Whether you're facing rapid growth, dealing with seasonal sales fluctuations or looking for additional capital to finance a new project, refinancing may be an option.
Put simply, refinancing enables you to restructure your debts to obtain better payment conditions, and can benefit successful companies as much as those in difficulty.
Start with a sound analysis of your financial situation
When your business is growing, it's not unusual to have cash flow planning and management challenges. Perhaps your sales growth isn't in line with your overhead expenses, or you're lacking the working capital to manage higher inventory levels. Whatever your situation, before you consider refinancing, the first step is to look carefully at your balance sheet and cash flow statement.
The balance sheet is a financial statement reflecting your company at any given time. It provides a snapshot of your assets (what you own), liabilities (what you owe) and equity (what was invested). You use your balance sheet to report your company's annual accounts, help investors and creditors assess how much your business may be worth, and analyse and improve how you manage your company.
Typically, your balance sheet will show:
- Current assets (what your business could turn into cash within a year: accounts receivable and inventory)
- Long-term assets (what you own, fixed assets such as buildings, land and equipment and intangible assets such as intellectual property rights and goodwill)
- Current liabilities (what your business owes and has to repay in the short term: accounts payable and line of credit)
- Long-term liabilities (what debt needs to be repaid over an extended period of time: building and equipment)
- Equity: what was invested (capital) and retained earnings (profits that have been reinvested in the company from day one)
By looking at your balance sheet, you can better understand your short-term and long-term positions. You'll be able to see:
- How well your business is performing
- If your assets can be liquefied easily (such as being turned into cash or stocks)
- How much your company is in debt
- How much capital you're using
- Where you can restructure your debt
Future cash flow statement: provides a detailed forecast of whether or not your business will have enough cash to pay its loans and expenses. When used properly with your balance sheet, your cash flow statement can help you:
- Predict and prevent cash shortages
- See when you'll need additional financing
- Step-up efforts to ensure you are collecting your receivables quickly
Know your refinancing options
Now that you've carefully assessed your financial situation, take a look at some of the most common scenarios where refinancing could help your business. Keep in mind that when you refinance a loan, you may incur some additional costs:
- Payback fee, penalty for repaying a loan prior to its due date
- Study fee, cost of a financial institution reviewing your portfolio and assessing your potential
Keep these costs in mind. But in general, they are minor in comparison to the benefits of restructuring your debt.
Better terms and conditions
Here you'll be looking at your loan structure, period, interest rates and payment terms.
- Loan structure A common error for entrepreneurs is to use short-term assets such as cash to pay for fixed assets such as equipment. Since short-term debt is less expensive than long-term debt, some business owners tend to want to pay for long-term needs with their working capital. In reality, few entrepreneurs can pay out these large sums of money without making their companies vulnerable. Ultimately, it's not a good idea to take chances with your operating funds. A better alternative would be to take out a long-term loan to pay for fixed assets such as equipment. By doing this, you can use working capital to fund other important growth projects such as exporting, for example.
- Payment period Be sure you negotiate a loan amortization period that enables you to handle your payment and not tap into your working capital, which you need for operations and growth. With extra money from the lower payments, you can focus on growth projects, such as marketing, which ultimately generate long-term revenues. Example: if your equipment is worth $120,000 and it's amortized for 4 years, you might consider renegotiating a 7-year amortization period in order to lower your monthly capital payments.
- Payment terms If you have a seasonal business, such as in tourism or farming, in which you have slower periods, you can negotiate variable payment terms where payments are disbursed according to your cash flow structure, quarterly vs. monthly; this makes it easier when business is sluggish.
- Interest rates As a smaller business, your original long-term loan may have carried a higher interest rate because you were considered riskier by your lender. Today, your company may be showing consistent and strong financial performance, which means you may be a lower risk for a lender. This gives you the power to renegotiate a better interest rate. You may also want to change from a floating interest rate to a fixed rate. If you are looking for peace of mind, a fixed rate provides unchanged payments for the term of the loan. A floating rate should mainly be considered if variations in your interest payments do not seriously impact your financial viability.
Leverage assets for special projects
Another refinancing option is to assess the value of your fixed assets, such as equipment, and to leverage that equity to give you more cash to support your business for special projects, such as expanding into new markets, product development and R&D. For example, if you have assets worth $1 million, and a loan of $500 thousand left, you could leverage that asset,-for example, for another $300 thousand. You would apply for a new loan of $800 thousand by refinancing the $500 thousand debt and use the leveraged asset as collateral to your new loan.
Refinance to consolidate debt
Typically smaller businesses and start-ups may have many smaller loans, which can be difficult to manage. Your company's cash flow might not allow you to fulfill your obligations according to the loan terms. In this case, you can always consider consolidating your loans with refinancing. Essentially, you could get one long-term loan and one easier-to-manage payment per month.
Businesses can also combine larger loans in order to diminish their monthly payments by extending the total of the debt over a longer period of time. For example, a business may have an equipment loan of $400 thousand over a 7-year period and a building loan of $1 million over a 15-year period. By consolidating the loans into one, the terms and conditions are improved if the payment period is now 12 years.
When you consolidate your debts with refinancing, your lender will use a debt-to-equity ratio calculation which measures the proportion of assets that you now finance with debt compared to the equity in your company. Equity is defined as the assets available for collateral after the priority lenders have been repaid. The higher the value of the ratio, the higher risk your company carries. In general, a company's ratio is benchmarked to the specific industry standard.
Refinancing to increase working capital
You can also increase your working capital by refinancing expenditures, such as equipment or inventory. Keep in mind that working capital is the amount of money you need to operate your business on a daily basis. To understand how much working capital you need, make projections for items such as accounts receivable, inventories and accounts payable. Then compare the working capital that you actually have with what you've forecasted. If there's a gap, you will need more to continue your operations.
Content in this section is provided in partnership with the Business Development Bank of Canada. BDC provides entrepreneurs with financing, venture capital and consulting services. To find out more go to BDC.ca.