Spending money that you don’t have is the quickest way that you can take your small business and bury it in a mountain of debt that will be next to impossible to climb over. It is especially important not to fall into this practice if the economy is flushing itself down the crapper.
There is an old business saying that, “you have to spend money to make money,” and that is true when the economy is flourishing. When the money is rolling in hand-over-fist it’s no big deal to build up some debt in order to improve your business, but when the economy is on its deathbed, intentionally building debt is a sure-fire way to end up closing the doors for good, bankrupt.
Even a journey of 1000 miles begins with a single step — figure out your debt-to-equity ratio and interest coverage ratio.
Figure out how much debt you are in and then compare it to how much equity you have in your business – in other words, figure out what your “debt ratio” is. For instance, if you owe $10.00 in debt, but the equity you own in your business is only worth $2.00, you have a debt-to-equity ratio of 5. With a number like five, it means that the company is leveraged to the throat and is using that debt to finance most of the company’s assets. Doing this will lead to high interest rates, and your company needs to make sure that you have enough money on hand to make those interest payments while remaining open and operational.
It’s a simple equation once you have the tallied numbers from your business books:
Total debt / Total equity = Debt-to-equity ratio
If you end with a high debt ratio it may mean that no matter how much money your business can bring in, you will unlikely ever be able to pay off the money that you owe to creditors. Remember, there is no “perfect” debt-to-equity ratio number because each industry is so different from the next that their financial probabilities are not comparable.
Like assessing your debt-to-equity ratio, there is a simple way to figure out if you’re paying too much interest, you can calculate your Interest Coverage Ratio. To do that you must take your earnings before interest and taxes (EBIT) and divide it by your interest expense.
Earnings before interest and taxes / Interest expense = Interest Coverage Ratio
The equation shows you how easily you will be able to pay off your interest expenses on your outstanding debt based on the profit you bring into the business. Again, as with your debt-to-equity ratio, there is no perfect number here either.
How do I deal with this, I need to be able to eat.
“Slow and steady wins the race” might sound like a solid plan for dealing with debt, but, the quicker that you can get your bottom line back to even the quicker your business is going to start to grow and flourish. Life’s a lot easier when you are putting money in the bank instead of feeding it to creditors.
Start a conversation with people on both ends.
It doesn’t hurt to start a conversation, so reach out to the people who supply your business and those who are looking to collect from it. You must realize that both your suppliers and your collectors have a vested interest in seeing you get out of debt as opposed to claiming bankruptcy and closing up shop. If you go bankrupt your supplier losses a customer and a large amount of future business, and your collector doesn’t get their money. Some may not be willing to work with you, but there is no harm in waiting.
Bring all your debt together.
Do you owe money to several different creditors? Are several monthly payments (plus interest) killing you slowly? Well, if so, it might be time to consider going on the offensive. There are a couple of reasonable options; you can take out a business loan at a lower interest rate and pay off your entire debt load, creating a system for yourself with a single payment towards the loan. Or, you can look at possibly consolidating your debt, but that requires you hire debt consolidators to do the work for you.
Getting the business loan may be the smarter play, but it can be hampered if you have ended up with bad credit because of the situation that you find yourself in with your business. If you can’t find a bank to give you the loan you can always look to private loans but that can get tricky with higher interest rates that come with less flexible repayment terms in the long run.
If the loan is out of the question you can work with a credit consolidator who will contact all your creditors (if you have more than one) and consolidate your debt into one lump sum so that you have a single monthly payment. One of the few drawbacks to this strategy is that you will have to pay out of your own pocket for the consolidator to do their job. You will also end up taking a blow to your credit rating, so you will have to decide if it is worth it.
Stay within your means.
It’s not just small business owners that need to realize this basic truth, most regular people working Monday to Friday, 9-5 need to understand this as well, you must live within your means. Spending money that you don’t have on things that you “think” you need is a sure-fire way to see yourself buried up to your eyeballs in debt. All it takes is for you to set up a budget and stay within in it.