Episode 31: Business Lending and Tax!

August 9, 2021

Today’s episode is everything you need to know about Business Loans! Lending is already super overwhelming without adding the complexity of Business Loans! So Trudi fires all of your questions at resident loan expert Sarah. Trudi and Sarah take you through when your business might consider the need to bring some external finance into your business. They will take you through the different financing options and which types of loans are best for which types of cash flow need. Sarah highlights why it is important to get the right Business Loan product for your needs, and some of the different types of lenders (even heard of a FinTech?). This is a great listen for anyone with a business, whether borrowing is on your radar or not.

Podcast Transcript Available Here

Duration: 29:37

Sarah Eifermann: Welcome everyone to today's episode of Financial FOFU, we are talking today about Lending and Tax. Trudi Cowan: Yes, and in particular we're talking about lending from a business perspective, and borrowing for your business. Sarah Eifermann: Absolutely, absolutely. It's a common question that I obviously received but I'm guessing you do as well Trudi based on. Trudi Cowan: Oh, from time to time, from time to time. Yes, definitely, in the context of having discussions around cash flow, as well as discussions around the need to purchase particular assets for a business. Sarah Eifermann: Yeah, so part of tax planning sometimes as well. Right. Trudi Cowan: Definitely. Sarah Eifermann: Yeah, completely, completely. So I thought we would start with maybe sharing what people, you know what they need to have when they need to prepare to, get their finance, it's not too dissimilar to what happens if you've listened to some of our previous episodes about what you need to prepare if you're self-employed, usually, speaking, most of our clients are self-employed. So, it's kind of the same sort of thing. So, depending on the type of lending that you're looking at doing. will really change the what's the word I'm trying to say, the type of lending that you're doing will really change the needs that are required that you need to prepare so for some types of loans, with particularly major banks, you'll need to have your financials up to date, you may need to have up to date bank statements. especially if you haven't done your previous year's tax return. Trudi Cowan: We've talked about that. Sarah Eifermann: So that will require up-to-date books, so sometimes it could be two weeks to a month's worth of work that needs to happen before you're in a position to even approach a broker or a branch directly. Trudi Cowan: And that's why it's always good to have that chat with your accountant as well. let them know that you're gonna be going to this finance at some point in the future so let's get these things up to date and ready to go. Sarah Eifermann: Yeah, I suppose want to raise the point just there though, so it's coming out in the market, at the moment that accountants trusted advisors well we know that, but a lot of businesses are turning to their accountants for lending advice and lending options and when it goes on lending, and I want to point out that accountants, unless they have one are not qualified to talk about credit. Trudi would never talk about credit with you specified credit products and lender options because ethically that's not what she does and legally she's not qualified. As I don't talk about tax, so it's really important that your questions that are specified to lending and lending products go to either a finance broker or a branch staff member or business banker and not to your accountant specifically. When we're talking about up-to-date information, usually this type of finance, you need to have two years' tax returns, and some lenders will do one year that's great, but when we've just ticked over a financial year. We're reliant on the previous year. It's been 13 months since that financial year ended if we're looking at, you know, a late July, August, calendar, timeline that you're looking to do some lending on. Trudi Cowan: A lot can happen in 12 months. Sarah Eifermann: Well, yeah, so that's when I say we want bank statements but usually what happens is if you haven't done the latest tax return and yes it's not due until May if you watch it through. Trudi Cowan: For a lot of clients depending on the size of them sometimes a bit earlier if they're a big business. Sarah Eifermann: Yeah so, I mean, and that's the thing, like if you wait too long to get them done, you may not have to pay your tax until later but we've talked about this previously, leaving it too long. How do you know where you're at in terms of your business and our business plan episode we ran through this as well as in our tax planning episode, but the issue from a lender's point of view is that it doesn't give an accurate position on where business is right now when it's coming to do the lending now and for future. And so what we often say is get your tax done if you can, because if we're relying on bank statements to justify the income, then there's going to be more questions potentially about depreciation and interest and you're going to need your accountant, potentially to write you a letter, and 1, they need time to go through your financials and you're up to date books to do that, which means your book needs to be up to date, and 2, accountants are really not in a position to make statements about your current or future position that isn't facts. Trudi Cowan: That's right. and this is very much a topic in the industry at the moment, a lot of banks are asking for letters from your accountant, but we can very much only include things in those letters that are fact. So your profit at 30 June, in your financial report was x, and here's a copy of your financial statements to show that. if we don't have those financial statements done, Or we don't have your tax return done it makes it a lot more difficult for us to make those statements, and we going to need a bit