Most businesses have some form of borrowing. Common examples are loans used to purchase machinery, business premises or work vehicles. Credit cards and overdrafts are also forms of borrowing businesses often make use of.
Interest rates on residential and business borrowing are rising rapidly as the Reserve Bank ratchets up the Official Cash Rate in an effort to get inflation back under control. Given the impact these interest rate rises have on business owners, it is timely to step back and look at what borrowing means from a more symbolic perspective.
The connection between borrowing and time
Borrowing is about making a deal with the future. It brings the potential of the future and places it in the present. Whether the borrower is a householder or a business owner, by borrowing money they are saying to the lender, “I’ll give you some of my future earnings if you give me the money now.”
Let’s take a plumbing business as an example and imagine the owner wants the capability of doing bigger drainage jobs and needs an excavator to do this. One option is to wait and save the cash over several years before making the purchase, but this means missing out on potential earnings in the meantime.
Another option is to take a bet on future earnings, then make a deal with a lender to access those future earnings now. The benefit of this option is to unlock more productivity immediately, resulting in enough output to cover the interest and start paying down the principal.
However, if the expected increase in productivity does not occur, the only other way the output can increase is to work faster. In this sense, from a symbolic perspective, borrowing has the effect of speeding up time.
As a result of this connection between borrowing and time, small businesses with borrowings can quickly find themselves in a state of frenzy, where everything seems to be speeding up as they struggle to maintain the output needed to cover interest expenses.
Will this asset purchase substantially improve productivity?
This is the question to ask before taking out a loan for an asset purchase. In a rising interest rate environment, the answer needs to be a firm “Yes”.
While it might feel good to borrow and upgrade to the latest Ute, if the existing one is serviceable and reliable then the new purchase is unlikely to substantially improve productivity. Contrast this with the example of an excavator purchase, which is more likely to substantially improve productivity, by enabling larger and more profitable jobs.
Looking at asset purchases and borrowing decisions in this symbolic way can lead to better business decisions, especially in the current rising interest rate environment. It can also reduce the likelihood of your business entering a whirlwind where interest expenses come so fast that output cannot keep up.