Small Business Dealing with Debt

One of the biggest challenges that any entrepreneur or small business owner ever faces is the challenge of debt. Debt is one of the major causes of business failure and many small businesses are simply not equipped to deal with debt. Debt is always a challenge in personal finance but becomes an even bigger challenge in a business context. Common business debt includes suppliers, salaries and bonuses, financial institutions or tax authorities in the case of Value Added Tax (VAT), Employers Tax and other applicable taxes.

The Big Deal

Every entrepreneur dreams of that one big deal which transforms a business and provides cash flow to meet expenses. Businesses land in debt while chasing ‘the big deal’. Many business owners observe extreme caution when dealing with small clients, insisting on upfront payments and other measures before supplying a service or product. However, many otherwise prudent business owners, throw caution to the wind and do not practice prudence when approached by big business.

A lot of small businesses have been known to take substantial overdrafts, credit facilities and huge stock inventories when contacted by what appears to be a lucrative deal from large clients. Business owners sacrifice healthy cash flows for debt with narrower margins in order to gain economies of scale. A number of businesses with insufficient cash flows, take out major loans just to service a large client, reducing their debt coverage ratio. To worsen the situation, once the big client is “secured”, new business development and marketing often take the back seat to service this new client. A situation where “all eggs are one basket” soon develops, and when a slight payment delay or order cancellation occurs, a thriving business can be driven to bankruptcy in a very short period.

In order to avoid falling into this situation, a small business must continue to increase client numbers and develop the business even after a large client is secured. It may also be wise to engage an inventory management and financial consultant to assist with calculations and scenarios in order to maintain a business’s risk exposure within acceptable limits.

The Cost of Capital

Borrowed capital is expensive, and it is prudent to pay down loans as quickly as possible, especially in a volatile trading environment. In order to exceed payment schedules, it may be required to consider methods to improve cash flow and manage debt. This may be through renegotiating payment terms, for example reducing payment days after delivery of goods.

Another way to get the best deal is to remain abreast of new suppliers who may offer more favourable terms to a current supplier. A business can also consider ways of rapidly reducing inventory such as discounts and specials for early settlement.  Reducing inventory to “just in time” delivery and purchase may also assist in improving cash flow.

Just as in personal financial planning, methods such as debt consolidation can help improve a business’s cash flows. This may involve a move away from multiple financial service providers to settle to one institution with favourable terms for all products utilised by a business. It is also possible to negotiate interest rates on loans and credit balances with a business banking manager, and in some instances “lock into” fixed rates in a rising interest scenario. A business must also avoid becoming liable to pay penalties and interest, on revolving credit such as a credit or charge card where debt repaid within 30 days attracts no interest.

What to do when in Debt

In some instances, a small business may simply have cash flow challenges due to debt whilst in possession of viable long term contracts. In this instance, it may be possible to consider debt factoring. Debt factoring is simply where a business sells its unpaid invoices to a third party in return for cash, often at a discount to the invoice value. This frees up cash flow to meet debt obligations or to enable a company to produce more product.  Many companies doing tender based business with government and state owned companies use this service, especially in periods of high demand where cash may be tied up in invoices. Many specialist companies and many business banking managers offer this service.

Debt is simply when expenses exceed income, and although a lot of effort is put into improving income and cash flow, many entrepreneurs forget that similar attention can be paid to managing a business’s expenses. Office overheads, staff expenses and travel may need reduction and in other instances the business’s entire budget may need to be redone to cater for fundamental changes in a small business’s trading environment.

Another cue borrowed from personal finance is debt counselling. Professional business debt experts may need to be hired to help solve matters. Counsellors may recommend debt consolidation, negotiation with creditors or counsellors will try and find ways of making a business more efficient to keep a business as a going concern.

Be Realistic

When dealing with debt, it is important to understand that debt is a useful and necessary business tool that needs to be managed. It is easy to become overwhelmed by debt but many simple solutions are available such as renting out an office or excess warehouse space. Other solutions may be to adapt existing equipment for other functionality that can be rented out or even liquidation of non-essential assets. Such interventions require courage and a longer term viewpoint to prevent a business becoming a casualty of business failure.