more time as well to do that work, to be able to make those statements in order to submit any required letter to the bank. Sarah Eifermann: Yeah, completely. And again, all of that stuff takes time, so if you're not up to date and you go and you launch an application and you sit in a queue, you could wait six to eight weeks in the queue and not realize when the business banker comes back to you and says on now we need a letter from your accountant to justify this. But you told me that we could rely on 2020 tax returns oh yeah I did but we need to confirm your income for this year. So, you know, like when you do the painting when you paint a room, preparation is 90% of the work, it's the same for when you prepare for a lending application, the preparation is 90% of the work. Using somebody that is experienced in this space business lending is not something that most mortgage brokers will have technical knowledge in, they may do it, and amazing if they do, but it is really quite a niche specialty so find a broker that actually knows what they're talking about when it comes to this type of lending. So that's if you're going for a major lender or some second-tier Fintechs use financial statements, but then the flip side of those are those fintech or institutions that don't and they just rely on your bank statements, and they use bank statements.com For example, to log into your portal and they'll take 12 months worth of your turnover and they'll adjust that for what they're prepared to lend you. and that may be if you turn over $100,000 a month, they may be prepared to lend you one and a half times which would be 150k as a loan limit. So those are sort of lenders, a lot easier to potentially get finance from but you pay for it in other ways, and that's what we really want to talk about today is different types of products that might be a nice segue across into how do you choose the right loan feed business needs. Trudi Cowan: Before we segue. What's the fintech.? Sarah Eifermann: Oh, well yeah, financial technology companies, so the institutions, they may be a bank, they may have a banking license but they're usually a company that has got what's called a wholesale fund. And so that people give them money to loan out, and they use technology in their processing for how they assess applications, how they deliver that product to you, how it works in the back end with the portal. Trudi Cowan: Can you give us a couple of examples we might be familiar with. Sarah Eifermann: A lot of people are familiar with Maula and Prosper, for example, they're pretty well known in the marketplace these days, but literally, there's a list as long as my arm of the different fintech that are sitting in the marketplace currently So, okay, they all have slightly different products, a slightly different service proposition, slightly different offerings in terms of timelines for turnaround time and giving finance interest rates, it really depends on the restrictions that their warehouse fund puts onto them and where they think that they're happy to sit in the marketplace. so you know, from a safety point of view, as an institution lending money where they want to sit. Trudi Cowan: Okay. All right. So, if we go on to types of loans, or why we might like to borrow it, which should we talk about? Sarah Eifermann: Maybe we'll talk about why we might like to borrow. Trudi Cowan: Why we might like to borrow. so the two main reasons that I see is that, either. There's a cash flow, need, you might be a product business where you need to outlay money on the product and the sales aren't going to come for some time later so you just need to bridge that cash flow timing space, and the second would be that you need to purchase some form of asset to help your business so that might be some equipment, or a factory or some sort of industrial site or a car, and you need some finance, in order to help you be able to afford that particular set. Sarah Eifermann: Yeah that's pretty much all of them. Trudi Cowan: That's the main two reasons you say as well? Sarah Eifermann: Yeah, look. Traditionally you either need funds for growth and growth could come as an asset, like a piece of equipment. Invest in feeding out a factory, or if you take on a lease it's a lease fit out, so that it's either growth and expansion or cash flow, they're really the main reasons that I say. The other reason may be, debt consolidation, but debt consolidation has usually come as a result of you've had the wrong facilities in place, and you haven't planned out your cash flow, and your turnover, and then you've had market factors that may have changed what your projected position was gonna be like, COVID. Trudi Cowan: So that's really just refinancing existing loans, already in place. Sarah Eifermann: And they fit through back under you either took the original debt for growth or for cash flow. Trudi Cowan: Yep. And I'm presuming therefore that depending on the type of the reason you're borrowing the type of loan is going to vary. Sarah Eifermann: Yeah 100%. So you mentioned a couple of different reasons, before as to what you would do and you mentioned a factory. So, if you had to buy a factory, you would be looking at a commercial loan because the asset class of real estate is commercial, it's commercial factories commercial. The same goes for an office space or retail shop; the clause is commercial effectively from a lending point of view. So, because the security that is being used with something work that type of lending is the asset so the shop or the factory. That's a secured loan, and it's a property loan, a commercial property loan. Trudi Cowan: It's really working in a similar way to a mortgage, just talking about it in a commercial sense? Sarah Eifermann: Yeah, absolutely. They usually have more restrictions than home loans and higher interest rates but yet, pretty much, otherwise, very similar. From that point of view. So that's probably the one that sort of sits slightly separate to traditional forms of business finance because you could be an