SecurityA bank won’t lend you money unless it thinks that your business can generatesufficient funds to pay it back. Often, however, the bank takes an added precautionby asking you forsecurity30—business or personal assets, calledcollateral31, thatyou pledge in order to guarantee repayment. You may have to secure the loan withcompany assets, such as inventory or accounts receivable, or even with personalassets. (Likewise, if you’re an individual getting a car loan, the bank will accept theautomobile as security.) In any case, the principle is pretty simple: if you don’t pay24. Period of time for which a bankloan is issued.25. Loan issued with a maturitydate of less than one year.26. Loan issued with a maturitydate of one to five years.27. Loan issued with a maturitydate of five years or more.28. Commitment by a bank thatallows a company to borrow upto a specified amount of moneyas the need arises.29. Schedule by which you’llreduce the balance of yourdebt.30. Collateral pledged to securerepayment of a loan.31. Specific business or personalassets that a bank accepts assecurity for a loan.Chapter 13 Managing Financial Resources13.4 The Role of the Financial Manager711
the loan when it’s due, the bank can take possession of the collateral, sell it, andkeep the proceeds to cover the loan. If you don’t have to put up collateral, you’regetting anunsecured loan32, but because of the inherent risk entailed by newbusiness ventures, banks don’t often make such loans.InterestInterest33is the cost of using someone else’s money. The rate of interest charged ona loan varies with several factors—the general level of interest rates, the size of theloan, the quality of the collateral, and the debt-paying ability of the borrower. Forsmaller, riskier loans, it can be as much as 6 to 8 percentage points above the primerate—the rate that banks charge their most creditworthy borrowers. It’s currentlyaround 3 percent per year.Making the Financing DecisionNow that we’ve surveyed your options, let’s go back to the task of financing yourlaundry business. You’d like to put up a substantial amount of the money you need,but you can only come up with a measly $1,000 (which you had to borrow on yourcredit card). You were, however, able to convince your parents to lend you $10,000,which you’ve promised to pay back, with interest, in three years. (They werewavering until you pointed out that Fred DeLuca started SUBWAY as a way ofsupporting himself through college).So you still need $22,000 ($33,000 minus the $11,000 from you and your parents).You talked with someone at the Small Business Development Center located oncampus, but you’re not optimistic about getting them to guarantee a loan. Instead,you put together a sound business plan, including projected financial statements,and set off to your local banker. To your surprise, she agreed to a five-year loan at areasonable interest rate. Unfortunately, she wanted the entire loan secured.