Averages – They Don’t Work
If you are not one for reading blog posts then there is a video version of this post available.
The financial world loves averages. A quick Google search of the word ‘average’ brings up suggestions of ‘average interest’, ‘average income’ and ‘average life expectancy’. The whole world of statistics is driven by average figures, the financial world loves statistics and loves to quote everything against an average.
If I was to ask you if you were average I cannot believe anyone would say yes. There is not an SME out there that considers themselves average, there is not a person that thinks that way. Every one of us in some way is unique and totally not average.
And therein lies the problem.
A while ago I was explaining inflation to a group of business students. They told me, quite rightly that the average rate of inflation was (at the time) around 1.5%. They explained to me that this meant that what I could have bought for £100 last year would now cost £101.50.
The problem is that the whole measure of inflation, like other financial statistics, is based on average figures.
For that group of students I explained what inflation meant for them. I asked what they were spending their money on. It was things such as;
- A first car
- Electronic goods
The price of used cars has fallen, TV’s and other electronic goods have come down in price, clothes from retailers such as Primark or New Look have seen prices remain static and alcohol is definitely cheaper than when I was their age.
For that group of students they were seeing deflation not inflation. Any financial statistic is personal to you, the average does not apply.
The same thing applies to borrowing money.
Head, Oven & Freezer Analogy
Loan underwriting is about taking the average statistics and applying them to the individual. This method creates statistics which can be used to identify risk which in turn allows a lender to make a call on whether to lend or not.
The problem is that an average borrower does not exist with any commercial borrowing. It is slightly easier to apply statistics to personal borrowing due to the income cycle, but for businesses it is much more difficult.
Whenever a lender declines a loan based on ‘average’ figures then the Head, Oven & Freezer analogy comes into play.
If you are ever quoted the word ‘average’ when a decision is communicated to you then quote the analogy.
If I lie with my head in an oven and feet in a freezer then, on average, I am at a comfortable temperature. In reality I am anything but comfortable.
For most businesses they have times when they are in an oven or a freezer, or sometimes both. Over a period of time you can apply an average to things. If you are borrowing for your business then the chances are it is because you are either in a peak or trough, oven or freezer. Rarely is finance ever required when things are steady and consistent.
Don’t let a lender ever quote you on averages, you are much better than that…
By Dave Farmer
Lime Consultancy is a commercial finance broker specialising in trading business and property finance. Please add any comments using the button below or feel free to get in touch.