Commercial prudence? Debt and the SME

lostinrates

I'm getting the arguments for affordability and mulitples on a domestic scale and have formed some of my own conclusions.

I was wondering if the great economic minds and those with Small and Medium Enterprise experience could start a similar discussion over affordabilty/debt levels that are prudent in relation to TO or profit and how these figures are calculated?

Give me another year I'll be on to trying to understand the finances of mulitnationals

EG, is there a debt multiple recommendation for SME? How is it worked out? Does it hold true in the past boom?

Really2

lostinrates wrote: »

I'm getting the arguments for affordability and mulitples on a domestic scale and have formed some of my own conclusions.

I was wondering if the great economic minds and those with Small and Medium Enterprise experience could start a similar discussion over affordabilty/debt levels that are prudent in relation to TO or profit and how these figures are calculated?

Give me another year I'll be on to trying to understand the finances of mulitnationals

EG, is there a debt multiple recommendation for SME? How is it worked out? Does it hold true in the past boom?

That is very difficult to answer as margins etc are different for most industry's.
A person selling services would need a very small debt to grow .
A company distributing goods would need access to a lot of funds to grow.

I could not guess, we operate on a 12% gross 4.5-5% net after tax and wages.
But that is only supported by a high turnover.

So my answer would be I should imagine it would be sector specific.

lostinrates

Absolutely, which is why I'm hoping to see how its effected different people with different types of SME

Conrad

I own a small ltd company with T/O under £200k pa, and I do not consider any debt to be necessary other than that I used to purchase the premises which is asset backed anyway by the premises.

I could not bare to fund cashflow from debt of an overdraft.

Really2

lostinrates wrote: »

Absolutely, which is why I'm hoping to see how its effected different people with different types of SME

We just have to finance our busiest months, I would say max is 15% of turnover for the year.
Luckily we do not have to finance that from a bank though.

Conrad

There is no definitive answer, merely opinion.

There are large business's without any debt. Marconi for example built a huge cash pile and never used debt.

It seems to depend on the owners outlook. Some would rather expand slowly only ever using cash, whereas others want to grasp oppotunities as they arrise - for example a great big order which requires which they want to win but that needs Bank finance to bridge the gap in order to fulfil the order.

Some like to expand thier outlets quickly and again this can be done faster with debt, but as an example that wouldn't be my approach. Some of us prefer slow but steady.

Funnily enough, another broker called me this morning and was saying how p1ssed off he was that he had a number of brnach outlets and broking staff working for him, yet he has realised he would earn more had he stayed small.

I know one firm that employed over 100 staff in plush offices yet he has gone bust, and even in 2007 his profit was less than mine! Society though would judge him to have been more sucessful at the time - it would appear looks really do count.

Never go on visual impressions. I know a 1 man band footwear shop owner that has a £850k house with £200k mortgage and 5 other properties owned outright, yet he is not regarded by most as someone to be reckoned with, whereas some loud mouths with Range Rovers and lots of staff are local big whigs but I know they have little in the way of free assets.

Pennywise

You can't just talk about "debt" in total. It depends on the types of debt and what the debt is used for.

A long term loan (10 years plus) or mortgage is fine for buying premises.

Short term loans (under 5 years), leases and hire purchase are fine for most vehicles and equipment. The key is to balance the repayment of the debt over the useful life of the asset.

Overdraft is fine for stock and debtor financing. As a rule of thumb, it is wise to keep the debt below 50% of the value of the stock or debtor - this means that the debt can be repaid when the stock is sold and/or the debtor pays you and leaves a 50% margin for bad debt, stock damage/obsolesence etc.

The trick is to balance the debts against the assets. Where a lot of businesses go wrong is to use long term debt for short term assets, i.e. use a 10 year loan to buy stock or a vehicle. They also make the classic mistake of borrowing to cover losses or proprietors drawings.

I'd say it is a big mistake to base a "sensible" level of debt on arbitrary figures such as turnover or profit. Matching debt to assets is the answer.

lostinrates

Pennywise wrote: »

You can't just talk about "debt" in total. It depends on the types of debt and what the debt is used for.

A long term loan (10 years plus) or mortgage is fine for buying premises.

Short term loans (under 5 years), leases and hire purchase are fine for most vehicles and equipment. The key is to balance the repayment of the debt over the useful life of the asset.

Overdraft is fine for stock and debtor financing. As a rule of thumb, it is wise to keep the debt below 50% of the value of the stock or debtor - this means that the debt can be repaid when the stock is sold and/or the debtor pays you and leaves a 50% margin for bad debt, stock damage/obsolesence etc.

The trick is to balance the debts against the assets. Where a lot of businesses go wrong is to use long term debt for short term assets, i.e. use a 10 year loan to buy stock or a vehicle. They also make the classic mistake of borrowing to cover losses or proprietors drawings.

I'd say it is a big mistake to base a "sensible" level of debt on arbitrary figures such as turnover or profit. Matching debt to assets is the answer.

Thank you, this makes a lot of sense to me.

Wookster

I don't think there are right answers here, it entirely depends on:

- industry norms
- how capital intensive the business is
- stability & predictability of cashflows
- degree of operational gearing
- seasonality of revenue streams
- diversity of revenue streams
- rates at which financing can be obtained

One thing that is absolutely clear is that companies simply cannot rely on overdrafts which are repayable on demand as they can be withdrawn at the whim of the bank.

Really2

Pennywise wrote: »

I'd say it is a big mistake to base a "sensible" level of debt on arbitrary figures such as turnover or profit. Matching debt to assets is the answer.

But what asset property or stock?

We could not offset any debt agains property as we do not own one.

I think that is why it is a dificult one to set a rule too a fast expanding business as little need to hold assets other than stock.

Where say a proprty developer would want to have solid assets to loan against.

As above says I think you can not set a rule to it. But having assets makes hard time and expansion easier providing they are not devaluing assets.

lostinrates

Wookster wrote: »

I don't think there are right answers here

See, I'd say that about domestic borrowing too....depends on the borrowers- jobs, ages-sexes-versitilty-, not a mulitple