resulting in two (most critical for the country’s economy) systemic banks failing themselves and leading to an unheard off (until then) ‘’Bail’’ in remedy.
Therefore, in recent years the need developed for a more sophisticated and prudent approach to lending for the benefit of all parties involved, by identifying the most common mistakes to be avoided when seeking finance. These being as follows:
- Non-existent / overoptimistic financial planning:
When applying for finance, any entrepreneur must be able to present their business plan for a number of years ahead (Cyprus banks now ask for a 5-year planning period). The plan must acknowledge both opportunities and threats in the years to come, as well as provide cash flow projections based on modest or even pessimistic scenarios.
A correct business plan will consider all the company’s financial needs in the near future, allowing them to apply for the accurate amount of financing required. Note that excess financing can create as much a problem as underfinancing, since it will not serve its purpose.
- Considering that any kind of financing, most commonly an overdraft facility, is suitable for all purposes:
This assumption couldn’t be more misguiding. There is a type of financing suitable for the purpose of each investment, based on the life span of the asset to be purchased and the need to borrow again to replace it sometime in the future. Not too long ago, businesses in Cyprus were allowed to acquire huge amounts of overdraft facilities, based on the mortgage offered. As a result, companies used this financing for the purchase of fixed assets (even personal cars in some cases) creating what is known as a hard-core borrowing. This type of borrowing has no repayment date and is costing a company huge amounts in interest payments, which ultimately nobody paid attention to, since the interest was debited in the overdraft account, hence reducing the company’s profitability.
- Not keeping correct and truthful financial statements:
History of the profitability of the company gives a view of its prospects and the abilities of its management team. A banker requires to know what happened in the past and why. Therefore, audited accounts of the past few years are a prerequisite in order to finance existing companies.
- Ignoring interest rate fluctuations and finance-related expenses can create catastrophic cash flow problems.
- Very long-term or very short-term duration of lending repayment:
If the loan repayment is not based on realistic prospects and the results of the company and the purpose of the investment, problems will inevitably be created soon, leading to turbulence and reduced profits.
- Mixing company revenues/costs with personal income and expenses:
The most common practice for small businesses, where everything is paid ‘from the money in the drawer’, with no clear line between the proprietor’s own income and the business’ income. Such cases will result in a misguided approach in lending requirements.
The above mistakes are common to all businesses, but for every segment of the market, different parameters must be considered to reach the appropriate type and amount of financing required. Even though every businessman is always certain that they know their area of expertise better than anyone else and, of course, their valuable knowledge will definitely be considered, professionals like Revita should be involved to ensure that a realistic plan is prepared. Our firm has engaged recently in a campaign to promote proper financing so that companies can invest/build on solid ground and not on sand.
A profitable and growing business reflects the management skills and abilities of its owners and, admitting that one does not know everything, is actually the first step to success.
“THE REVITA TEAM”
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