Strategic Borrowing for Businesses
With the present and upcoming challenging times, it will take months or years for many businesses to recover from cash flow problems. Governments and lending agencies across the world play an important role in the economic recovery and growth. Different countries have used different strategies. The values for lending Interest Rates reported in several countries in Euro area and United Kingdom are close to zero as depicted for March 2020. Amid wavering economy certain measures can greatly help fund-starved businesses get long-term finances. The question is not when, but how soon, the governments provide these supportive financing options. As the hardships are severe because of Covid-19, among many other initiatives, the governments and lending agencies are contemplating and/or offering businesses:
· extended payment plans,
· interest only payments plans, and
· low interest loans or zero interest small loans
Extended payment plans
Extended payment plans allow businesses to pay back the loan in instalments for a longer period than the original loan agreement. In a crisis like Covid-19, the businesses can opt to extend payment plans by negotiating the term of the loan. Cutting the payment as much as possible and freeing up cash to stave off disaster is an option but may result in higher total interest payments. However, if there is flexibility in plan, then once the emergency has passed, principal payments can be stepped up to reduce the extra interest costs incurred when the loan term was extended.
Sometimes an interest-only payment is the only payment the business can afford for a limited period. The interest-only payments plan is where the borrower pays only the interest for some of the term of the loan. The principal balance remains unchanged during the interest-only period. After the agreed upon specific time, the instalment includes principal and interest with each payment as the loan eventually converts to an amortizing loan with higher monthly payments. Most of the time, the interest-only payment plan is for a short term only; such term could be negotiated and can be set between a few months to a few years. Some lending agencies provide this benefit for a maximum of six months only. While initial lower payments provide more flexibility for a short period, later either the instalments are higher or are for a longer amortized period. During challenging times with irregular income due to uncertainties like Covid-19, an interest-only payment plan can be a good way to manage expenses for short period and then pay principal when funds are available later. Interest-only payments don’t last forever, and the monthly payments are low during the interest only period.
As a result of interest only payments, lower payments provide more flexibility for how and where to put the money as the surplus cash can ease the cash flow problems. The extra money each month can also be put toward payments of other high interest liabilities. However, an interest-only payment plan keeps the monthly payments on the loan low for a few months or few years, but it doesn't eliminate the need to eventually pay back the full loan.
Low Interest or interest free loans
Another option to induce growth of businesses during these challenging times is the loans to suitable entrepreneurs at ―a reduced rate of interest or even extending interest-free loans. In contrast to interest only payments where the principal amount does not get reduced, a low interest rate loan means that when making monthly payments, more of the payment goes towards the principal balance instead of going towards interest ―that can lead to reduction of debt. The primary benefit of low interest or interest free loans is their stimulation effect on the economy. By reducing interest rates or charging zero interest, the governments help spur business spending on capital goods, which also helps the economy’s long-term performance. Many businesses use it to pay off credit cards with high rates of interest, take care of outstanding bills with high penalties for late payments, reducing the debt, restoring the credit thus relieving stress. It can also contribute to manage emergencies and unexpected expenses. Low interest rates help a business lower their cost of operation, which not only contributes to the profit margin but also creates the likelihood to spend more where needed.
In present times, the financial activities covered by government financial agencies and other lending agencies have been widened. To sum up, on the lending side, with most traditional loans, the monthly payments go toward both interest and principal balance. Over time, the borrower keeps up with interest charges and gradually eliminates the debt.
Extended payment plans can reduce installment amounts but would result in longer term with higher total interest cost. With an interest-only payment plan, the payment is towards the interest on the loan for a short period, and not on the amount of the loan itself which remains due. It helps in lower monthly payments initially and for a fixed period. Eventually, the full loan is to be paid off. Low interest loans or zero interest rates are like traditional loans but with a low cost of borrowing.
Interest-only payment plans aren’t necessarily bad, but they’re often used for the wrong reasons. If you have a sound strategy for how you will use the extra money (and a plan for getting rid of the debt), then they can work well.
It’s important to distinguish between true benefits and the temptation of a lower payment. Not to ignore ― a loan is a loan; and is borrowed money which needs to be paid back sooner or later. If anything, the governments do insist on transparency for the public money involved and as the requirement is that the principal be paid back, applications assessment may be based on ability to pay back.
Stay tuned on further articles on economic development and tips on applying for funding…….
Dr. Pawan Chugh
Chugh Consulting Limited