In his weekly business banking post our CFO Greg Taylor continues his explanation of key business finance terms to help you be better prepared for that meeting with the business banker or accountant.
This week we continue to discuss key business finance terms to help you in your meetings with your business banker.
Gearing. For lenders this is the level of debt a business carries compared to the level of the owners’ equity in the business. The higher the level of debt, the more vulnerable a business is to interest rate increases and the more dependent it is on the ongoing availability of debt to keep operating. Lenders prefer lower gearing, though in many small businesses there is little equity so gearing is often high. This is one reason why many lenders require security for small business loans but are more willing to lend unsecured to bigger businesses.
Working capital is current assets less current liabilities. Current items generally require payment within the next 12 months. Lenders look for the amount of and changes in the level of working capital as a way of seeing how “liquid” a business is. That means how comfortably the business can meet its current liabilities from the current assets it has on hand. Businesses need working capital, usually in the form of an overdraft.
Debtors are people who owe you money. They occur when you sell goods or services and allow the purchaser to pay later. Debtors are an asset as they will eventually pay you cash. Creditors are people to whom you owe money. They are a liability as you will pay them cash.
An ‘aged’ listing of debtors or creditors shows how much is owed and to whom. This means you can see the number of days your debtors or creditors have been outstanding. Most accounting software packages will produce these reports. Lenders look at Debtors / Creditors ageing to make sure businesses are not allowing long standing debts to accumulate and they are paying creditors in a timely way. Late payment of creditors can be a sign a business is having cash flow problems or could be creating a poor reputation.
Did that help? Got a business finance term you don't understand? Let me know below.
This post is based on Greg’s weekly column in the Newcastle and Lake Macquarie Post.