Category: კატეგორიის გარეშე

Companies operating in any industry or market segment may need to obtain loans from banks. At this stage, many questions may arise, such as: what information do I have to present to the bank to obtain a loan? What collateral is needed for a bank loan? Is it better to take GEL loan, USD loan or EUR loan? What is the effective interest rate?

This article answers the above questions and provides useful information on bank loans and their characteristics.

 

What information do I have to present to the bank to obtain a loan?

In order to obtain loans from banks, the following information is often required:

• Information about revenues, which shall be provided by the company’s accountants and which is often verified through web-page operated by the Georgian Revenue Services (RS.ge);
• Information about the company’s expenses, which shall be provided by the company’s accountants;
• Bank statement, which reflects the cash turnover on the company’s bank accounts, typically for a period of a minimum of past several months;
• Company’s balance sheet, which reflects the company’s assets, liabilities and equity.
• Other relevant information that bank may need in the process of assessing the company’s solvency.

 

What collateral is needed for a bank loan?

Bank typically needs certain collateral to approve a loan. Collateral is the property that a company pledges as a guarantee for loan repayment. For instance, if you decide to take a loan to buy an office for your company, typically the bank would request the subject office to be pledged as a collateral for the loan. An alternative way would be to pledge a different property owned by the company as a collateral. In case the company fails to repay the loan, the bank would be entitled to possess the pledged collateral and sell it to cover the loan. Value of the property, which is intended to be pledged as a collateral, should typically be higher than the loan amount. For instance, if the property value is 100,000 GEL, bank may be able to only issue 80,000 GEL loan. This is necessary since, in case loan is not repaid by the borrower and the pledged property is to be sold to repay the loan, the selling process may take significant amount of time. To accelerate the sale, the bank may be forced to sell it for a discount to market value and price it at the so-called “liquidation value”. Another reason why the collateral value shall exceed the loan amount is that the bank assumes certain risks e.g. property devaluation risk.

 

Is it better to take GEL loan, USD loan or EUR loan?

As in the most cases, the answer to this question is – “it depends”. Both approaches – taking GEL denominated loan and taking foreign currency denominated loan – have its pros and cons as discussed below: key advantage of foreign currency loans (USD/EUR) is that they carry typically less interest rate as compared to GEL loans. For instance, USD denominated loan may carry interest rate of 8%, while GEL loan interest rate may be as high as 16%. The reason for this is that USD and EUR currencies are more stable, and GEL is less stable, which is natural and is caused by the fact that Georgia’s economy is less strong compared to that of the USA or EU.

On the other hand, key disadvantage of foreign currency denominated loans is that the borrower assumes exchange-rate risk, if, of course, its revenues are not earned in the same foreign currency as the loan itself. For instance, if company takes 100,000 USD loan when USD-GEL exchange rate is three to one (3/1) and in several months the exchange rate becomes three and a half to one (3.5/1), then in GEL terms, loan amount increases by 50,000 GEL and 100,000 USD is no longer 300,000 GEL as it was at the date of loan issuance, but instead is 350,000 GEL now.

 

What is the effective interest rate?

In accordance with Georgia’s law, any bank is obliged to let the borrower know the information about the effective interest rate. Typically, the effective interest rate exceeds the nominal interest rate. For instance, if a bank approves company 1,000 GEL loan with 10% nominal interest rate and 2% up-front loan issuance fee, the company will receive 980 GEL as net proceeds from the bank as opposed to the approved loan amount of 1,000 GEL. The 980 GEL is derived after subtracting 2% commission from the approved loan of 1,000 GEL i.e. 20 GEL. Therefore, the effective interest rate is calculated from the 980 GEL net proceeds which leads to higher interest rate as compared to the nominal interest rate. In other words, loan issuance fee increases the effective interest rate. Besides, sometimes banks have other fees and commissions as well, which cause the effective rate to be higher at say 10.5% or 11%.

IFRS accounting represents bookkeeping based on international financial reporting standards.

What is the difference between IFRS and cash based (cash inflow/outflow on bank account) accounting?

