Re-structuring your borrowing can save you money

The majority of businesses that we deal with owe money to the bank. Typically, there is a term loan that relates to either the purchase of the business or plant and equipment as well as an overdraft facility that helps fund working capital. Sometimes this debt structure is absolutely fine but often a bit of tweaking is required to get the optimal result.

A common issue we find is that the entire overdraft facility is being used continually and the business struggles to keep within the limit.  There can be many reasons for this:

• It can be a symptom of a serious underlying problem, such as losses being incurred
• It can be the result of poor credit control or poor stock management, allowing debtors and stock levels to grow
• Growth may be causing cashflow problems
• Fixed assets may have been purchased using the overdraft facility

The proper purpose of an overdraft is to fund fluctuations in working capital and given that an overdraft facility is nearly always more expensive to have than a term loan, an overdraft should be used in the right way. Ideally we like to see businesses go in and out of overdraft either on a month by month basis or in rhythm with their seasonality.  This pattern shows that an overdraft is being used to fund relatively short term working capital requirements, as it is intended to do

The following is an example of the significant savings that can be achieved simply by restructuring debt.  We discovered from meeting with a relatively new client to review their monthly financial statements that they were constantly struggling to stay within their overdraft limit of $600,000.  They hadn’t been out of overdraft for two years.  The company was profitable with a steady turnover and seemed to have stock and debtors largely under control.  However, in the prior year they had taken a lot of money out of the business for a house renovation and they had also purchased significant items of plant and equipment that were funded by the overdraft facility.

Our analysis showed that their overdraft had consistently been at $350,000 or more for the last twelve months and often it was right on their limit of $600,000.  In this case, their overdraft interest was costing them 12.10% interest which compared unfavourably to the 6.50% interest on their term loan that they had taken out a few years earlier.  We completed cashflow forecasts and quickly concluded that they needed to convert $400,000 of their overdraft to a term loan facility and we were able to arrange this with their bank.

Their overdraft limit was reduced, however they now bounce in and out of overdraft only every few months.  The end result was an interest savings of over $24,000 a year, with those savings being used towards repaying the term loan.

We also regularly come across business owners who have significant personal debt, the interest on which isn’t tax deductible, while their business has little bank debt and has largely been funded by the owners.  Often it is possible to legitimately restructure these sorts of situations so that the interest costs become a business expense which are tax deductible, which ultimately saves you almost a third of your funding costs.

If you haven’t reviewed your debt structure for a while, you are looking to borrow more money (for business or personal use), or if some of the issues discussed above apply to your business, get hold of us.  It could save you a lot of money.

Tristan Dean Business Advisory Director
T +64 9 448 3231
E tristan.dean@hayesknight.co.nz