As lenders tighten the belt on small business borrowings, many small businesses find themselves balking under their debt burdens, with profit margins steadily decreasing due to rising commodity prices and increased competition among other factors. As such, up to half of all startup businesses end up failing within the second year, and even more barely break even.
While filing for bankruptcy is one way to try and save the business without shutting down completely, the price comes far too steep. From court and attorney fees to restricted borrowing and expenditure and poor credit scores for business and owner, many small businesses cannot even afford this option.
As such, many owners need the advice to help them reduce their debt burden without going the bankruptcy route. This article lists preventive and curative ways to do this, depending on the stage of indebtedness the business is in.
1. Improve cash flow by cutting costs
Find out which parts of the business caused you to sink into debt – perhaps potentially profitable projects you borrowed for that didn’t prove as profitable or non-moving stock tying up cash. Other reasons for increasing debt is a disparity between debtor and creditor turnover rates (debtors not paying on time necessitating more credit to keep business afloat) and high expenses.
Check your expenses and see where you can tighten the belt: do you need an office or can you work from home? Does the office have to be where it is, or will a less prime location do just as well? Do you need cable, Wi-Fi or that expensive phone system? You can also sell off unused or rarely used assets like equipment. In dire circumstances, think about lowering your profit margins or eliminating them altogether from gettingting rid of dead stock and hence get some cash for important expenses.
2. Rework your budget
If you keep finding yourself short at the end of your accounting periods, it means that your recurrent expenses exceed what the business can support. While the budget you had may have worked when the business was healthier, you may need to redraw a budget that considers your current financial situation.
For starters, your fixed costs, such as utilities, rent and salaries should not exceed your anticipated revenues. After these, allow a portion of the income for variable costs like a stock purchase. Devote as much as you can from the balance to debt repayment. If you own and use a credit card, pay more than the minimum and restrict its use to absolutely necessary and income-generating expenses. Simply paying the minimum will keep you in debt for many years to come. Invest in accounting software like Quicken or QuickBooks to help you track your incomes and expenses.
3. Plan for debt repayment and management
From your balance of income after fixed and variable costs, plan for debt repayment, especially if you have multiple debts. Begin by tackling the debt with the highest interest after paying the minimum amount on all other loans. Consider restructuring your debt by taking lower interest loans to pay off high-interest ones. Most likely, credit cards will be your highest-interest loan. In addition, work on paying down any debts that you personally guaranteed, since creditors can claim your personal assets should you default.
Another strategy may be to take a debt consolidation loan to amalgamate all payments into a single one. For instance, you can take one long-term package and pay off all your short-term loans and hence reduce your monthly debt repayment budget.
You can also visit a debt counseling organization, who are better at negotiating with creditors and can help you sustainably pay down your debts. While most deal with individual consumers, you can find some that deal with small businesses. You may need a bankruptcy attorney if you have more complex debt issues e.g. if you’re being sued by multiple creditors.
Consider using professional debt management consultants who are qualified with identifying business inefficiencies and negotiating with debtors and creditors. Be cautious about who you use, though; some people are scammers. Check out their accreditations and references before trusting them with your business records.
4. Negotiate with creditors
If you’re facing cash flow issues, such as occurs during low business seasons, talk to your creditors about your business hardships and ask if they have a more lenient repayment plan that is sustainable. This is far better than staying quiet and simply defaulting because you can’t afford it. Not only will you attract late payment penalties, but also, you may risk losing your collateral assets. If the creditor doesn’t have such a plan, ask if there’s a lesser settlement amount. They may be open considering they stand to lose the whole amount if the business folds or goes bankrupt. Ensure that you can meet the new terms; don’t set up a repayment plan you still can’t keep to.
5. Research your loans
Before applying for a credit facility, you should calculate your current debt ratio. Determine how you will pay it back, without banking on speculated income. Lenders use the best coverage ratio to decide your loan amount, interest rates, and other terms. The debt coverage ratio is determined by the net operating income as a fraction of your total debt service (principal and interest repayments. Ideally, you should have a ration higher than 1 after including the potential repayment. Many banks consider 1.15 and above ideal for new loans. If it’s lower than one, find ways to boost your cash flow before taking another loan. Don’t take a large loan simply because you qualify for it, instead, take the least amount you need to fulfill your use.
6. Find ways to boost cash flow
It’s a bad idea to take a loan to service recurrent expenses, since these are unlikely to make the interest repayment worth it in the future. Ideally, you should borrow for projects that will boost your cash flow in the future, and hence make the interest expense worth it. Instead, before going for a loan facility, find ways you can boost your cash flow internally before turning to external sources. Plug inefficiencies to reduce production costs, invest in employee training or better equipment to increase profits, find new markets for products and services, get rid of dead stock and replace with more fast-moving stock etc.
With these tips, you’ll be able to reduce your debt over time and hence build your business to realize greater profitability.