As a continuation from the previous post, less debt is always good but there are exceptions though; two which come to mind is a low interest rate environment and where a company has a large cash position or strong cashflow.
A low interest rate environment means bank loans are cheap-er than what it would cost during times when the economy is up and running at a brisk pace i.e. during the height of expansion or at the peak of an economic cycle.
When the economy is up, spending is up, lending is up, trickle down economics is working its magic, inflation also starts to creep up - the impact of this is that your goods and services will also increase in price. Sometimes fast, sometimes not so fast but there will be an increase.
This will then (in most cases) lead to an interest hike by the country's federal reserve or bank negara for us in Malaysia. This should then stem inflation. How?
By increasing interest rates, loans will be costlier for people and companies so there will be less borrowings and consequently less money circulating in the economy. Concurrently, savings rates will also increase and this will spur people to place more money into FD or money markets too; which also results in less money circulating in the economy. The result of this is to ultimately decrease the amount of money moving about in the economy ie everyone will be cutting down on spending, which in turn causes prices of goods and services to also decrease, and this will result in a lower rate of inflation. In effect, it's abit like putting the brakes on the economy coz you are slowing its growth.
Inversely, in an environment created by high interest rates (well there are other stuff like decreased money supply), economic growth is stifled and inflation is growing slowly. So, to put the pedal to the metal, economy wise, governments will do the exact opposite and lower interest rates. This means money becomes cheaper to borrow, companies will start borrowing to create businesses and enterprises, and people get to spend stuff to get more stuff so that the stuff that was previously there can be upgraded with newer stuff or to replace the old stuff with the new, it just translates into money circulating about in the economy.
So, how does this tie in with the low interest rate environment and it being a good idea for companies to borrow money? So, first let me paint a picture for you - you are a company with good prospects, you have growing revenue on an annual basis, your net income is also growing by the quarter, your customer base is growing and also diversifying; in short, you are doing well even being able to weather the hell that has rained down on you over the last 2 covid years. Now, bear in mind, you were able to do well during a period when things were looking like it's gonna be over and now, faced with the possibility of reaching greater heights by taking up a loan that's gonna cost you what 2% per annum, would you do it? Bear in mind a million dollars term loan @ 2% with 10 years only ends up costing about 9K-ish a month - sounds like if you can make at least 9K a month, that sounds like something worth thinking about . Of course, you are a company so that number should be scaled up accordingly and you can of course negotiate different payment terms and schedules.
The point is, for a good company, taking up a loan with low interest rates seems to be an attractive proposition since the the cost of interest is outweighed by the benefits of having more cash; whether to weather unexpected disruptions in your cash collection cycle, have an extra buffer for some rough months ahead (especially so for cyclical businesses, or to increase your marketing spend especially now that covid has sort of levelled the playing field for everyone.
I see a quite a few companies do this especially those with a SAAS business model. These type of companies usually have good revenue growth and more importantly, and also to the next point, have strong cashflow generating ability/sitting on huge cash piles.
SAAS companies, as the name implies, provides a service on a subscription bases, so they collect money upfront and provide a service. There are so many wonderful things about the saas model and the ability to generate good cashflow is one of them.
Since you (the SAAS company) collect money upfront, automatically that's your cashflow right there - how much of that translates into free cashflow is another thing that determines the quality of the company and we shall talk about that next time - and having cash means you can execute right away; you can pay right away and make things happen. In the context of this discussion, it means you have a great ability to cover your interest payments.
It's the same as having a large amount of cash - you can afford to service the interest payments while you continue to make revenue->profits->cashflow or have enough of a buffer to sort out your business while still being able to meet the debt covenant. Although, having a strong cashflow is definitely preferable to just having a lot of cash.
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