Page 200 - Finance for Non-Financial Managers

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Financing the Business
strength of the purchase order to enable it to manufacture the
products needed to fill the order. This is very high-risk lending,
because the lender is betting the borrower will be able to make
the product and successfully deliver it. As a result, the require-
ments for this kind of borrowing are even stricter than for factor-
ing: strong customer, firm purchase order, borrower with good
track record of completing its work, and so on. Only the small-
est companies with the weakest working capital position, or
those with unusually large, one-time orders, typically seek this
kind of financing.
Long-Term Debt—Semi-Permanent Capital or Asset
Acquisition Financing

Let’s now look at the benefits of taking on long-term debt as yet
another way a business can finance itself.

Term Loans—the Old-Fashioned Way
A term loan is the kind of loan you and I use to purchase real
estate or to finance that dream vacation. We borrow the money,
use it for its intended purpose, and repay it in installments over
several years.
How does it work? To get such a loan, a company will apply
to its bank or other lender. Upon approval, the bank advances
the money and the company signs documents promising to
repay the loan over some number of years in monthly install-
ments, including principal and interest. The bank will usually
require the pledge of collateral to make the loan, which might
include a specific asset or it might be all assets of the company
that are not already encumbered with debt. If the loan is for real
estate, the real estate will always be pledged as collateral for the
loan. If the company is privately held, collateral might also
include a personal guarantee by the owners. Interest costs for
such a loan are typically moderate, as a company must be in
reasonably sound financial condition to be approved. Such bor-
rowers are in demand and banks will often compete for the
business of solid business borrowers.