Net profit doesn’t repay loans
Lending is one of the most important functions of financial institutions.All banking and non-banking institutions in the country earn their main income by way of interest on lending. It is therefore extremely important for lending officers of such institutions to arrange all lending propositions in such a way that it can be recovered without any hassle as scheduled until the facility is settled in full.
If the lending officer fails to arrange the repayment plan according to the repayment ability of the borrower, any good borrower can become a bad borrower, without any valid reason.
Once a borrower is identified as a bad borrower his or her name will appear in the Credit Information Bureau of Sri Lanka (CRIB) and he or she will be at a great disadvantage when getting into any financial dealings. This can happen to any borrower.
Although the corporate type of borrower has some idea of a repayment schedule reached at the time the loan is given, sometimes small and medium (SMEs) enterprises-borrowers totally depend on the lending officer to arrange their repayment plan. If the loans officer makes an error knowingly or unknowingly, the image of the borrower gets tarnished.
It is therefore paramount important for individual and SME borrowers to have an idea on key factors, when arranging their repayment schedule.
You should never think that if your business earns enormous profits, you can meet all the obligations of your loans and advances on time. In order to have a smooth repayment, in a regular manner you should study the “cash flow” of the business.
This statement shows how much money comes into the business and also goes out during a given period of time. This statement will help you to ensure that adequate cash will be available to meet the trading needs of the business; that adequate cash will be available to meet any capital expenditure which is already planned; and finally that adequate cash will be available in the business in order to meet the interest and capital repayment commitments on all loans and advances.
Of these three vital areas, I will focus my attention mainly on the last one: Meeting interest and capital repayment commitments on all loans and advances. For many businesses, the preparation of a cash flow forecast is fairly a simple procedure once the operational budget and the capital expenditure budget are completed.
The cash flow statement shows us how much cash will be generated and how much will be used during a particular period.
The sources of cash that come into the business per month are:
a) Cash sales (ie. sold on credit should be excluded)
b) From debtors
c) Cash sale of any assets
d) Receipt of any loans and advances
e) Increase in equity by cash
There may be any other cash receipts too. These figures add up to total cash inflow into the business.
The sources of cash that go out of the business per month are as follows:
a) Cash payments
1) For materials
2) Labour
3) Other production costs
4) Sales and distribution expenses
5) Administrative expenses
6) Capital expenses
b) Commitments on loans and advances Settlement of all other creditors
There may be any other cash payments too. These figures add up to total cash outflow from the business
Finally: If the total cash inflow minus total cash outflow is a positive figure then there is a cash surplus during the month, which can be carried forward for the next month If total cash inflow minus total cash outflow is a negative figure then there is cash shortfall during the month which has to be funded by a short term facility (ie temporary cverdraft).
However the constraints in meeting the commitments on loans and advances appear, only when there is a shortfall in the cash flow. Hence it is important to project the figures in such a way that there will be no shortfall in the cash flow in order to ensure smooth repayment of interest and capital on all loans and advances in the business.
When preparing a cash flow should you be concerned as to how realistic the figures are? Is the business being unduly optimistic in its sales projections? Have all cash items been included? Has the production cost been properly matched with the expected sales?
Even personal borrowers should have a clear idea of the amount of cash they receive and the amount of cash they have to spend during any given month, to ensure a smooth repayment of the commitments monthly on all loans and advances.
Nevertheless, with all these planning, there still can be unexpected expenses which have to be met by cash. Such expenses will bring sudden constraints in meeting the financial commitments once again. Hence it is important to have provisions for such unforeseen expenses, outside the cash flow.
(The writer is a senior banker who served at a leading commercial bank in the private sector and retired recently).