Economics/business question on credit

[bigrobbierob]

I recently heard of something I was unaware of and it's one of the things hurting businesses during the current credit crisis. I hope I explain it well.

Lets say I'm the business owner. I have vendors for my products I resell. They have me on credit so that I have either 30,60, or 90 day terms to pay them.

But I also have credit from my bank. I use the credit from the bank to pay my employees and buy the inventory.

Hopefully the customer pays me and I repay the bank.

But if the bank quits lending me money, I can't pay the employees or vendors. Business grinds to a halt.

So why do businesses do that (pay employees/vendors with loans/credit) as opposed to having a business account that handles money? ie using profits to pay for employees/inventory directly.

 

[suncloud]

some times you have to loose/borrow money for a few years before you can make the money - i.e. you have to build up the solid customer base before you can do that. if that's not done, then customers see items out of stock, limited supply, etc, and usually go elsewhere.

that's what i think at least.

just like restaurants. you have 3 years of work before you can pay back the investors (on average), and after that its all profit. but that means for the first 3 years, there's no money for the owner to make.

EDIT : robinkuwait or is my guess off?

 

[Dwight Schrute]

I recently heard of something I was unaware of and it's one of the things hurting businesses during the current credit crisis. I hope I explain it well.

Lets say I'm the business owner. I have vendors for my products I resell. They have me on credit so that I have either 30,60, or 90 day terms to pay them.

But I also have credit from my bank. I use the credit from the bank to pay my employees and buy the inventory.

Hopefully the customer pays me and I repay the bank.

But if the bank quits lending me money, I can't pay the employees or vendors. Business grinds to a halt.

So why do businesses do that (pay employees/vendors with loans/credit) as opposed to having a business account that handles money? ie using profits to pay for employees/inventory directly.

Mainly expansion. Business after a certain level is not a cash business unless you want to grow at an extremely slow pace and have your competition increasingly take market share from you especially in industries with low margins. If one company takes the risk to borrow and raise capital for expansion, you are going to lose out in the end if you do not follow along and learn how to manage it properly.


That is a VERY generalized version of it. If you want a more expanded version, ask CDB.

 

[roids1]

revenues should always be enough to cover routine expenses (inventory and SG&A). If it's not, that's a sign of trouble, with start-ups being the exception. Credit should generally only be used for expansion and only sporadically used for those purposes when times are tight.

 

[Dwight Schrute]

revenues should always be enough to cover routine expenses (inventory and SG&A). If it's not, that's a sign of trouble.

Not always. It could be a sign of extreme growth.

 

[roids1]

I mean generally speaking, long run. During an expansion, a lot of debt might not be bad at all.

 

[bigrobbierob]

The reason I ask is I have heard with credit drying up some companies had a hard time meeting payroll.

I know where my wife works borrows for payroll and to buy inventory. The money made from sale pays the lender back. That sounds messed up. It's not borrowing for startup or expansion, it's just the way business is done.

 

[roids1]

The reason I ask is I have heard with credit drying up some companies had a hard time meeting payroll.

I know where my wife works borrows for payroll and to buy inventory. The money made from sale pays the lender back. That sounds messed up. It's not borrowing for startup or expansion, it's just the way business is done.

A lot of businesses have a LOC for when receivables are running slow. They also put inventory on credit thru the vendors and pay for it 30 to 90 days afterward. It's still short term credit.

 

[Dwight Schrute]

it's just the way business is done.

Correct.

 

[EasyEJL]

yeah, that doesn't mean its smart though to have cashflow at the point where you can't pay your basic expenses out of direct income