individual person that just likes to invest in commercial property, and you can still get a commercial loan so it has like a dual purpose it can either be for an individual or for business use, You may choose to buy in a family trust. Trudi Cowan: It's really coming down to the nature of the asset that you're buying the commercial nature rather than the fact that you are operating unnecessarily a commercial business. Sarah Eifermann: Correct. In this instance you would just be self-employed, purchasing, and your entity type, whether you're buying in a trust, whether you're buying in a trading company. And what that looks like that's the borrower though, not the loan type. So, yeah, as opposed to a business loan for example. Trudi Cowan: And I'm assuming a business loan therefore is something that's a bit more general in nature is that more a cash flow type loan. Sarah Eifermann: Look, it depends, like a lot of people use business loans for refinancing existing debt but yes you can use it. So again it comes back to that business plan, what's the debt for how long am I going to need to pay this debt off, and can I afford the repayments and the term is usually longer on a business loan. Either it's two to three years or five years depending on the institution. And the thing with a business loan is that it's a set term, often it doesn't have a redraw facility in it, so you take a $100,000 loan, and over five years you pay that off in monthly installments so you'll make 60 payments on that loan. And at the end, your debt is gone so if you know for example that you're going to fit out your factory, and you don't have the money to fit out the factory, but you know that you can afford to pay $3,000 a month to fit out that factory and that the debt will take you three years to pay it off, if you're going to do that, that's potentially a better loan option for your needs for your business than trying to take that on the credit card or an overdraft where the interest rate is much higher. And then there's no set repayment term so it really comes down to, we've talked about this so many times about knowing what your cash flow is, what your projected cash flow is in your business and being able to match. You know it's like that mix and match. Trudi Cowan: Yeah, we're purchasing a long-term asset and matching it with a longer-term form of finance. Which makes more sense for getting a better interest rate than what you would offer for the short term. Sarah Eifermann: Yeah, completely. Trudi Cowan: Arrangement, and I presume that business loans can be secured in certain circumstances. Sarah Eifermann: Look, they can. Yeah absolutely, I mean the government back guarantees the GGS government guarantee scheme that is available, they have one, two, and three, which includes bushfire and COVID related. I can't think of the word it's literally slipped my mind. But when you qualify is the qualifications, is the word so if you qualify if you, if you're affected by the bushfires or you store saving job caper between January and March 2021 you qualify for the that's secured by the government. But sometimes business loans can be secured to a house or a commercial property if there's equity available in them so they can be secured. Yes you will get a slightly cheaper rate again if they are secured, but it's just important to realize that your house is the security for that. And that comes with additional risks. Trudi Cowan: And the bank sometimes asks for personal guarantees from the business owners as well. Sarah Eifermann: Yes, yes. So sometimes even if your house is not the security, the personal guarantees portfolio which means if anything happens and you don't pay back that loan your house could be on the line, which is why it's important that you have quality advisors around you that explain these things for you and that you've read the documents that you signed. Trudi Cowan: It is definitely important to read the documents that you're signing. I had an example recently where the client, buying a commercial property and the bank was getting them to sign a particular guarantee that basically put all their assets on the line which was not what they had agreed to in the first place so if they just signed those documents without actually reading them. You know that they fully intend to repay the loan but if something was to happen, they're putting assets at risk that was not the original intention, and which didn't need to be put up as security in the first place for this particular as well. so it is very important to read anything before you sign it. Sarah Eifermann: Yeah, so the next type of loan we've got is a line of credit or an overdraft very similar to a mortgage line of credit in that it's like a big credit card you can say you've got a limit. And as you draw down on that the interest gets charged and then you pay it back in lump sums there are no set repayments, often it's either called Evergreen so that the limit never reduces or can have a set term, the difference between a line of credit and an overdraft. Is that an overdraft is an account that's attached to your trading account, and you draw the overdraft into debit. So your bank account goes into a negative, whereas a line of credit is usually a set facility, a separate facility where you take the money out, you put it into your trading account, and then you use the money. Trudi Cowan: And I say I've addressed a lot of my business clients, particularly where they just had a very occasional need to fill their bank account to go into negative, you know, typically only quite small amounts, but it gives them a bit of a safety net, and if they're having a bad month or if a lot of bills come in at once. They still got the cash flow to cover those expenses. Sarah Eifermann: Yeah, exactly, exactly. So, they are really good for that cash flow management sort of style or if you've got payment terms that are delayed, but not necessarily for invoices. invoice financing or debt financing as a separate type of trade facility, and you use that for quick and