Business Debt for your Company: Is it Good or Bad?
As we move into spring and summer, this is often the busy season for most companies. This is a time when many owners will start to look at asset acquisition, such as a new vehicle, equipment, or tools. These considerations will involve the question: Do I have the cash to pay for these items, or will I need to incur debt? And if I incur debt, is that a good strategic move for my company?
In general, a company will not want to just be debt adverse across the board. If you need to acquire a vehicle, piece of equipment, or tool to grow and expand your business, debt may be a very desirable option. Adding a new vehicle, piece of equipment, or tool can help you service more customers and grow your business. So you will need to look at several key items in your financial records.
Pull a Statement of Cash Flows
Don’t just look at your Income Statement to determine if you can afford to service the debt. You will need to know how much cash you will have available at the end of each month to make payments on the loan or note.
If you have a lot of cash left over, each monthly payment, will be a lot easier to consistently make.
However, if you have very little cash left at the end of the month, you may not have enough to take on another payment. You may want to focus on improving the business’s efficiency before taking out a new loan. That way, you do not take on more debt than you can repay or spend your reserves to service this debt. It is important to have a plan in place to pay off your debt and to understand your debt to equity ratio or debt to income ratios.
Determine your quick and current debts ratios.
You want to know how much you have in Liabilities. And then you want to know how much you have in Assets in order to pay off those Liabilities. For your quick ratio, compare your liquid assets (such as cash) to determine whether you can cover the current debt payments due next month.
There are a lot of different types of debt ratio measures. Small businesses need to make sure that they can float any short term debt or long term term. Borrowing money is something that needs to be understood using these ratios
Do you have cash reserves?
If you do not have the company’s cash flow to support adding debt, do you have any cash reserves? This would need to be enough cash to cover expenses for the next three to six months, so that your new vehicle, piece of equipment, or tool has time to increase your cash flows and enable you to repay the debt.
What will be the cost of the debt?
You will want to research the cost.
Are you looking at a secured loan?
Are there any incentives offered?
What is your credit score?
For a secured loan, you are typically looking at an interest rate of 7% to 15%.
However, if this loan is unsecured, the interest rates will typically be much higher, and you may also have to pay origination fees.
One special note: please avoid any loans from “loan sharks,” or loans that you cannot pay off early without penalty.
Don’t use debt to pay off debt.
You only want to take on debt in your company when it will grow your business or otherwise improve it, with a reliable, realistic plan to pay it off. You never want to take on debt to pay off existing debt. That is called a “debt cycle,” which often will cause a company to struggle or even be forced to close.
Contact Us
You can like and subscribe to our channel so that you are up to date on the YouTube videos we put out. You can follow our series of videos that dive deeper into the concepts of debt with your company.
If you are looking for more help figuring out where your cash is going, or if you want advice on managing current debt or taking on future debt, please feel free to reach out to us here at Waterford Business Solutions. You can call us at 864-351-0852 or send an email to info@waterfordbusines.com.
Additional Resources
For more information on Current and Quick Ratios, please check out the Corporate Finance Institute website: https://corporatefinanceinstitute.com/resources/accounting/current-ratio-vs-quick-ratio/
For more information on Secure vs Unsecured Debt, please check out Investopedia at: https://www.investopedia.com/ask/answers/110614/what-difference-between-secured-and-unsecured-debts.asp. You can also check out Bankrate.com at https://www.bankrate.com/personal-finance/debt/secured-vs-unsecured-debt/
