One of my known entrepreneurs used to enjoy a lavish lifestyle, bought a costly car, indulging in family foreign tours, and everything peripheral was also indicative of good business and profit.
After one year, I came to know that he defaulted on bank loans. His account becomes NPA, and several private loans recovery issues cropped up.
His affordability of all the lifestyle he used to enjoy was not financed by business profit but by creditors and lenders.
Many SME entrepreneurs think money in their account is their own money. Money generated by deferring creditors, availing short-term and long-term business loans, is not the money available for your personal expenses and investments.
But this is a mistake many entrepreneurs do knowingly or unknowingly. This could be really dangerous.
This post is for entrepreneurs who do this mistake unknowingly.
Cashflow can be generated by the following means:
Working Capital Loan
Bank finance working capital gap in the form of cash credit, bill discounting, packing credit, overdraft, etc. These are several products as per various business need and the cash conversion cycle of the business.
This money is also allowed to be used for the purpose mentioned in the sanction letter. Using the money for anything other than the specified purpose is known as diversion of the fund.
Fund diversion is an offense.
This loan is given to buy capital assets. This could be business machinery for manufacturing units and office and office equipment for other business.
The loan repayment is stipulated at the time of sanction and depend on how cash flow from operations supports comfortable repayments.
Short Term Loans from Outsiders
These are the loans entrepreneurs’ avail from friends, business acquaintances, and other parties.
This is usually availed to manage short term cash flow mismatch.
Many a time lender bank wants entrepreneurs to enhance own capital to make debt to equity ratio bankable. When entrepreneurs could not bring own money, they avail loans from family members. The lenders would take undertaking not to withdraw this loan as long as the bank’s loan is in existence.
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Loan Against Property (LAP) for Business Purpose
Bank /NBFC also gives loan against the mortgage of immovable assets. This is known as LAP. Entrepreneurs avail this facility when some bigger investments have to be made and the loan could not be availed as term loan.
However, this loan operates as a term loan with a fixed tenure and periodic repayment of interest and principal.
This loan is either for a specific purpose or for the general purpose.
Caution: An asset is mortgaged against the loan. If the money is not used for the productive purpose and existing business can’t support the repayment, there is a chance of losing the mortgaged asset.
A single bad loan can spoil the credit history the borrower, It impacts borrowing power in the future.
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Deferring Creditors’ Payment
A business can also see enhanced cashflow when creditors payment is delayed beyond the due date. This is the creditors’ money.
If you use this money, your credit history with creditors gets affected. It can also, affect your business as in the future you may get no credit or increase in price.
Deferring Loan Repayment
Like creditors, you can have money with you when you defer payment of the loan to the lenders.
Using this money as own money seriously impacts the creditworthiness of the borrower.
Like a loan, loan interest deferment also generates cash. Unless used for genuine business purpose, it can impact both business and creditworthiness.
Many times, the cashflow crisis can be averted by deferring cash repayment liability but it has a cost. The cost is the deterioration of the credit score.
This can be tolerated for a business need but if the money used for personal purpose on a regular basis, it could have a serious consequence.
Deferring Tax Payment
Income tax, TDS, GST, PF, and all statutory liability can be deferred and cash flow can be improved. But it has a very dangerous consequence.
Using Govt money not only would cost interest for delayed payment but entails prosecution and imprisonment.
Advance from Customers
Sometimes customers pay advance. Though it has come a component of profit, ret of the money is for the cost of purchase of manufacturing the product to be supplied.
This money also does not belong to the entrepreneur.
IPO or Public Money
For larger companies, this is also a source of huge cash generation. Though this money is considered shareholders money, is the costliest source of fund.
We have several case studies of promoters splurging on IPO money and the company goes out of business sooner.
This is what owners invest in the business. Their own money. But business owners have to be careful in using this money for personal purpose.
Using this money for personal purpose lowers capital. Reduced capital impact several important ratios. It also affects your credit rating. It also affects business liquidity which is very critical.
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This is your money. After doing all the business activities by investing own capital, lenders money, manufacturing and delivering to customers, and finally recovering from customers entrepreneur earn their profit.
The whole endeavour is to earn this profit. This is the money you can call your own money and you can use to maintain or enhance your lifestyle.
Entrepreneurs who consider all other money floating in the business as their own money sooner or later fumbles. They face a financial crisis.
The example given at the beginning of the post is the story of many entrepreneurs thriving on the future possibility of profit by spending all other money sources mentioned from 1 to 10 above.
Cashflow is critical for the business but at the end of the day, it’s not your money. Don’t make this costly mistake of spending from the cash flow. Entrepreneurs have a right only on the Profit.
& remember thriving on cash flow at the cost of profit could be short-lived, it is the realised profit that fuels the business’s longevity.
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