Do you spend sleepless nights worrying about your business debt? If you do, then you’re not alone. Recently, Gallup, a research-based global performance management consulting company, conducted a survey and found that 49% of small business owners find it extremely difficult to manage their current debt. The fact is, handling debt can be one of the most difficult challenges a small business owner can face.
When things get really tough and there’s no way out, historically, many ailing businesses declared bankruptcy. But, new laws have made it more difficult to simply declare bankruptcy to get out from under piles of debt. Furthermore, bankruptcy is no easy way out, as it comes at a high price. Typically, a bankruptcy filing costs thousands of dollars in court and attorney fees. Even worse, your credit scores, not to mention your business reputation, will take a severe hit, making it nearly impossible to regain business stability.
Fortunately, there are ways to avert this type of financial disaster. Here are a few helpful tips to control your debt before it controls you.
1. Do your homework before taking a loan
It’s important to calculate your debt coverage ratio before you apply for a loan. This will determine how easily you will be able to pay it back. Debt coverage ratio is also one of the yardsticks used by the lenders to determine the amount, interest rate and the terms of a loan.
One of the most common methods of calculating debt coverage ratio is to divide net operating income by the interest and principal payments of the debt (total debt service). For example, If you have an annual net operating income of $25,000 and total debt service of $21,000, your debt coverage ratio will be 1.19. Typically, most commercial banks consider a ratio of 1.15 and above to be optimal. If your ratio is 1 or lower, then it is time to look at ways to boost your cash flow.
Your inclination may be to convince a bank to give you a large loan, but play it safe. If a debt coverage ratio suggests that the loan you are seeking will be a stretch, then there is a good chance you will struggle to make your loan payments.
2. Increase cash flow to pay down debt
Being in debt is not the ideal state. So, for most businesses, paying down debt should be a priority. Here are several ways to increase your cash flow to pay down debt.
- Increase productivity: Building efficiencies in your business or finding new ways to generate revenue can be sound strategies for increasing cash flow. Increasing employee skills through training or introducing a new technology can be great investments in productivity and increasing profits. New marketing initiatives can also increase the bottom line. Granted, this may increase costs in the short term, but a well-thought-out marketing plan can increase your profits, which in turn, can be used to pay down debt.
- Renegotiate terms with vendors: Proper management of accounts payable can significantly increase cash flow and accelerate your ability to pay down debt. Many suppliers will offer payment terms of 15, 30, 45 and even 60 days after the delivery of goods and services. Conversely, you may be able to negotiate an early payment discount – early payment discounts can be anywhere from two to ten percent. Finally, periodically, shop for new suppliers that will offer you better pricing. These are all great ways to increase your cash flow.
- Optimizing inventory turnover: Stagnant or access inventory can drain your cash reserves. Inventory should be closely monitored and be purchased “just-in-time” for anticipated demand. If possible, work with suppliers that offer consignment inventory or rights of return for unsold goods.
3. Ask your card issuer for lower interest rates
The national average credit card annual percentage rate (APR) fell to 14.95 percent. While rates are at historical lows, many would consider paying nearly 15 percent interest on a loan exorbitant. Frankly, it is! Ideally, you should pay off your credit card balance every 30 days and avoid interest charges completely.
Many businesses, unfortunately, have snowballing credit card debt. Clearly, paying down high-interest credit card debt should be a focus for any business. Obviously, this can be challenging for some businesses. In these cases, one option would be to consider a balance transfer. The idea behind a balance transfer is to consolidate your credit card debt under one card with a lower interest rate. There are fees associated with balance transfers, so do the math to ensure that the lower finance charges offset the fees.
Actually, the easiest way to get a lower credit card interest rate is to ask for it. If you have a good credit score and you are a long-term customer who pays on time, then a request for a lower interest rate may be all it takes. If you are able to reduce your interest rate by one or two percent, you could end up saving hundreds of dollars a year.
4. Future-proof your debt
Interest rates for credit card debt, mortgages, auto loans and lines of credits are expected to rise by 1.25 to 1.50 percent by the end of 2015. If and when interest rates rise, businesses with high debt and variable loans will be most susceptible. With interest rates at record lows, it is worth considering locking in a fixed rate interest loan before they rise. A fixed rate interest loan is a lender’s promise to maintain a certain rate for a specified period. This ensures that you pay the lower rate even if there is a hike in the interest rate. The first step is to identify what types of loans you are carrying – fixed or variable.
5. Consolidate loans
Consolidating debt is one of the fastest ways to lower your interest rates and pay down your debt quickly. Instead of paying different loans with varying interest rates, you can consolidate them all into a single low-interest loan.
For example, let’s say you hold two different loans: one with an annual interest rate of 13 percent and a current balance of $10,000 and the other with an annual interest rate of 12 percent and a current balance of $20,000. Your current monthly payment would be $1200. With debt consolidation, let’s say your interest rate dropped to 9.2 percent. You would be paying $750 per month. This will save you $450 every month. Consult a financial advisor to determine whether debt consolidation is right for you.
In the long run, the decisions you make today will affect both your personal and business finances. Consider all your financial resources and explore your options fully before you decide to commit to a particular solution.
With debt, the best advice just may be what our parents told us when we were young – don’t spend more than you earn.