Before You Borrow Anything, Answer These Three Questions

This sounds obvious. It is not.

Many businesses that approach finance for working capital have not clearly identified what is causing the working capital pressure. Is it debtor days, with customers taking too long to pay? Is it stock, with too much cash tied up in inventory? Is it cost structure, with the business spending more than it takes in? Is it growth, with sales increasing faster than cash flow can support?

Each of these has a different answer. A business that is cash flow constrained because of long debtor days needs invoice finance. A business that is constrained because of stock needs trade finance or an asset-based facility. A business that is spending more than it earns needs a different conversation entirely, and probably not more debt.

Borrowing without clearly understanding the cause of the problem means the finance is unlikely to be the right structure. And the wrong structure does not solve the problem. It delays it, at cost.

The discipline of this question is not bureaucratic. It is practical. The more clearly you understand why you need the money, the better placed you are to identify the right product, the right lender, and the right structure.

Knowing why you need finance and knowing how you will use it are related but not identical questions.

A business that needs working capital to take on a large new contract has a specific deployment plan: the money covers the gap between starting work and receiving payment. The deployment is defined, the timeline is known, and the return is predictable.

A business that needs working capital because it is generally cash flow constrained has a less defined deployment. The money will circulate through the business. The return is harder to quantify. And the risk of the facility becoming a permanent crutch rather than a specific solution is higher.

The quality of the deployment plan affects the quality of the financing decision. A lender who understands exactly how the money will be used can structure a facility around that deployment. A vague deployment plan produces a vague facility, usually at a higher cost.

Before you approach any lender or broker, be able to articulate clearly how the money will be used, over what period, and what it will enable the business to do that it cannot currently do.

This is the question that is most frequently skipped, and it is the most important one.

Every debt creates an obligation. The obligation has a cost: the interest, the fees, the repayments. That cost comes out of the business every month, regardless of what the business is doing. Before you take on any debt, you should be able to answer clearly where the repayment is coming from.

For a specific, project-related facility, the answer is often straightforward. The project completes, the client pays, the debt is repaid from the proceeds.

For a working capital facility, the answer is more complex. The repayment comes from the ongoing trading of the business. Which means the business needs to generate enough additional cash flow, above its existing costs, to service the new debt. If it cannot, the debt creates pressure rather than relieving it.

This is not an argument against borrowing. It is an argument for borrowing with a clear understanding of the repayment source. A business that can answer "the debt will be repaid from X, over Y period, because Z will happen" is in a fundamentally different position from one that is borrowing on the assumption that things will work out.