In Chapter 7, I wrote about how savings can help you create a network. Savings help you build your net worth which in turn is one way of building your network. Society is attracted to wealthy people hence you will find that once you are wealthy it is easier for you to access any network you want. More often than not the higher your net worth the more important the networks you are able to join. This is why the world’s richest individuals become key decision makers in the geopolitical issues of the world. It is also true that rich people are invited to networks rather than the other way around. Such is the power of savings. I ended with a quote from Jeff Bezos which summarizes the link between wealth and networks; “Life’s too short to hang out with people who aren’t resourceful”.
In my over 30 years of banking experience I have learnt that you need money to attract capital (i.e. the money you need to start a business or project). As a practicing lender, one of the first questions I ask my borrowing customers is how much of their own money they have invested in the project or business they want me to invest depositors funds into. This means that for you to borrow you need to have saved.
A demonstrable ability to save gives comfort to the bank that you are serious about the project or venture you are borrowing to finance. As they say, you need to put your skin in the game as a sign of commitment. The acid test is demonstrating that you have something to lose personally if the project was to fail.
In assessing a project for financing, banks compute and rely on many ratios to inform them about the project’s chances of success and ability to repay the loan. One of the key ratios is the Debt to Equity ratio. This ratio computes an individual or company’s leverage (i.e. the amount you borrow versus the amount you have invested from your own savings) and is calculated by dividing the entity’s total liabilities by its equity. The higher the ratio the riskier the project as the entity may be overwhelmed by debt service commitments, typically interest and capital instalments. Savings therefore help shore-up one’s equity thereby reducing the debt service burden. Savings also make sure that a project has a better chance of survival in difficult times as equity, which is built by the shareholder, is more patient. Debt, on the other hand, once issued to the individual or company, becomes payable at predetermined times irrespective of whether the project is performing well or not.
The importance of savings also goes to the core of banking in that the Bank’s balance sheet is made up of 2 side. One side is made up of liabilities. These are amounts that the banks owe other people or entities, typically deposits from its customers and shareholders, the savers! On the other side are the assets which are typically the loans that banks issue to those that want to borrow. This is why banks are normally referred to as intermediary institutions. They link those that have excess funds (i.e. Savers) and borrowers. Borrowers are those that do not have money immediately but have productive use for the money before the savers demand it! It follows therefore that without savers, banks will be unable to lend money. It also follows that for banks to lend longer term there should be savers who are also able to keep their money in the bank for longer periods. This is why savers are critical in capital raising initiatives.
Accordingly, next time you think about starting a project you should make sure you have saved enough to be able to raise the equity that makes your project less risky financially. This will help you to convince the Banks that you are worth lending to as your project’s debt to equity ratio will be much lower and attractive to lenders.
I have spoken about how one can save to access financial markets through borrowings, but have you thought of an even more satisfying achievement which is to save and accumulate all the capital you need for a project and avoid debt altogether? This is an option for those who are risk averse and require the peace of mind that no one has an interest in their project or idea, and they stand to benefit from all the profits from their project. When a project is financed totally through savings it is more resilient to down turns and is therefore unlikely to attract the attention of third parties such as banks, debt collectors, lawyers or other shareholders who may be invited when we do not have enough capital.
Here is a tough quote from Bill Gates which goes “If you are born poor it’s not your mistake, but if you die poor it’s your mistake”. I am sure this quote will torch a lot of debate in many circles!
This is why you must talk to your banker or financial consultant now and enjoy the benefits of saving to build your equity and to increase the amount of debt you can avail for your project.
Author: Ralph Watungwa
BAZ President
ENDS