Borrowing money to acquire real assets or buy new equipment can lead to genuine improvements in a business’s opportunity to make better profits. Borrowing money in this situation is a reasonable bet, but it needs to be supported by a genuine plan and clear sightedness by management.
But borrowing money to solve business problems like cash flow shortfalls or finance receivables is a double-edged sword. Debt incurred for these purposes typically makes matters worse by crushing profits into the dirt. As debt increases, more and more of the daily, weekly and monthly revenues are assigned to service debt. Less and less goes to keeping the business healthy. Debt then forces businesses to borrow indirectly by slowing supplier payments, getting behind with payroll taxes, and cutting owner pay.
Then more borrowing takes place and the debt spiral takes a sickening lurch and the end is near.
Here is the mechanism.
People and businesses borrow money. Essentially this is a long term bet that the enterprise will generate the cash to repay the loan. But debt service charges are a fixed cost, like rent, payroll and lease payments, that do not rise and fall with revenues. You can cut purchases in response to a fall in revenues. You can cut hours; you can switch off power; you can lay off staff. But you cannot stop making debt payments without repercussions.
Moreover, the debt servicing amounts are taken directly from profits and if profits are not there or are slow to arrive, then the business can collapse.
This is why lenders want to see a concrete plan for recovery.
How to solve debt problems:
Borrowing more money to solve the immediate problem may be a great move, provided there is a credible strategy to return to manageable levels of debt. Quite often, however, there is no plan beyond wishful thinking.
So, having a written plan is step one. This plan must have good research and solid numbers backed up by that research. Quite often this will mean a better pricing strategy that builds in a pre-determined profitability on each transaction. Need a better pricing strategy? Then read my book Pricing Strategies for Small Business.
Step two, would be to devise written management targets to retire the new debt within a 2 to 4 year period. This should take the form of a cash management programme.
Step 3 would be to work that strategy to retire the debt and get into the habit of retiring debt.
But what happens if the problem is truly intractable?
When this position is reached, it is possible to park the debt while rebuilding the business. Sometimes the solutions are harsh and sometimes lengthy. If it took a few years to get to that unhappy position, then it will not be a five minute fix. But it can be done.
This typically involves convincing the creditors to stand by for a limited period. But assets pledged against the debt are in danger of being seized. That pledge could have been for the receivables, equipment, vehicles and even personal homes.
When the plan starts to work?
When the plan is underway and the cash comes in it is perfectly normal to think that all problems are solved. But you are wrong. Why?
Even the re-payment of debt has to be managed. Some debts are more dangerous than others even if they have lower costs attached. Debts for payroll taxes can lead to seizure of bank accounts. Debts to workman’s compensation can lead to the premises being locked down. Debts against assets can lead to the assets being seized.
What to do? Refer to the cash flow plan. It is unwise to pay “soft” debt before the dangerous ones. If your plan was accepted by the creditors, then work the plan. Pay early or at least on time. Rebuild your credibility and please stop whining.
Next, pay the high interest rate debt first. And when you can utilize some credit availability to move high interest to lower interest, then do so.
Finally, when the worry of debt is gone and cash is not totally dedicated to servicing that debt, you can Build Your Business.
Remember that the people who worry least about money or a temporary downturn in business are debt free and have low fixed costs. You want to be there.
To discuss your debt challenges call:
Floodlight Business Consultant:
Andrew D. Gregson B.A., M.A. M.Sc.(Econ)
Kelowna, BC, Canada V1Y 8A6
toll free: (888) 959-0752
Andrew@pricingstrategies.ca
These are some great tips, my business is currently suffering from the downturn in the economy and demand for our product has decreased. I'm currently looking into all sorts of things to get us back on track, including going to a conference on business coaching in Macclesfield, which was quite useful. One idea I got from there was to borrow money to invest, but I just wanted to do a bit of research into managing debt before I got myself into any trouble. Thanks for the advice, it's given me a lot to think about.
ReplyDelete