How Can I Tell If My Business Is Highly Or Under Geared?

If I begin Invoice Discounting – How will my business’ gearing be affected?

Most businesses become aware that outside Credit Analysts always ask, “Is this business adequately geared?”

The question can puzzle a businessman. This article gives a simple way to understand the concept:

What the Credit Analyst is after here is to compare the amount of money the applicant has invested in his own business compared to the amount of money other people’s money they are risking.

A good banker would like to see that the Credit Applicant has at least put into his business an equal amount as other people are risking.

In other words he would like to see a My Money compared to Other People’s Money expressed in a ratio of 1:1

Then if he was going to lend money to the business he would prefer only to lend up to half the amount that the businessman has invested in his own business 1:.5

Example:

Let's say a businessman has invested $10,000 in his own business. According to the given ratio of 1:0.5, the lender would only prefer to lend up to half the amount that the businessman has invested.

So, the maximum amount the lender would be willing to provide is:

10,000 \times 0.5 = 5,000

This means the lender would lend $5,000 to the business.

As we can see this is a very conservative but common approach in the banking community, more than likely not enough money to enable the business to grow and expand very quickly.

What happens then if I discount my invoices?

Most businesses who seek Working Capital by way of Invoice Discounting are likely to be highly geared. (Refer to our previous Blogs for more information on this topic)

But let’s look at what happens if a business’ Sundry Debtors are sold to a Financier:

He would be able to payoff his overdraft!
He would be able to pay off the bulk of his Creditors

So we can see that the business’ reliance on Other People’s Money has fallen away completely!

Therefore from starting out as a Highly Geared Business – the minute he discounts his receivables his business swings into an Under Geared one that Credit Analysts prefer to deal with!

Conclusion

Most businessmen do not want to rely overly on Other People’s Money. After all a banker can get out of bed one morning and demand repayment of his overdraft! – All overdrafts are repayable on demand!

This scenario is not possible if invoices have been discounted because the Financier has to wait until the tenet’s of the transactions have passed, the 30, 60 or 90 days credit the Supplier gives his buyers.

Here we are seeing another strong reason why a businessman should discount his invoices because, in theory, provided he keeps the working capital he has raised in the business, and keeps selling to creditworthy buyers he should always have enough money on hand to keep his Creditors paid, and will be able to see to it that wages are paid on time.

In the link below you will find information that can assist you in understanding Invoice Discounting and Modern Working Capital Techniques more fully and where to find the best providers of Working Capital for YOUR business.

Payment Accelerator