efficient cash flow, but it gets secured to your invoices, and it's based on the terms that you have on your invoices. Trudi Cowan: So we're talking invoices receivable here? Sarah Eifermann: Yeah, yeah, accounts receivable, yeah. Yeah, so usually they'll pay up to say, 80% of the invoice to you in cash, on the day that you issue your invoice, and then often what happens is that the invoice gets paid to them, and then they give you the balance of that 20% Minus their costs, so they can be really valuable depending on the type of business that you have. They give you really quick access to cash, and they can be reasonable in terms of the interest rate, but it really, Trudi Cowan:That was going to be my question. I was like this would be something that would have a higher rate, but they can have reasonable rates if you shop around for the right one? Sarah Eifermann: Look, everything comes down to the cost of funds in business lending, as opposed to the interest rate. So, what will it cost me in terms of operating? What if a job costs me 100% Sorry I get paid 100% on the job and then 50% is my materials and my profit margin is 40 say 48%. Can I afford 2% of the cost of the invoice so that I get paid straight away so I can keep trading, right, as, but if your profit margin is really low, you don't have the 2% to pay for the privilege of the facility? Trudi Cowan: If your profit margin is really low, it's kind of highlighting other potential issues in your business right. Sarah Eifermann: So, again, all of this kind of lending it's really important that you do have that working business plan, you know what your cash flow is at what you're doing what you're trying to achieve because without it, you could end up with the wrong facility and end up costing 1000s of dollars, sometimes a higher-priced facility for a shorter period of time to get you over a big hurdle in business and keep your trading to get that profit payday is a much better lending option than trying to fight a major bank, or an institution, to give you a cheaper interest rate for different facility? Trudi Cowan: Well, a shorter term loan at a higher rate, can sometimes be cheaper than a longer-term right, longer-term loan at a lower rate. Sarah Eifermann: So right so short term debt or long term debt soft debt or hard debt, is how we sort of refer to it here. So if you know that like that factory fit-out really is hard because it's a longer-term asset. Yeah, you're not being able to pay wages this week because a supplier hasn't billed you correctly, or you haven't been paid correctly by a client that's soft term debt because if that's gonna happen regularly, you're not trading solvently. Trudi Cowan: So what I'm hearing here really is don't rock up to your business broker saying, I need a loan without knowing why you need the loan, what are you going to use these funds exactly for. How long do you need these for what type of assets or cash flow are you funding? Because, without that information, it's very difficult for the broker to determine what is going to be the right type of loan. Sarah Eifermann: And I think it's really important to say that some banks don't offer all of these types of facilities. They either only have an overdraft or a business loan or they only, and some financial institutions some fintech only have a debt to finance. So one of the benefits of using a finance broker in this instance is that they have multiple lenders, therefore multiple products or multiple product types. So that's, you've got a great relationship with a business banker at a major lender, amazing, really glad to hear that. That is genuine for me, but don't cut your nose off to spite your face because they may not be able to offer you all the range of products that are on the marketplace. Trudi Cowan: Yeah at the end of the day it's their job to sell you that loan so they're probably not going to bring to your attention that they don't offer all the different types of loans. Yeah, in the marketplace, they'll tell you what they do offer and how that might work for you. Sarah Eifermann: Slight conflict of interest that bankers don't legally have that brokers usually get thrown under the bus for, that's a different conversation. Trudi Cowan: So look, there's one other category of commercial loans that I don't think I've covered which is really the equipment finance which to be honest I most commonly see with cars. Sarah Eifermann: Yes, but equipment finance can be for a range of things it can be cars, it can be for yellow goods or excavators, dump trucks like all of that sort of more construction-based or agribusiness agricultural-based product, specialized machinery, but it can be for medical and dental machinery, it can be for your appliances. Yep. Yeah, in your restaurant, it can be for internal fit-outs and furniture. Yes you can get a lease for that. I've seen gym finance. Trudi Cowan: Yeah that would make sense. Sarah Eifermann: Yep, their physical equipment with equipment finance loan office equipment, computers, there are plenty of options. The question is once again, what's it for? How long is the debt gonna be around for? how long are you going to have the piece of equipment for because let's be honest. Equipment we usually keep it's a shorter-term debt facility. Like all the equipment you don't keep it as long because you depreciate it, it wears and tears you trade it in you get something new. So, the one thing the biggest piece of advice I have for this is to make sure that the equipment finance is right for you needs its own to be either a mortgage slash commercial loan these days. Higher purchases are kind of gone or an operating lease, and the difference is whether the equipment sits on your balance sheet, or the lender's balance sheet. So again, conversation with your accountant is really important to make sure that it meets your tax positioning and we're going to talk about that in a moment. But yeah, so lots and lots of different things to consider with that. And the final tip that I've got on equipment finance is to