As a small business owner, you probably manage the books, take care of suppliers, and keep an eye on the bottom line. You probably also negotiate contracts with vendors and suppliers, and sign off on expense reports. Unless you’re an accountant or have one on staff, you might not think much about your company’s debt position. If your company is like most small businesses, it probably has some debt. Debt provides capital to fund operations until sales can cover costs without further investment. But taking on debt as a business owner has potential downsides. There are many ways that debt can hurt a business — for example, interest expenses reduce profits, loan covenants limit flexibility in case of unforeseen events and lenders have rights that can be challenging if they don’t get paid back as expected.
What is Company Debt?
Debt is a financial obligation that has to be paid back, with interest. Typically, we think of debt as a personal obligation, such as a mortgage, student loan or car loan. If a company has debt, it’s a promise made by a corporation to repay a debt owed by the company. The corporation borrows money from a financial institution and promises to pay the lender back by a certain date with interest. Company debt can take many forms, such as term loans, promissory notes, bonds or commercial paper. Company debt is also referred to as corporate debt or corporate liabilities. The debt can be short-term (maturing in one year or less), intermediate (one to five years) or long-term (more than five years). Debt is often categorized as current or non-current. Current debt is due within a year, and non-current is due after a year.
The Dangers of Company Debt
The advantages of company debt are easy to understand — it can help you get the financing you need to grow your business. However, debt also has the potential to threaten your business’s health if you’re not careful. Without careful planning and affordable repayment, company debt can soon become a serious threat if not managed properly.
Strategies for Dealing With Company Debt
If you need some financing to get through a rough patch, taking out a short-term loan is often preferable to taking out a long-term loan with a high-interest rate. That said, most entrepreneurs would prefer to avoid debt altogether — and many do. But, sometimes it’s necessary to take on debt to get through a bad patch or fund a major expansion. How do you know when to take on debt and when to avoid it? Here are some tips for managing company debt:
- Know Exactly What You’re Getting Into – Before you agree to take on debt, make sure you understand how much you’ll owe, how you’ll pay it back and what happens if you can’t pay it back. Make sure you understand the terms and conditions of the agreement.
- Set a Debt Limit – Decide how much debt is too much and set a debt limit for your business. Estimate how much you’ll need to borrow for each debt type and determine how much you can borrow based on your revenue and cash flow projections. Avoid taking on the additional debt until you’ve paid off all existing debt.
- Keep Your Debt Low – Make sure that your company debt is as low as possible. You don’t want to take on debt unless it’s absolutely necessary, but if you do need to take on debt, make sure you carry as little as possible.
- Use Debt as a Tool – If you decide that debt is necessary, use it as a tool to grow your business. In many cases, debt can be a positive force in helping a business prosper.
While the points above are useful to consider when assessing company debt, it’s often worth seeking professional advice from a reputable debt advice company. These specialist financial experts can help you navigate the complex world of borrowing to support your company.
Leveraging the Value of Company Assets
If your company has valuable assets, such as real estate, equipment or inventory, you may be able to use them as collateral for a debt loan. In this scenario, lenders use the value of your assets to secure the debt. This is common in the real estate industry and can help you take on debt without paying interest or securing a traditional bank loan. If you have company assets that you can use as collateral for a debt loan, make sure you understand the terms and conditions of the loan.
If your company has cash in the bank, you may be able to use it to secure a debt loan. This is referred to as cash collateralization (sometimes referred to as cash collateral) and it allows you to use the cash in your bank account as collateral on a debt loan. For example, let’s say you want to borrow £100,000 from a lender. If you don’t have assets to secure the loan, you may have to pay interest on the loan. If you have £100,000 in cash in the bank, you may be able to use it to collateralise the loan. The lender will take your cash as collateral, and you’ll receive £100,000 in debt funding. If you don’t repay the debt on time, the lender will take your cash.
Covenants and Protections
Lenders typically impose covenants and provide protections in the event of default. Covenants are promises made by borrowers about how their business operations will be conducted. Lenders often require borrowers to maintain certain financial ratios — such as a debt-to-equity ratio or debt-to-earnings ratio. They also may require that the company maintain a certain level of assets. Protections are actions lenders can take if a borrower is behind or fails to meet covenants. This can include acceleration of the debt.
Company debt should be avoided if possible, but sometimes it’s necessary. If you decide to take on debt, ensure that you understand the terms of the loan and have a repayment plan. Make sure you keep your debt low and avoid taking on additional debt if at all possible. Finally, leverage your company assets, cash and earnings to minimize your need for debt.