In order to better see the difference, let’s discuss an example. Assume company, that manufactures furniture, carries out all its transaction through its bank account and has no cash-on-hand transactions. At the end of January, the company manager logs into internet bank and sees that during January: GEL 100,000 was received from clients on the bank account. On the other hand, the company transferred GEL 70,000 to its suppliers and paid GEL 10,000 in monthly salaries. Based on this, the manager concludes that company’s profit during January comprised GEL 20,000. This conclusion, which is based on the bank account turnover, is wrong and does not reconcile with IFRS accounting due to the following three reasons:

1. Apart from usual orders, in January, the company received orders from client firms on manufacturing and delivering furniture within the next two months. To fulfill the order, the company requested GEL 40,000 advance from the client firms and received the amount in January. Therefore, from total of GEL 100,000 that was received from clients in January, GEL 40,000 represented advances received from clients. As a result, the company’s actual revenue for January was not GEL 100,000 but GEL 60,000 (advances received from clients, GEL 40,000, represent next two-month revenues based on IFRS).

2. To fulfill the above discussed order within the next two months, the company ordered wooden materials to its suppliers for aggregate value of GEL 18,000. The materials were agreed to be delivered by the suppliers within the next five weeks. Therefore, out of GEL 70,000 transferred to suppliers, GEL 18,000 represented prepayments for materials to be received in the future. As a result, the company’s actual material expense for January was not GEL 70,000 but GEL 52,000 (prepaid amount, GEL 18,000, represents expense for the coming months).

3. From total transferred salary of GEL 10,000 in January, GEL 1,500 represents salary prepaid to one of the company’s employees. The employee asked manager to pay him next month’s salary in advance due to some urgent personal needs. As a result, the company’s actual salary expense for January was not GEL 10,000 but GEL 8,500 (prepaid amount, GEL 1,500, represents expense for the next month).

Conclusion

To sum up, in accordance with IFRS, the company’s loss for January was GEL 500 (GEL 60,000 revenue minus GEL 52,000 material expense and minus GEL 8,500 salary expense) and not profit of GEL 20,000. Unlike bank account turnover, IFRS enabled the company to see the actual financial result for the month.

We are often asked – why should I do budgeting? Budgeting is something that only big companies need, while small companies only have few transactions, and everything is clear even without a budget. But, is this so?

Why should a company have a budget?

Most of the people know that budget is a plan for future, however benefits of budgeting far exceed those of a simple forecast. We can tell from our own experience that budgeting has three crucial advantages:

Budgeting helps the management to clear their thoughts and express ideas in the form of a
plan

While carrying out his/her duties, a lot of ideas may come to the mind of a company’s director (manager) on what he/she could do in the future, how he/she can improve company product/service and increase profitability. For example, manager might think that it would be a great idea to form quality control department in order to improve product of service. Or he/she may think that it would be a good idea to stimulate sales through digital marketing. Budgeting is a tool for transforming these ideas in specific plans. Namely, during the budgeting process, manager is planning future revenues and expenses. Detailed budgeting of expenses pushes managers to transform one or more ideas that he/she has to a specific plan and input them in the budget. For example, manager could allocate funds for digital marketing in the budget and input the amount as a planned expense. Manager could also estimate salary expenses needed to form and run a quality control department and could input such expenses in the budget. If it turns out that forecasted revenues are insufficient to implement all the ideas that came to the manager’s mind, or in case of implementing all of them would lead to sub-optimal profits, then manager will be forced to prioritize the ideas and implement only those ones that he/she believes are more important. Therefore, it can be concluded that budgeting helps  managers to organize their ideas, transform them in specific plans and prioritize implementation timeline for ideas based on their relative importance.

Budgeting pushes managers to act

As noted above, company’s manager may come up with number of ideas regarding business development and related projects. However, often these ideas are never acted on. It is common knowledge that reflecting specific idea in a budget and translating the idea in specific numbers ultimately aids implementation of the idea, which aids company’s development and growth process. Besides, budgeting helps managers to forecast possible difficulties and plan respective measures to cope with those difficulties.

Budgeting helps to better understand and digest the company’s existing financial and non-financial position

During the budgeting process, in order to forecast the future, management is forced to dive deep into the company’s specific nuances and translate those nuances in specific numbers. During this process, management better acknowledges the existing resources, past experiences and most importantly, those key factors (so called “drivers”) that cause the company’s financial performance. As a result, management develops a better sense of existing circumstances and this aids more informed decision making in the future.

Conclusion

Budgeting is not a theoretical process with nominal value. Instead budgeting brings significant practical value to both large and small companies. Budgeting helps to organize thoughts, make better sense of company’s existing circumstances and pushes management to act.