make sure that the balloon that you take matches the asset so often I see clients that did the five-year term with a 20% balloon because it made the repayments cheaper. Trudi Cowan: But then it's probably not worth that at the end. Sarah Eifermann: It's not worth it in the end but also often the asset like five years is a long life cycle like two years is a long life cycle in business so they often want to trade the asset in because especially if they're a growing business. It no longer meets their needs so they bought just a unit but it had a tray on the back of the normal tub, and sorry, so it had the normal tub they needed a tray. And so they wanted to upgrade to get either a tray or a larger vehicle, and so now not only with the commercial loans like this. Do you pay the interest upfront as part of the repayments in the first 12 months because that other loan term works because it's a fixed rate fixed repayment. On most facilities, but now the asset, they still owe a heap of money on the asset because they extended the repayments across five years so when they go to trade it in at two or three years, they have what's called negative equity, or a shortfall on what the debt is outstanding versus what the trading amount is on the vehicle. Trudi Cowan: Which is, again, still not good for your cash flow so it comes down to that right matching of the right loan type but also the right loan term and conditions to what you're borrowing. Sarah Eifermann: Yeah, completely. So, I suppose that's a really good time to chat then about what potential tax implications would be of this type of lending/asset purchasing. Trudi Cowan: So for most of these types of finance. You know you're purchasing and let's just say we're purchasing an asset that asset comes on to your books, and then that's going to apply the usual tax depreciation or write off rules that we've discussed many times, either written off over the life of the asset or under the current temporary expensing rules you may be able to write off the full value of that particular asset. In terms of, I guess, the loan repayment itself, the repayment of the loan is not deductible. That's just a capital repayment from a tax perspective but it's the interest component, which you should be able to get a tax deduction for. And it's deductible, over the life of that loan. Really So even for example on the equipment finance where you said the interest component is really paid upfront. If it's a three-year loan we would still be spreading that interest deduction across the three years of the loan. because that's actually the period that they mean if you have paid at all. Yeah, upfront. So that is the interest that really is that the texts relevant I guess component of the loan. Sarah Eifermann: Which is interesting, then though because if a client has painted it up front and then paid the loan out for the terms finished, they'll have paid the full interest amount but they won't have been able to claim it. Trudi Cowan: Well, you would then do a calculation at the closeout of the loan. Yeah and so you might get a more lumpy interest deduction in that final year when you close it out. Sarah Eifermann: I suppose the other point I would like to raise here is that if you have an operating lease where the loan, and the asset. So the asset stays on the lender's balance sheet so not only yours, that the instant asset writes off and the depreciation. Don't apply because Trudi Cowan: No. Yeah, in most cases, you wouldn't own, or hold the asset which is the technical word. So, if it's a genuine operating lease for tax purposes, where you are just leasing the asset and the lender owns the asset and you had to have gotten the rights over the asset you had to be in, then it would be the full lease payment. Sarah Eifermann: That will be claimable though. Trudi Cowan: That would be more claimable as the tax deduction than the asset cost itself. Sarah Eifermann: So it's again another really important part of tax planning is to know what you're trying to do, and what is beneficial for your business. do you take a depreciation and interest deduction, or do you try and take 100% lease repayment, because that principle repayment is not deductible. Trudi Cowan: Yeah. And that's also why it's important to make sure that when you do sign these things that you're making sure you're keeping copies of all these documents. Yeah because your accountants are going to ask for them so that they can check for themselves exactly what type of arrangement you've entered into and then how the text would then apply the payments that you're making. Sarah Eifermann: So any final tips for today, for our listeners Trudi? Trudi Cowan: Well, for me, the takeaway is you know you need to speak to both your accountant and your broker let them work together to help you out. Really understand, why are you borrowing this money. It's not just a general thing for your business. You know what are the specific reasons that you're borrowing this money. And finally, before you, you know, start applying for the loan, make sure that you've got financials invoices and tax returns and things all ready and it's up to date as they possibly can be. To avoid any complications down the track. Sarah Eifermann: Yeah, I think you've labeled them all there. My only other comment on that would be maybe have a quick chat with your broker first let them know what you're thinking of doing, because they may say to you, You won't qualify anyway, we need to look at a lender that only uses bank statements.com. And then you don't need to go down that process with everything else. So yeah, that's the only point I've got there. Well, I think that was a nice quick episode today that highlights that. if you've got any questions as always feel free to shoot them through on our socials or leave us a message on Anchor. You've been listening to Financial FOFU. I'm Sarah Einfermen. Trudi Cowan: And I'm Trudy Cowan. Sarah Eifermann: Cheers. Trudi Cowan: Thanks. Sarah Eifermann: Bye

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