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No Money Down Borrowing

The fundamental philosophy of any business is to increase profits. One way to increase profits is basic--reduce costs. Cutting costs can be accomplished in many ways. One way is to be more efficient. Another way might be to expand the business to enable a reduction in production cost per unit. Increased efficiency, expansion, or whatever adjustments are implemented often translates into the purchase of sophisticated equipment--expensive equipment. But, in the long run, costs are cut and profits increase yielding the desired objective.

But what about the short run, i.e., now?

In the minds of many business persons the short run picture is bleak. Here is a typical example. Mr. Bleak owns a small record distribution company. His profits are currently next to nothing. He evaluates his situation and concludes he could increase his profits $2,000 per month if his business owned a better computer system.

So, he goes shopping. After much research he decides on a particular model. The computer system he chooses retails for $10,000. He offers the dealer $6,000. They go round and round and finally settle at $7,000. The salesman writes up the proposal invoice. With the invoice in hand Mr. Bleak heads to the bank.

The loan officer agrees to lend him $5,600--80% of the proposal. The payments come to $180 per month for 48 months.

Remembering his previous calculation that the computer will increase his profits by $2,000 per month, he is ecstatic. Even with the $180 payments he still nets over $1,800 per month in his pocket. That is over $20,000 a year--not bad.

But wait. You guesses it, he has forgotten one thing. If the computer costs $7,000 and the bank is lending $5,600, he needs a $1,400 cash down payment. His cash flow is tight and $1,400 is $1,300 more than he can afford! Consequently, Mr. Bleak continues his business without the new computer system--and without the $20,000 profit it would generate.

Here is another example. Mr. Bright also owns a record distribution business. His profits are currently next to nothing. He evaluates his situation and concludes he could increase his profit $2,000 per month if his business owned a better computer system.

So, he goes shopping. After much research he decides on a particular model. The computer system he chooses retails for $10,000. He asks the salesman for a written proposal invoice for the retail amount--$10,000. Mr. Bright heads for the bank. The loan officer agrees to lend him $8,000--80% of the proposal.

Mr. Bright returns to the dealer and offers him $6,000. They go back and forth and settle at $7,000. Mr. Bright contacts the loan officer again and tells him he only needs to borrow $7,000 instead of $8,000. The loan officer tells him his payments will be $208 per month for 48 months.

Mr. Bright purchases the computer and utilized it in his business. Mr. Bright pockets almost $20,000 more than Mr. Bleak in the next year. In the following year, Mr. Bright is able to lower his prices. He undercuts Mr. Bleak and most of Mr. Bleak's business clients switch to Mr. Bright. Mr. Bleak goes bankrupt. Mr. Bright realizes an additional $10,000 profit from Mr. Bleak's old customers.

Conclusion: Mr. Bleak's future resembles his name--both short and long run. Mr. Bright's future, on the other hand, looks promising both now and in the future.

Here is the outline to no money down borrowing:

1) The buyer obtains a written proposal invoice showing the suggested retail price of the equipment.

2) He secures the loan at 80% of the retail price (standard loan).

3) He returns to the dealer and negotiates a purchase price with the salesman for at least 20% less than the suggested retail price. He does not buy unless there is at least a 20% markdown.

4) He pays for the equipment entirely with the bank loan.

Although this seems to be a smart way to borrow money, it can result in disaster! Mr. Bright could be worse off than Mr. Bleak if he has miscalculated the increase in profits that the computer system will generate. It is possible he would be stuck with $208 per month payments and no increased revenues! This can happen--especially since equipment purchases, particularly high tech equipment, often have many hidden costs.

Therefore, Mr. Bright would never use the "no money down borrowing" technique unless he could suffer the entire loss of $208 per month plus the additional overhead burden that would be brought to bear along with his shinny new computer! If he could not afford to lose it all, he would say no to this borrowing technique.

Borrowing money with no money down, for the smart business person, is done to avoid liquidating other assets he could afford to lose. It is not to enable "shoe string" business expansion. The shoe string technique has a very high probability of failing in the long run.


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