Friday, October 26, 2012

Is leverage still good?

This article is dedicated to someone I hold very dear.

In my latest post, "The Italian Government’s insider trading ", I wrote about the fact in Italy the financial system has been stuck by the government and the central bank. Those institutions poured huge amounts of money to the major banking institutions and those same bankers invested in Italian T-bond earning buku bucks in just a few months. The problem is that money wasn't invested in companies that needed mortgages for their business goals. 

The Italian economy is made of small to medium sized companies, which are near to bankruptcy due to their limited cash restrictions. On the other side, I was told by a big wig, that if the banks had not invested in the Italian T-Bonds, Italy would have gone bankrupt. In my opinion there is not a black-or-white position. The right way is in the middle. And in the middle there are deserving companies which didn’t receive the money they needed and now are in big financial trouble.

For the above mentioned reasons, this is the best momentum to explain if leverage is still good. In the last ten years, Banks gave money to everyone. Everybody knows it. And the Subprime Crisis is a widely known concept as I wrote in my post. History showed it was a destructive formula.

Now we are suffering for the opposite reasons. Banks stopped banking. And even if you are a healthcare company CFO, you are going to pay for the sins of others. Although this is a destructive way also. So, the right way is supporting only those businesses that deserve to be supported. But how can a banker trusts a company? There are tons of theories on “how to lend money”. I will focus on two of them I usually adopt with my banks.

Lien. If you have money, banks will give you more money. Money follows money. You will experience it once you have a 7 figure bank account. For the bank this is the easiest form to secure its own interest, but if a bank considers this form of lending as the only form to secure its interests then it can be considered as financially suicidal. Because not every business is a good business…

In addition to the tangible assets, banks should also consider how much cash flow their given money would generate. This is the basics of commercial banking. If you have a good business with a strong cash flow, you deserve a financial injection from the banking system, obviously if you need it. Unfortunately in Italy it ain’t always possible.

If I were a Banker, first of all, I would certainly consider the customer's cash flow. I run companies with solid cash flow figures and with solid assets. Sometimes in Italy I found it difficult receiving financial lending for my companies, or if I found it, it was too expensive. In other countries it's much easier. So my advice is simple: first you have to set up a business with a positive cash flow so that it will be much easier for you to find a Bank that understands your financial figures. In the end during these hard economic times I would focus on the debt. A debt is not good or bad. When you use a debt you are simply using other people's money. The debt is good whether it is necessary to generate a positive cash flow. If the positive cash flow creates a stream of cash to pay interests and the capitalization rate, then is a good debt. I use this type of debt. And if you need it, you need to have a supportive banking system. But if you have too many loan repayments you are going to be in trouble.

Never forget Leverage is like fire. You can cook your dinner with it but if the flames overwhelm yourself you will be dead in few seconds.

Use leverage only if you are able to live without it.

Luigi Foscale.

A note on Italy. Unfortunately Italy is not the best place to establish a new business because banks only give money to those who have a friend or a relative in that bank. If you have no connection, it can be really hard.

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