Cash is the fuel that allows your business to operate. With it, you can buy inventory or raw materials, and wait for sluggish receivables to be paid. You can invest in expansion or other opportunities to grow your business, and have a cushion to pay bills during tough times. Debt is a time-honored way to get cash when you don’t have enough. When managed well, debt can be a significant boost to your business, but poorly managed debt can lead you down the road to Chapter 11.
Managing debt wisely is the mark of a well-run business. Here are some tips for owners to effectively use debt:
Be interest-rate aware:
Are you stuck with a high-interest small business loan that demands a mountainous monthly payment? If so, you should consider refinancing your loan at a lower interest rate. Your original loan might have been based on your credit rating, and if that is less than perfect, you can do better by choosing a lender that rates you more on cash flow, such as IOU Financial. Also, when you borrow from IOU Financial, you make daily payments, which abolishes the dreaded monthly repayment.
Work with suppliers:
Your suppliers want you to succeed, because they sell to you. Use this attitude to negotiate favorable credit terms with them, such as bulk discounts, and extended payment terms. Let your suppliers know that their flexibility will result in your loyalty. Another strategy is to join a buying consortium composed of several nearby small businesses, thereby increasing the size of your orders and qualifying for greater bulk discounts and better credit terms.
Milk extra space:
Are you paying a mortgage on more space than you need? You might not want to move to smaller quarters due to the expense and the risk always attendant upon a new location. Instead, consider subleasing your extra space, say for companies that need extra storage space or a small office. This can have the effect of reducing the net cost of your mortgage debt.
Don’t be fooled by alternative financing:
Some businesses turn to expedients like factoring invoices or wholesaling inventory rather than taking out a loan. However, many don’t understand the true costs of these tactics. For example, when you factor invoices, you lock in a lower profit margin, since you will be getting only 85 to 90 cents on the dollar, a much higher price than the interest on a good loan. Wholesaling inventory can result in an even-larger haircut. You’ll find that, most often, regular commercial debt is your best alternative.
Avoid being too debt-averse:
There is some old-school thinking out there that debt is always bad. Debt is neither good nor bad – it is a tool that can be used well or poorly. It’s not a good idea to take on debt for frivolous reasons, but it’s also bad thinking to avoid debt when it can enable greater profits, fuel growth or bridge seasonal sales slumps. You can use a business loan to seize sudden opportunities that would otherwise be out of reach.
The miracle of leverage:
If you have good profit margins but are constrained by limited cash, borrowing money allows you to increase sales and profits by letting you increase your offerings. Leverage – the use of debt – can boost your return on assets and return on equity. As long as your incremental returns exceed your incremental costs, your profits will increase through leverage.
Be wary of unwanted partners:
When you borrow money, you remain in charge of your business. If you instead invite in equity partners, you now have to deal with others who might not agree with your ideas. If you don’t want junior partners questioning your every move, stick to debt financing and avoid the extra headaches.