Consider this: you are an oil and gas service business and are confronted with road bans come Spring. In some cases, these businesses park their equipment and send their employees home for a well-deserved break until the roads dry up. In the meantime, cash comes in as the businesses are paid for all the work that has been done over the winter, however, operational expenses are minimized.

Now, you’re flush with cash, more than you need for operations… what to do with this good problem?

We at KBH often get this question: “should I make a lump sum payment on my loan?”

The first question we ask in return is, “what is the interest rate on the loan?”

Say it’s 5%; can you invest that money in something that earns more than a 5% return?

Most businesses can invest in employees and equipment and earn more than 5%, however, it’s important to note that there is no risk attached to paying down a loan. The 5% is guaranteed.

But let’s say you don’t need to hire, and you don’t need new equipment. Then the question we would ask is, “are you sure you have more cash than you need?” Remember, when the road bans lift and your team goes back to work, you will need cash on hand for expenses and payroll before your customers start paying you again.

Making a lump sum payment on a loan and then having to ask your bank to readvance the loan at a later date is indicative of poor planning; with your trusted advisor make absolutely sure that you won’t need this cash in the future and, ultimately, end up short of working capital.

Running a business short of working capital often results in interest charges from suppliers, late payment charges on tax remittances, inability to take advantage of early payment discounts, untold hours spent monitoring bank balances, saying a prayer as the post (wo)man pulls into the yard and determining which bills are ok to pay today.

In some cases, it is better to continue your monthly payments on the loan and keep the cash for working capital. You might consider reviewing twelve bank statements and finding the lowest balance in the year, if this balance is still more than you need for working capital, the lump sum payment on the loan likely makes more sense.

Now, consider another option: paying dividends to your shareholders or bonuses to employees, to provide them with some cash flow and a return on their investment or recognize their hard work.

Let’s summarize several options:

  1. Make a lump sum payment on your loan if you have enough working capital.
  2. Keep more working capital.
  3. Invest in equipment and/or employees.
  4. Pay dividends to your shareholders.

Ultimately, every business is unique and that’s where speaking with an experienced and trusted advisor comes in handy.