Why are borrowings good for your business? Why do we approach banks for business loans? Why do we say that 2:1 debt equity ratio is a standard ratio? Because it creates wealth. How?
You have rs 1000 and borrowed rs 2000. Your business return on investment (ROI) is 20 per cent. You have borrowed at 12 per cent per annum. It will create wealth for you. Your return at the end of the year is rs 600. You paid interest of 240 that is, 12 per cent on Rs 2000. You are left with 360 rupees. Return on Investment (ROI) on your own investment is Rs 200. Remaining rs 160 is your profit on other’s money. Now, if you decide to pay back rs 160 as principal amount. For next year, investment in business will remain the same as rs 3000. But your own capital will be rs 1160 rupees and borrowed money will be rs 1840 only. For the second year, your income is the same but the interest is less. Slowly, one day this amount of borrowing will become your own capital. In the next phase your own capital is rs 3000 and you can borrow rs 6000. So, you can grow and create a huge wealth.
But, the crucial decision is when to borrow? Where to borrow from? And, at what rate to borrow?
All these questions need to be pondered over before you make a move to borrow. Seek professional advice on these issues to create a win-win situation for you.
Very nice and very sugestive. Thanks