As a business owner, meeting and navigating financial obligations might not be the most intuitive of activities but it is a critical aspect of ensuring long-term success.
While debt is often necessary for ongoing growth and operational stability, without effective management, it can become a rather debilitating liability.
In this blog, we’ll help you understand what debt is, why managing debt is crucial for success, and suggest some actionable strategies for taking your debt handling to the next level.
Taking on debt as a business
The term ‘debt’ refers to borrowed funds. For a business, loans and debt can be taken on to finance a wide range of activities. It can be used to fund ongoing and daily operations, investment in market opportunities, or to purchase new assets, machinery and inventory.
The most traditional and commonly known form of debt is a business loan, but there are other forms, like lines of credit.
As mentioned above, debt can be instrumental in allowing a small and growing business to access the capital they need to grow but it also comes with financial obligations that must be repaid over time. Often, these obligations come with a cost, such as interest.
Why you need to manage debt effectively
Businesses taking on debt is neither good nor bad – it depends on the circumstances, the application, and the management strategies.
Mismanagement of this valuable facility can lead to serious consequences for a business, including any of the following.
Financial instability
Excessive debt or debt that balloons out of control can cause significant strain on cash flow and therefore inhibit a business’s ability to meet financial obligations, whether that’s payroll or even repayment of the loan itself.
Unmitigated risk
High levels of unmanaged debt increase a business’s financial risk. When interest rates are hiked, market demand dives, unexpected expenses arise or other unpredictable economic conditions fluctuate, this can present difficult-to-surpass challenges for the business in question.
Creditworthiness impacts
While a history of responsible debt management enhances a business’s creditworthiness, the opposite is true. It will become increasingly difficult to access lines of credit, financial facilities, and business loans if your creditworthiness is negatively impacted by ineffective debt management.
Unsustainable growth
Debt that is not managed carefully can prevent businesses with potential to grow from doing so in a sustainable way. Small businesses are often presented with opportunities for growth within the market, diversification of products and services, or new target markets. With the right level of debt management, a business can take advantage of these opportunities whilst maintaining financial health and stability over the long term.
Tips and strategies for managing debt
1. Create a detailed budget
Budgets are not the most exciting things in the world. But they are necessary.
Develop a comprehensive budget for your business that outlines the revenue coming in, the expenses going out and the debt obligations already taken on. This will give you a clear understanding of your financial position and allow you to identify areas where you can potentially save money or even improve revenue.
2. Prioritise your repayments
Once again, debt is not bad. But payments not made on time are. Penalties, fees, interest, and damaged credit scores are all consequences of unprioritised repayments.
Prioritising your debt repayments will ensure you avoid all of these pitfalls. Pro tip: Consider focusing on your high-interest debts and/or those with restrictive terms to further minimise long-term costs to your business.
3. Review your creditor terms
If your business is struggling to meet debt obligations, you shouldn’t hesitate to reach out to your creditors and negotiate new terms. There are often potential modifications available or even repayment plans.
Most lenders are willing to work with borrowers, even those facing financial strain, to find an amicable solution that works for both parties.
4. Consolidate your debt
This strategy is particularly important for those businesses with high-interest debt. Consolidating your different loans into one source of debt will allow you to more easily manage payments and keep track of them into the future.
Additionally, consolidated debt could potentially lower your overall interest rate costs and help you save more over the long term.
5. Monitor cash flow
Keeping an eye on the cash flowing in and out of your business is especially important. Not only does it ensure you have sufficient funds to cover your debt repayments as well as ongoing operating expenses and other financial commitments, but it gives you the ability to anticipate gaps in cash flow.
Being able to forecast waxing and waning access to necessary working capital will give you the ability to predict cash shortages and therefore take proactive measures to address these gaps before they become an issue.
6. Build up an emergency reserve
Emergency funds aren’t just for households and individuals. A reserve of capital that can be used to cover unexpected expenses and revenue disruptions will ensure your business doesn’t have to resort to taking on additional debt unnecessarily.
Ideally, you’ll have enough cash set aside to cover the operating expenses (and debt repayment) of the business for three to six months.
7. Work with professional advisors
Whether or not you are confident with managing your business’s debt, consider seeking the guidance and advice of experienced, expert professionals.
Oftentimes, these financial advisors, consultants or accountants will be able to recommend effective debt management strategies that you’d be otherwise unaware of. Their customised recommendations will take into account your unique business goals and circumstances to ensure the best result possible for you and your small business.
Call us for customised financing options for your business.
This article was originally published on ScotPac.com.au.
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