Starting a small business can take a lot of time and money, which is why many entrepreneurs leverage debt in the beginning. Debt can be a useful tool to start your business, but make sure your debt is working for you, not against you.
If your debt and expenses begin to outpace your revenue, this can lead to significant financial problems. This article will explain how much business debt is too much, and what steps you can take to improve your business’ financial standing.
How much debt does the average small business have?
Most business owners understand that debt isn’t necessarily a bad thing. Taking out a business loan, line of credit or business credit card can help you manage and repay your business-related expenses.
According to data from Statista, 17 percent of small and midsize businesses have outstanding debt that ranges between $100,000 and $250,000. Businesses can use debt to manage cash flow, supplier payments and payroll.
How much business debt is too much to carry?
There is no straightforward answer as to how much business debt is too much — it depends on the type of debt you’re carrying and the kind of business you run. How well you’re able to manage that debt matters, too.
For instance, if your business regularly misses payments or runs out of cash before the month is over, that’s a sign you have too much business debt. If your business debt exceeds 30 percent of your business capital, this is another signal you’re carrying too much debt.
Tip: The best accounting software can help you track your business debt, manage your cash flow, and better understand your business’ financial situation.
How should you manage your business debt?
If your business debt no longer benefits your company and is starting to hurt you, here are four steps you can take to manage it.
Take a close look at your debt
If you’re managing your business finances through an Excel spreadsheet, you may not be aware of how much debt your business is carrying. If you don’t have a full picture of your business finances, you can’t come up with a plan to manage it.
Consider using small business accounting software, which allows you to get a complete picture of your company’s assets and liabilities. This will help you come up with a plan for paying down your debt.
>> Learn More: See our review of Xero
Prioritize your business debt.
Not all debt is equal, and some types are more problematic than others. For instance, high-interest credit card debt should be dealt with before paying off a small business loan with a low interest rate.
Ask yourself what would happen if you didn’t pay a particular debt and make decisions about prioritizing your debts based on the seriousness of the consequences. The more unpleasant the result, the higher priority the debt.
Most often, payroll takes priority since you need employees to continue running your business. Before making payments to suppliers, vendors and creditors, focus on clearing payroll.
Renegotiate your terms on bank loans.
One option is to approach your bank and attempt to renegotiate the terms and conditions of your loan. If you’re a long-time customer, the bank may be willing to work with you to lower your interest rate or monthly payments.
Talk about an alternative payment plan.
If you’re having trouble paying off your monthly loan installments, speak to your creditors before they come to you and ask for money. If you can come up with an alternative payment plan and show them how you would maintain your payments, your creditors may be more willing to work with you. After all, if you default on the loan, they won’t receive any money from you.
Should you refinance your small business debt?
If none of the previous steps are an option, consider refinancing your business debt. Here are four reasons to consider refinancing.
Refinancing makes life simpler.
If you’re tired of juggling multiple due dates, bills and interest rates, refinancing can make your life easier. Refinancing will provide you with a single loan, so you’ll keep track of just one payment instead of several.
Refinancing saves your dollars.
Saving money is one of the biggest reasons to refinance. You can switch to a lower interest rate, which will cut down on your monthly payments. A lower interest rate can save you a lot of money over the life of the loan.
Refinancing helps grow your business.
You can improve cash flow by refinancing your short-term debt into a long-term loan. You’ll have more capital available every month, and you can concentrate on the expenses that matter most.
Refinancing boosts your credit score.
Combining your debt into a single payment could improve your business credit score. Whenever you refinance a commercial loan, you might see a sudden jump in your credit score since it reduces your credit utilization ratio.
Why is debt good for business?
Debt comes with many negative connotations, but business debt isn’t always a bad thing. When used responsibly, it can help your business in the long run. Here are a few reasons why debt can be positive for businesses:
- Lower financing costs: Debt requires lower financing costs when compared to equity. And unlike equity, debt is finite. This means you are required to make periodic payments for a specified amount of time until the debt is repaid.
- Optimize the effect of financial leverage: Debt can also be beneficial, as it allows you to maximize the effects of financial leverage. When a company owner uses debt as a method of securing additional capital, equity owners can keep extra profits that are generated by the debt capital.
- Tax savings: Another benefit of using debt for business is that it helps with tax savings. Using debt makes it possible to lower your company’s taxes, because tax rules make it possible to use interest payments as expense deductions against revenues.
FYI: Before taking on any debt, consider your business forecasts. Does your business have a stable base of customers and does it continue to grow year after year? If your business is still in an unstable financial situation, taking on debt may be too risky.
When is debt a bad idea?
Here are a few reasons you may not want to take on business debt:
- Repayment: When you take on business debt, it has to be repaid in full with interest. If you don’t follow through on your repayment terms you could damage your credit and business relationships.
- High interest rates: Certain types of debt come with hefty interest rates. If you don’t stay on top of your monthly payments, the amount of interest you owe can quickly balloon out of control.
- Credit rating: If you take on too much debt in a short period of time, this can negatively impact your credit rating since it signals you may be over-extended financially.
- Cash flow: Too much debt can adversely affect your cash flow. This is because your lenders typically expect the debt to be repaid in equal installments regardless of your income.