Guide to Business Debt

Understanding when to use business debt.

Debt is not inherently bad. When managed properly, it can help your business take advantage of opportunities and grow. But recognizing the right time and the right reasons for taking on debt is crucial:

Consider debt for investments that will grow your business.

Debt is often used for investments in areas like real estate, inventory, equipment, or acquiring another business that will increase profitability and contribute to long-term success.

Construction

In the construction industry, a loan can facilitate the purchase of state-of-the-art machinery or equipment that increases operational efficiency and allows you to take on larger projects.

Retail

For retail businesses, a loan can be pivotal in expanding inventory, especially before peak shopping seasons. Additionally, it can help acquire bulk inventory at a discounted rate, reducing overall project costs and increasing profit margins.

Healthcare

Healthcare providers can use loans to invest in new medical equipment, expanding their services.

Transportation

In the transportation sector, loans can enable the purchase of additional vehicles, such as trucks or vans, expanding service capacity. Investing in newer, more efficient vehicles can reduce maintenance and fuel costs, leading to higher profitability.

Restaurants

Restaurants can benefit from loans by renovating their space to increase seating capacity or create a more appealing ambiance. Additionally, funds can be used to upgrade kitchen equipment, enhance the efficiency of food preparation, and expand the menu to attract more customers.

Unexpected events and short-term cash flow problems.

Sometimes debt can be a solution to bridge a gap between a large, upcoming expense and liquid funds, as long as you have a plan to pay it back promptly.

For example, a construction or transportation company could use a business loan to cover ongoing expenses while waiting on final payment from customers.

Other factors to consider before taking on debt.

Before you approach a lender, there are several factors to evaluate to ensure that debt is the right decision for your business:

Your business metrics.

Evaluate your business’s debt service coverage ratio (DSCR) to determine if you have enough cash flow to cover new debt payments comfortably.

Market conditions.

Consider the current economic climate and market conditions that could impact your business’s ability to repay debt, such as interest rate fluctuations or industry-specific risks.

Your business’s financial health.

Assess whether you have exhausted all other financing options and whether taking on debt aligns with your overall financial plan and business objectives.

The purpose of the loan.

Be clear on how the loan will be used and how it contributes to the long-term strategy of your business.

Time to increase revenue.

Once you’ve decided to take on debt to invest in your business, understanding the timeframe in which you can expect an increase in revenue is crucial.  For instance, upgrading equipment may yield quicker productivity gains and revenue increases in manufacturing sectors, while investments in marketing or expansion might take longer to show tangible results.

Debt management strategies

Identifying your financial position and setting the right strategies is essential for effectively managing your business debt.

Create a debt schedule.

Creating a debt schedule might sound daunting, but it’s a straightforward process that can bring significant clarity to your financial management. Start by gathering all the relevant information about each debt your business owes. This includes lender names, the original amount borrowed, the current balance, interest rates, monthly payment amounts, and the maturity date for each loan.

Steps to Create a Debt Schedule:

1. List Each Debt: Begin with a spreadsheet or a table. List out each debt individually. This could include bank loans, credit cards, lines of credit, and any other form of debt.
2. Detail Loan Information: For each debt, record the total initial amount borrowed, the current balance owed, the interest rate, and the terms of repayment (such as the loan term or payoff timeline).
3. Monthly Payments: Note down the monthly payment required for each debt. This helps you understand how much of your monthly cash flow is allocated to debt repayment.
4. Update Regularly: Your debt schedule is not a static document. Update it regularly as you make payments or take on new debts. This will help you keep a clear picture of your financial commitments.

Manage your cash flow meticulously.

Effective cash flow management ensures you can meet your debt obligations and prevent undue financial stress. Start with detailed cash flow forecasts and consider seasonal trends in your business.

Increase your business revenue.

Boosting income through sales, diversifying your offerings, or exploring new markets can provide additional funds for debt repayment.

Cut unnecessary expenses.

Reducing costs by renegotiating vendor contracts, eliminating non-essential services, or finding more efficient operational processes can free up money to pay down your debt.

Negotiate with creditors.

If you’re struggling with high debts or interest rates, it’s worth reaching out to your creditors to negotiate more favorable terms.

Use windfalls wisely.

Any unexpected funds, such as tax refunds or a robust sales season, can be used to accelerate your debt repayment.

Consider selling off assets.

If you have assets not vital to your business’s operations, consider selling them to generate funds for debt reduction.

Use the snowball or avalanche method for debt payoff.

If you are managing debt from multiple sources such as credit cards and struggling to pay it off, consider adopting a focused method for paying your debt off. The snowball method involves paying off the smallest debts first, gaining motivation as you extinguish individual debts. The avalanche method focuses on paying the debt with the highest interest rate first, saving you money in the long run.

Be cautious with loan stacking.

Loan stacking is when a business takes on multiple loans from different lenders in a short period. This can lead to confusion and overcommitment. Instead, be strategic about the timing and number of loans you take out.

Consider debt consolidation and refinancing.

Debt consolidation involves combining multiple debts into a single loan with a longer repayment period, potentially lowering your monthly payments. Refinancing involves taking out a new loan to pay off your existing business debt, usually to secure a lower interest rate or better terms.

Monitor debt and revise strategies.

Managing business debt is not a one-time action. It requires ongoing attention, especially as your business grows and changes.

Regularly review and update your debt schedule.

New loans or changes in interest rates can affect your overall repayment plan. Updating your debt schedule ensures you’re always clear on your financial commitments.

Stay connected with your accountant or financial advisor.

Professional advice can be invaluable in navigating complex financial matters, including debt management and restructuring.

Be proactive in addressing potential issues.

If you anticipate having trouble making debt payments, communicate with your lenders early to explore possible solutions and avoid penalties or damage to your credit.

Debt can be a powerful tool for small businesses, but it must be wielded with care and sound judgment. By following the strategies outlined in this guide, you’ll be better equipped to manage and eventually overcome your business debt, positioning your company for long-term success.

Remember, effective debt management is not just about repaying what you owe—it’s about using your financial resources wisely to grow a thriving, sustainable business.

_{Information provided on this blog is for educational purposes only, and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strives to keep its content up-to-date, it is only accurate as of the date posted. Offers or trends may expire, or may no longer be relevant.}