Are you tired of dealing with the stress and burden of business debt? Achieving debt-free status is a goal that many business owners strive for, but it can be difficult to know where to start. The good news is, with the right plan and guidance, it is possible to become debt-free in 2023. Whether you’re a small business owner or the CEO of a large corporation, there are steps you can take to reach your financial goals and secure a brighter future for your business.
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Business Debt: An Overview
What is business debt? Business debt can take all types of forms, shapes and sizes. Some businesses have credit card debt, others have working capital debt. There are many different types of debt that a business can have, some of which are good and some of which are not as good.
Good Debt vs Bad Debt
What is good debt and what is bad debt for a small business? Good debt is what you need to keep your organization running and bad debt is something that doesn’t help the business move forward. Now, to break that down, good debt typically is a loan for equipment, working capital, or other business assets.
Bad business debt, typically speaking, is made of things like loans against accounts receivable and loans against inventory. Those types of loans are generally not very good for the business in the long run.
Why might a small business owner have debt?
A lot of this has to do with profit planning and goals and where the business owner wants the business to go. For instance, if the owner is able to obtain a new client or have an existing client that they can get earn more revenue from but need to increase production to do it, they might need to invest in another machine. Taking out a bank loan for that kind of purchase (where you’re acquiring business assets) would be good debt.
Other reasons a business owner might have debt are related to keeping the business moving forward and growing sales, perhaps a working capital loan, a loan to make payroll, etc. That’s not necessarily good debt, but sometimes taking on that type of debt simply cannot be helped.
What’s a good debt ratio?
Accountants, lenders, CFOs, anyone who is evaluating financial statements for your business will quickly calculate a debt ratio.
Essentially they’ll divide your current assets by your current liabilities and if the result is above one that’s a good debt ratio. That won’t trigger any concerns because it means you have plenty of money to be able to pay off your current obligations.
Anything less than one will trigger a closer look. It doesn’t necessarily mean bankruptcy or immediate problems but it does mean that caution should be exercised when taking on more debt for the business.
How to Minimize Debt in Business
Build a profit plan.
What is the first step in eliminating business debt? Get a profit plan in place so that you can figure out where you think you’re going to be in the next one to five years. Truthfully, if you’re already operating, you should have a profit plan. It’s difficult to make sound financial business decisions without one. If you don’t have one in place and you have debt, build one ASAP.
You’re going to need to evaluate your sales. You’ll need to calculate your breakeven point, and have a properly populated balance sheet and cash flow statement that can tell you where you truly are and where you might be able to go.
The process of putting one together will make you identify all of your obligations and expenses (your monthly costs, all operating costs) and all of your sources of revenue. Having a clear picture of your financial position will allow you to see opportunities to add more to your bottom line and generate cash flow that’ll allow you to start paying off debt.
These opportunities don’t always necessitate big changes, either. Even small tweaks can improve your margins.
Focus on increasing revenue – not just cutting expenses.
I don’t know anybody that has ever been able to cut their way to profitability. Cutting expenses doesn’t make you profitable, increasing sales and improving your profit margins does.
There’s the old adage that sales fix everything. While it is a bit misleading – if you’ve got negative margins you can have all the sales in the world and you still won’t be profitable – there is some truth there. There’s a reason sales managers and business owners say it.
Choose a debt reduction strategy.
Of the two most common debt reduction strategies, (the snowball method and the avalanche method) my preference is the snowball.
The snowball method focuses on paying off the smallest debt first, while making minimum payments on the other debts. Once the smallest debt is paid off, you move on to the next smallest debt, and so on.
On the other hand, the avalanche method focuses on paying off the debt with the highest interest rate first, while making minimum payments on the other debts. By targeting the debt with the highest interest rate first, you can save money on interest charges over time. Once the highest interest rate debt is paid off, you move on to the debt with the next highest interest rate, and so on.
Though the avalanche method is technically the most sound method as it saves money over time, slow and steady wins the race. Slow and steady also allows you to live a life. Sometimes, when you set down a highly aggressive repayment plan, it becomes unsustainable and burdensome and you fall right back into the trap, but if you move forward slow and steady, you will see progress quickly. You’ll be motivated by that and you will win the race.
Create a debt schedule.
Create a three to four year outlook of how those payments will affect your principle and interest over time. Then, look at how the snowball method will start reducing the bigger payments and debts over the same period. It’s helpful to see, clearly and in black and white, what outstanding debt costs and how planned repayments move you toward becoming debt-free.
Automate business debt payments.
Don’t just automate your debts payments, automate all of your business’s payments. ACH is the way to go. Generally speaking, your bank will provide that service for you for a flat fee per month (usually based on transaction volume).
It’s secure. It’s quick. It’s electronic. It’s traceable. It is absolutely the way to go across the board on every payment, not just debt.
Debt-consolidation is not the answer.
Debt consolidation is never a good idea for a small business. They’re equivalent to a payday loan for businesses.
Yes, they will lower the interest rate and they will give you one monthly payment, but the damage to the credit of the business is not worth the trade off. Vendors and suppliers don’t want to see strained credit when they are extending credit terms to you.
While consolidation might seem like a good move from a payment perspective, the damage that ripples through your credit is hard to recover from. Instead, build a debt-reduction plan and stick with it.
To build your debt reduction plan assemble all your bills, write them all out (include all business expenses) out. Look at what your terms are and your balances, and then just start making payments on the lowest balances and move forward.
Why Work With Margin Authority
At Margin Authority, we focus on helping business owners manage their company’s financials for faster, more profitable, and more efficient business decisions. If you’re looking for support in reducing your business debt in 2023, let us help. It’s what we do. Reach out to begin creating your debt-reduction strategy today.