Getting a business into debt is often easier and more silent than most people think.
With the pandemic ravaging most businesses’ top-lines during 2020, it is easy to see how debt might have slipped through the cracks of even the most pragmatic business owners as they were forced to strengthen their liquidity by taking on external funding.
However, debt it’s not always bad, a good debt is the money you owe but it’s used as an investment and will make you increase your revenue. A small business loan is a planned debt that you know in advance how to pay. Bad debt is when you spend more than you have or can pay and lose control of your finances. With that in mind, the following article aims to illustrate some of the most common practices that can accelerate the amount of debt held by a business.
#1 – Using debt to cover the company’s operating expenses
Short-term expenses should always be covered by the business’ organic cash flow. If the business is not able to fully cover its operating expenses that could be a signal that the business model is not sustainable as is and, therefore, the firm might not be able to survive once lenders refuse to approve further financing. There are two options in this case, either transform the cash flow cycle or the company or analyze if the business is actually feasible based on the market’s acceptance of its value proposition.
#2 – Financing ambitious projects through debt alone
Ambitious projects such as expansions, big capital expenditures, and acquisitions of other businesses should not be financed solely through debt as there is a chance that the project might not live up to its expectations, which will have catastrophic results when the amount of debt obtained has to be repaid. Consider mixing the sources of funding used to finance these projects by using both equity and debt instead of just the latter.
#3 – Paying for previous commitments with expensive new debt
Using new debt to pay for your previous financial commitments often leads to accepting higher interest rates that will end up eating the firm’s profitability. This is a vicious cycle that business owners tend to be swept into by taking small business loans for companies with bad credit at a moment when the company’s financial performance is declining. In most cases, it is wiser to sell some assets or reduce the business’ overhead to pay for these commitments rather than accepting expensive debt that may end up eating the business’ bottom-line in the long haul.
If you are currently engaged in some of these practices, you can take a pause and contemplate the ripple effects of continuously hoarding debt at a fast pace. Meanwhile, if you are still struggling to understand why excessive debt is bad for your business, you can consult with a qualified professional such as a financial planner to understand the ripple effects of taking on too much of it.
Author: Camino Financial
Statements of the author and the interviewee do not necessarily represent the editors and the publisher opinion again.