The emergency loan as an alternative
The interim loan. In this case, your bank will provide you with a new loan for the repayment of the original loan each year, at the repayment dates. In this way you can make the repayments agreed at the time and still do not have any liquidity problems.
Example: An entrepreneur gets $ 25,000 more in liquid funds and also saves $ 1,625 in interest: Since the borrower followed the advice of a financial advisor, he saves 6.5% pa. Previously, he had to overdraw his current account by $ 25,000 in order to agreed loan repayments, which cost him a total of 13.0% interest, including 4.5% overdraft. Now his bank has granted him a special loan and only charges him 6.5% interest. So he saves $ 1,625 interest per year for every $ 25,000 loan.
In early 2004, the entrepreneur had taken out an ERP loan for $ 250,000. The loan was repayable for 5 years. After that, he had to repay $ 25,000 every six months. As of June 30 and by December 30, 2004, he had already repaid $ 25,000 each. Since his company did not go as well in the short term as he had expected in 2005, he lacks the money for the repayment. The result: his current account is currently overdrawn by around $ 25,000 and he has to pay the bank not only 8.5% pa overdraft interest but also 4.5% pa overdraft commission for the amount above the limit. He calculates that he has additional costs of $ 1,750 per year compared to the ERP interest rate, which is 6.0% pa As the repayment increases, his current account overdraft increases and his burden will continue to increase. He wondered how long the bank would tolerate the overdraft.
In order to fix the amount of liquidity and to finance himself more cheaply, he took advice and immediately spoke to his house bank about a collateral loan. Thanks to his initiative, the bank came to meet him and promised him 50% of the annual repayment. Now he only repays $ 25,000 a year, the remaining $ 25,000 as a new loan. For this, the bank charges him 7.5% pa interest.
The two repayments already made were included in the agreement, so that his house bank credited him back with $ 25,000 in his current account and set up a new loan of this amount. The loan is provided by the bank without repayment until the ERP loan is repaid in full. Only when his company has repaid the ERP loan does the repayment of the collateral loan begin. His “profit”: he takes advantage of the fact that he does not pay back for 5 years in order to accumulate liquidity for the following redemption years. But be careful: from the start, remember not to tie up your free liquidity in fixed or current assets. In this way you avoid difficulties due to the later – and significantly higher – repayment rates.
For you as an entrepreneur, one of the most important tasks is always to ensure secure liquidity first. And it makes a considerable difference for you: Instead of calculating an annual loan of $ 50,000 later with an ERP loan, for example, as shown by the figures from the initial example (initially loan-free loan compared to the calculated repayment for all years) , Important: It is of no use to you if you take out a particularly low-interest loan but are unable to repay it. With a simple rough calculation, you can check to what extent you can actually raise the upcoming repayments.
Your quick calculation to check the ability to service capital
Draw up a cash flow calculation by comparing your future profit plus depreciation and addition to long-term provisions with your withdrawals, equity-financed investments and the agreed loan repayments. In this way you can determine whether you can make the necessary repayments or not. Example: A doctor’s office with a gross cash flow of $ 150,000 and a net cash flow of $ 50,000 cannot afford a further $ 50,000 loan repayment due to agreed loan repayments. Cash flow calculation: How to calculate whether you can actually pay the repayment for a new loan. Simply insert the values of your company into the diagram and you will immediately see whether and to what extent you can “afford” another loan.
Based on the practical example, you can see that the company cannot earn the required loan repayment of $ 50,000. If you nevertheless make a repayment agreement in the amount, you will have a liquidity deficit of $ 25,000 per year, which will lead to a higher overdraft facility drawdown. The result: you have a higher interest expense. Your goal: Make sure that you not only have liquidity coverage for your company, but value a liquidity surplus of 10 to 20 percent of the gross cash flow, because only then will you have the necessary liquidity security.
If in doubt: Arrange an early loan of the right amount in good time
Anyone who hopes to be able to make the necessary loan repayment can take precautions and agree on a collateral loan. However, when you apply for public grants, it is best to simply arrange a pooling loan – regardless of whether you need it or not – simply as a liquidity reserve. For example, if you have determined that you can only make a repayment of $ 25,000, but your loan requires twice the repayment, you should talk to your bank about a $ 25,000 annual loan. Your bank can easily accommodate you, because the risk loan does not change the risk situation because it is already in primary liability for public financial assistance.
Your advantages with a collateral loan: You can finance the repayment shares that you have not earned through a new loan on favorable terms, without missing liquidity for your working capital. If you had to make full repayment in the originally agreed amount, you could only do so by making greater use of your current account credit. You might even have to overdraw your account. You would lack credit to finance your current assets, and you would have a higher interest expense in the current account, not to mention any overdraft interest that may arise.
How you plan to avoid emergency loans
Always agree the term of your loan according to the economic useful life of the objects financed with it. Use the depreciation as a basis when determining the loan repayments. Check your ability to pay on a net cash flow basis. If you always agree on unscheduled repayments, you can repay your loan in full and reschedule if necessary.
