Page 201 - Finance for Non-Financial Managers

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Finance for Non-Financial Managers
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Who uses it? A company might use a term loan to finance
an acquisition program, to develop or improve new products
for its market, or to obtain funds to buy or build a factory. The
idea is to put a large amount of money to work immediately
and repay it over time as the company receives the benefits of
the front-end investment. The company expects that the addi-
tional earnings or other benefits will more than cover the cost
of servicing the debt, including principal and interest, for the
life of the loan and hopefully beyond. The challenge for many
companies is to do a thorough enough analysis that the return
is reasonably assured before they take on the long-term debt
obligation. The risk is that a company won’t be able to pay off
the loan, which means a painful series of meetings and negoti-
ations with the lenders as everyone tries to work out a win-win
solution to the dilemma. This is the stuff of which corporate
turnarounds are made.
Equipment Purchasing or Leasing—Two Paths to One Goal
Equipment purchasing is what you do when you buy a new car.
You pick the car, negotiate the loan, and buy the car and the
bank pays the seller off. Then you make installment payments to
the lender until you’ve paid off the loan and you finally own the
car. In exactly the same manner, a company can buy manufac-
turing equipment or computers or, for that matter, new cars. The
business purpose is to extend the outlay of cash for the new
equipment over a period of time more closely related to the
length of time the purchase is providing benefit to the company.
Such loans are typically paid off in three to five years, well
before the equipment is worn out, so the benefit continues after
the loan is paid and the strain on the company’s cash balances
is minimized. This is particularly valuable to rapidly growing
companies that, as we’ve noted earlier, have a constant
appetite for cash to finance their growth. The cost of such
loans is typically related to the creditworthiness of the borrower
and the expected value of the collateral over the life of the
loan. Interest rates charged will vary, but will be higher than