SME Toolkit Logo
Partner Logo
Home  > Managing Debt
 Share  Print Version  Email

Managing Debt

Adapted from content excerpted from the American Express® OPEN Small Business Network


For a growing business, having a manageable level of debt can be an effective way of doing business. While some small business owners are proud of the fact that they've never taken on debt, that's not always a realistic approach. Growth often demands considerable capital, and getting that money may require you to seek a bank loan, a personal loan, a revolving line of credit, trade credit, or some other form of debt financing.

The question for many small business owners is: How much debt is too much? The answer to this question will lie in a careful analysis of your cash flow and the specific needs of your business and your industry. The guidelines below will help you analyze whether taking on debt is a good idea for your company.

Explore your reasons for borrowing

There are a number of scenarios when it may make sense to take on debt. In general, debt can be a good idea if you need to improve or protect your cash flow, or you need to finance growth or expansion. In these cases, the cost of the loan may be less than the cost of financing these moves through ongoing income. Some common reasons for seeking a loan include:

  • Working capital - when you're looking to increase your company's work force or boost your inventory.
  • Expanding into new markets - when companies enter new markets, they often face a longer collection cycle or must offer more favorable terms to new customers; borrowed funds can help weather this period.
  • Making capital purchases - you may need to finance new equipment in order to move your business into a new market or expand your product line.
  • Improving cash flow - if you have less than 10 years left on an existing long-term debt, refinancing can improve cash flow.
  • Building a credit history or relationship with a lender - if you haven't borrowed before, taking out a loan can help in developing a good repayment history and can help you obtain financing in the future.

Plan effectively

Before taking out a loan or any other kind of debt financing, you should spend time planning your capital needs. The worst time to take on any kind of debt is during a crisis. A sudden loss of trade credit, the inability to meet a payroll, or other emergency could force you to take on debt immediately, and that can result in highly unfavorable terms. A plan will allow you to forecast your cash requirements, allowing you to determine what you will need and when you will need it. This will give you the extra time to explore all possible borrowing sources and negotiate the most favorable terms. A capital plan should consist of a complete review of your balance sheet to help you analyze cash flow, assets and liabilities. You'll also want to construct a pro forma statement, which is a projected balance sheet for the coming 1-3 years.

Examine short-term vs. long-term debt

Just as you need to be certain you're taking out a loan for the right reasons, you also need to make sure you're taking out the right kind of loan. For example, taking out a short-term loan when a longer term loan is required can quickly create financial problems since you may be forced to take unnecessary measures (such as selling a piece of the business) to meet the obligation.

In general, use short-term loans for short-term needs. This will help you avoid higher interest expense and more restrictive conditions of longer-term borrowing. For instance, if you experience a temporary rapid increase in sales -- such as that brought on by increased seasonal demand -- then you should look at a short-term loan. If the growth will continue over a long time, take a look at longer term options such as an expanding line of credit based on sales, accounts receivables, or inventory ratios The term of your debt will have no impact on your debt-to-equity ratio. However, you will see changes in liquidity indicators such as your current ratio, since current liabilities include only the debt that must be repaid within one year, not debt due at later dates. So longer term loans can positively affect your liquidity ratios.

Base new debt on current needs

When interest rates are low and money is cheap, you may be tempted to take out loans to buy equipment or make other capital purchases. If that's the case with your business, be sure to base your decision solely on your current needs. The possibility of rates increasing is not a rationale for spending money on something you don't need. For example, if your business needs additional computer equipment, you might want to take out a loan to buy it. But buying additional computers now because they'll be more expensive next year is not ample justification. You can end up getting stuck with equipment you don't need and debts that you are still obliged to pay off.

 

Copyright © 1995-2016, American Express Company. All Rights Reserved.

 Share  Print Version  Email
Comments & Ratings (5) Overall  
  • Currently 3.6/5 Stars.
If you are a human, do not fill in this field.
Click stars to rate.
   Comments are truncated at 1000 characters
What Others Are Saying
Sort by
View
  • Currently 4.0/5 Stars.
Bryan Roland  |  October 06, 2016
LOAN OFFER!!! We are Barclays Loan Service we Provides both long and short term loan financing. We offer secure and confidential loans at a very low interest rate of 2% per year, Personal loans, Debt Consolidation Loan, Venture Capital, Business Loan, Corporate Loans, Educational Loan, Home Loan and Loans for any reason! We are the trusted alternative to bank financing, and our application process is simple and straight forward. Our loan ranges from $5,000.00 to $25, 000,000.00. (Twenty Five Million Dollars). Additional Info: We're fast becoming the private, discreet, and service oriented lending choice for general loans. We're the company to turn to when traditional lending sources fail. If you are interested do not hesitate to contact us with information’s below by Email, barclaysloanservice247@yahoo.com Warm Regards, Mr. Roy Smith, Head, Loans Application Department, BARCLAYS LOAN SERVICE, Email: barclaysloanservice247@yahoo.com.
  • Currently 5.0/5 Stars.
Jade S Combs  |  September 18, 2016
My real estate agent referred me to JCLF, I found them to be very thorough and they clearly understood the market very well in terms of the different lenders and the competition.  I will contact them in the first instance the next time I need finance for anything and refer any friends or family that need the same. Contact them through website or through phone: +1 267-884-0582 
or email: jamescarlconsults@hotmail.com
  • Currently 4.0/5 Stars.
Barclays Loan  |  July 12, 2016
We are Barclays Loan Service we Provides both long and short term loan financing. We offer secure and confidential loans at a very low interest rate of 2% per year, Personal loans, Debt Consolidation Loan, Venture Capital, Business Loan, Corporate Loans, Educational Loan, Home Loan and Loans for any reason! If you are interested do not hesitate to contact us with information’s below by Email, barclaysloanservice247@yahoo.com
  • Currently 5.0/5 Stars.
Mahmoud Jaafar  |  June 26, 2016
Looking for 24 hours Cash Loan, Business Loan, Payday Loan, Small Business Loan, Personal Loan, Mortgage / Home Equity, Hard Money Loan and so on? Email: jaafarlending44@gmail.com
  • Currently 0.0/5 Stars.
Thomas Dawson  |  October 06, 2015
Welcome to Thomas Credit Firm, I am an international business man and Lender that has offered Loans to so various individual and firms in Europe, Asia, Africa and other parts of the world. We give out our Loan for a interest rate of 2% per annul for a minimum of 100.00 to a maximum of 100,000,000.00 rubles, dollars, pounds, euros, etc. The maximum loan term we can offer is 30 Years at fixed interest rate. Available Loans * Personal Loans (Secure and Unsecured) * Business Loans (Secure and Unsecured) * Combination Loan (Secure and unsecured) * Consolidation Loan (Secure and unsecured) * Mortgage Loans (Secure and unsecured) Interested candidates should please contact us today for your online quick and easy loan without collateral deposits. E-mail: thomascreditfirm@gmail.com Sincerely,