How To Ensure Your Business Doesn’t Sink In Debt?

How To Ensure Your Business Doesn’t Sink In Debt?

6 mins read

When small businesses have faced financial difficulties, business owners traditionally had an easy escape route in the form of declaring bankruptcy. However, changes to the laws have now made bankruptcy declaration far more difficult and it comes with a very high price. Filing for bankruptcy can cost several thousand dollars in legal fees and cause severe damage not only to your business reputation but also to your credit score. It is possible for business owners to avoid this sorry state by ensuring that they manage their finances well and not allow debt to overtake them.

Calculate Debt Coverage before Taking on a Loan

Before you take on any loan, it is vital that you calculate your debt coverage as then you will be able to figure out whether it is possible for you to pay the loan back. Lenders also go through the same exercise before lending any money, so you might as well do the calculations yourself to avoid the embarrassment of rejection of the loan application. The typical way of figuring out the debt coverage ratio is to take the net income and divide it by the sum of the loan principal and interest. For example if the annual income of the business is $50,000 and the debt service figure is $25,000, then the debt coverage ratio will be 2:1. Commercial banks will usually have no concerns lending when the figure is above 1.15 but if your ratio is 1 or below, you seriously need to think about ways of boosting your income before applying for more loans. Alternatively, you can ask for a smaller loan with a lesser debt service.

Increase Operational Income to Service Debt Better

Taking loans is integral to operating a business as it allows you to leverage borrowings without having to make contributions to equity that might not always be possible for the entrepreneur business owner. However, if you do not play your cards right and take on excessive debt, then it can pull your business down quickly and surely. You need to concentrate on finding ways of boosting your operational income by exploring new avenues of income. Introducing technology, automation or investing in skill improvement of your employees could make a significant difference. A well-thought out marketing strategy with fresh product or service initiatives can make your business forge ahead and yield better revenues and profits.

Drive Interest Rates Down

If you have loans that are on floating rates of interest then it might be worth the while to switch them a fixed rate at a time when interest rates seem to have bottomed out. With this step you can avoid the impact of any future rise of interest rates. If you have a number of business loans all carrying different interest rates, then it might be better if you seek debt relief by going in for a debt consolidation exercise, whereby all your debts will be rolled into one carrying a specific interest rate and requiring only one payment per month.

If you are in the habit of making business purchases with your credit card, then ensure that you pay off the entire dues every month before the due date and strictly avoid rolling over the outstanding amount as it typically attracts very high APRs. A good way of getting a lower rate of interest is to simply go ahead and ask your card issuer. If your transaction volumes are significant and you have a good payment history, you may be able to knock off a few percentage points off the existing rate and potentially save a lot. If you have racked up a lot of credit card debt then explore the opportunity of making a balance transfer at zero or lower rate of interest and then focus on paying it off as fast as possible. If any fees are applicable, then you must factor them in and find out whether it is still a good option.

Improve Supply Chain Efficiency

One of the most efficient ways of increasing cash flows is to properly manage the accounts payable. Try to get the maximum credit possible from your suppliers so that you can pay them off from the sales proceeds and not have to use your working capital. You could also think about paying them in advance or on delivery if you can extract handsome discounts and if your products move off the shelf fast. Keep a hawk’s eye out for new suppliers promising better prices or quality and negotiate with your existing vendors so that they up their ante. Running a small business is a complex job at the best of times. You need to pay heed to all the steps and more to ensure that you make the best use of business debt without going under.