Debt is both a useful tool and a dangerous pitfall for entrepreneurs. When handled properly, debt can support growth, fund expansion, and fill cash flow gaps. But when not handled properly, debt can become a major problem, making it difficult for a business to make a profit or even jeopardizing its very existence. How you handle debt determines your success or failure. Smart entrepreneurs don’t avoid debt entirely; they just learn how to use it in a way that minimizes risk.
This article discusses some practical, actionable ways to handle debt that can keep your business financially healthy. These tips will help you take control of your business’s financial future, whether you have a loan coming due or are looking for a new one.
Know the Difference Between Good and Bad Debt:
Not all loans are equal. Good debt comes with benefits that outweigh the costs, such as a business loan to buy equipment to produce more products. Bad debt, such as a high-interest credit card for everyday expenses, only finances costs without adding value. The biggest difference is whether the debt helps your business grow or just keeps it afloat. Effective debt should have clear repayment terms, a reasonable interest rate, and be directly related to profitability. Ask yourself: Is this debt helping my business make more money than the debt is costing me? If the answer is not a clear “yes,” please consider reevaluating the cost.
Develop a Strategic Plan for Paying Off Your Debt:
A planned approach to paying off your debt can prevent it from spiraling out of control. Keep track of all your bills, including due dates, interest rates, and minimum payments. Businesses can benefit from two popular approaches: the avalanche method, where the highest-interest debts are paid off first to save the most money, and the snowball method, where the smallest debts are paid off first to speed up repayment. For entrepreneurs, we recommend paying off high-interest debts that are straining your cash flow first. Talk to your lender to negotiate better loan terms. Many lenders will work with you if you can show that you will repay them. Setting up automatic payments can help you avoid late fees that can add to your debt load.
Use Debt Consolidation Wisely to Keep Your Debt Under Control:
Debt consolidation combines multiple payments into one, ideally with a lower interest rate. This can make it easier to manage and save money, but it is important to be careful. Business owners can get financing in several ways: a line of credit, a fixed-term loan, or an SBA loan. Transferring your balance to a lower-interest credit card can help if you can pay it off quickly. There are risks associated with using debt consolidation as “new money” rather than as a way to pay off your debt. For debt consolidation to be effective, you must be careful with your spending. Otherwise, your debt could continue to grow beyond the amount you consolidate. Before you apply for debt consolidation, always calculate the total amount you need to repay, not just the monthly payments.
Ensure that you have sufficient cash flow to pay off your debts:
Managing your debts depends on a steady cash flow. If your business runs out of cash, you won’t be able to pay off your debts, even if you’re profitable. Have strict debt collection policies: send invoices promptly, receive discounts for early payments, and follow up on late payments. You can keep track of your debts by asking vendors to extend the payment term without charging extra fees. Keep enough cash on hand to cover three to six months of debts. This strategy will prevent you from missing payments when business gets tough. Update your cash flow plan regularly to be prepared for situations where paying off debts could become difficult for your business.
Use Alternative Financing Wisely:
In addition to traditional loan options, some may make more sense in certain situations. When sales are slow, income-based loans can ease the situation. Equipment loans tend to have the best terms, since the equipment itself can be used as collateral for the loan. Factoring can make you money right away by selling your unpaid bills for a set price. Each option has its pros and cons. Generally, the pros are higher prices and more flexibility. You should only use them for specific items rather than general financing, and you should always compare the effective annual percentage rate (APR) to other options.
How to Build and Maintain Business Credit:
Good business credit allows you to get better loan terms and differentiate personal debt from business debt. The first step is to open a business credit account with a vendor that provides payment statements. Pay all bills on time and use no more than 30% of your credit limit. Check your business credit report regularly for errors. Avoid making personal promises if possible. These promises put your assets at risk if the business goes bankrupt. As your credit improves, you can get lower interest rates and higher credit limits. This makes your debt easier to manage.
Knowing When to Seek Professional Help:
There are situations when you need professional help. Paying off old debts with new debts, multiple late payments, or debtors threatening legal action are all red flags. Business debt counselors can work with lenders to lower payments or settle debts. Bankruptcy attorneys can help businesses reorganize under Chapter 11. Turnaround experts help businesses reorganize so they have more money to pay off debt. Seeking help early can prevent a small problem from becoming a crisis. There are many ways to address problems before you file for bankruptcy.
Conclusion:
Smart debt management isn’t about paying off debt; it’s about getting the most out of it. Understanding the distinction between beneficial and harmful debt, formulating a strict repayment plan, and maintaining a high cash flow can assist you in harnessing the power of debt and avoiding the trap. Remember, staying flexible is key. What works during times of growth may need to change during times of recession. As your business grows, it’s a good idea to review your debt plan regularly and always consult experts when necessary. Using these strategies, you can transform debt from a stressor into a business-building tool that can help your business move forward while managing financial risk.
FAQs:
1. How much debt does my business have?
It’s best to keep monthly debt payments under 30% to 40% of monthly revenue, but this varies depending on your business and profit margins.
2. Should I use my money to pay off my business debt?
Only do this if you have to—merging personal and business finances makes it harder to keep track of and leads to debt.
3. What’s the best way to communicate with clients about business loans?
Talk to them early about reasonable repayment options and emphasize your commitment to repaying the loan in full over time.
4. Will taking on debt help my business grow?
Yes, using debt to purchase profitable assets or expand the business can accelerate growth beyond just cash flow.
5. How often should I review my business debt plan?
Have a formal evaluation done every three months and repeat whenever there are significant changes in your income or new financing options become available.