Practical comparison: A loan from the ERP expansion program with and without a collateral loan
You are planning an investment of $ 500,000. Now compare how much it will cost you to finance this with and without a back-up loan in the event of a liquidity shortage. If you can receive a loan from the ERP development program in the amount of $ 500,000 for an eligible investment, then you have the following conditions, for example: loan amount: $ 500,000, interest rate 5.50% pa, payment 100%, term 15 years, 5 Years free of repayment, payment June 30, 2004, repayment semi-annually $ 25,000, repayment beginning December 30, 2009, repayment until June 30, 2019
Interest and repayment plan for a repayment loan of $ 500,000
(Interest rate 5.5% pa, term 15 years, 5 repayment-free start-up years) For reasons of space, the simplified representation only shows the annual values. However, the calculations are based on a six-monthly payment cycle.
That’s how much the ERP loan costs
If you take out and repay the ERP loan on the terms mentioned, you will have to pay a total of $ 281,875 in interest. Let your bank provide you with an interest and repayment plan from which you can see the performance rates due.
What to do if the repayment is too high
If you see from your cash flow calculation that the loan repayment of $ 50,000 per year is too high for your practice and you see that you can only make half of the annual repayment, the best thing to do is to speak directly to yours to ensure liquidity House bank on a special loan.
Cash flow calculation: This is how you can determine whether you really earn your debt service
Simply insert the values of your institution into the diagram and you will immediately see whether you can “afford” another loan.
If you have a liquidity deficit to cover
If you are unable to provide the repayment services and have calculated a liquidity shortfall of $ 25,000, for example, you should negotiate with your bank about a collateral loan in the amount of 50% of the necessary annual repayment of $ 50,000. The bank will probably give you a commitment and take over half of the repayment of the development loan in a collateral loan. For example, you have to pay 7.5% pa interest on the general loan. The repayment of the collateral loan only begins when the mortgage loan has been repaid in full. So you always have to make an unchanged high loan repayment of $ 25,000 annually. First on the building loan, then on the collateral loan. The emergency loan is gradually building up. For every half-year repayment of $ 25,000, your house bank provides you with a collateral loan of $ 12,500. The emergency loan grows to $ 250,000 within 10 years.
Collateral loan: This is how a collateral loan develops if the house bank provides you with half as collateral loan for the originally agreed loan repayment of $ 25,000 every six months:
Interest that you can save on a current account loan over current account financing
Determine how much interest you have to pay on the emergency loan of $ 25,000 annually at 7.5% and compare this effort with a current account interest rate of 9.5%. Do not take into account that you would probably have had to exceed your current account limit even over time, so that the matter would have been even more expensive. They come to the conclusion that the emergency loan would cost you $ 98,435, but a current account loan would cost around $ 124,685 in interest.
Calculation of the different interest expenses for a general loan and a current account credit
Interest rate for the collateral loan 7.5 percent pa, interest rate for the overdraft facility 9.5 percent pa
Interest savings of $ 26,250 through the collateral loan
If you had financed the high repayment of the extended loan through your current account, you would have to pay interest of $ 124,685.00. Due to the “orderly” financing through the collateral loan, you only have to pay $ 98,435.00 and save $ 26,250 in comparison.
Interest and repayment plan for a repayment loan of $ 250,000, interest rate 7.5% pa, term 10 years
The simplified representation shows the annual values for clarity. However, the calculations are based on a six-monthly payment cycle.
The repayment of the collateral loan begins after 15 years
In order for you to retain the liquidity advantage that this construction is to bring you, the repayment of the collateral loan – which has gradually increased – only begins after the full loan has been repaid. If you have your house bank draw up an interest and repayment plan for the repayment phase of the general loan, you can use this to better plan the respective due rates.
The total expenditure for construction and collateral loans
Calculate the total expenditure for your financing. For the development loan and the subsequent collateral loan, you come to $ 480,977. (Calculation of the total interest expense for an ERP construction loan with subsequent collateral loan)
For your own interest, you can still calculate how high your interest expense would have been if you had also processed the amount of the collateral loan for the repayment phase using a current account credit with 9.5% interest. Have your house bank draw up an interest and repayment plan for it and ask them to use an interest rate of 9.5%.
Interest and repayment plan for the repayment of a current account credit in the manner of a repayment loan
Loan amount $ 250,000; Interest rate 9.5% pa, term 10 years (The simplified representation shows the annual values for better clarity. However, the calculations are based on a six-monthly payment rhythm).
What you should consider when negotiating an emergency loan
Determine the amount of your loan repayments for loans with repayment periods only based on the repayment period and not on the entire term of the loan. Use a cash flow calculation to determine which loan repayment your facility really makes. Measure the amount of your collateral loan so that you do not need an additional current account credit. As a matter of principle, negotiate with your bank about a special loan for public promotional loans, regardless of whether you currently need it or not. Create a liquidity reserve with the collateral loan. If the interest is low, remember to agree on a fixed interest rate for the collateral loan. Try to enforce an unscheduled repayment clause at your bank for the emergency loan too. For the loan term, use the economic useful life of the financial items as a guide.