Taking on debt can help build a business. Borrowing works well when the cash generates a return in excess of the cost of the debt. Sometimes, however, leaders take on too much debt which they need to reduce while managing cash carefully. Let’s look at some ways to tackle this high-risk situation.
An important responsibility of leaders is figuring out how to fund business operations and growth plans.
In the best case, a business will generate enough cash for operations, growth and shareholder dividends. However, in many cases, leaders need to borrow money for growth and, in tough times, even the operations of their businesses.
Debt has its place…
Taking on debt is not necessarily a bad thing. In fact, some astute business people argue that it is better to use someone else’s cash for your business investments (even if you have the cash yourself). This assumes you can put the cash to use and generate returns which are higher than the cost of that debt.
How do businesses get into too much debt?
Excessive business debt can arise for a number of reasons. Investments may not pan out or take much longer to realize gains. An owner can run up debt on a personal credit card or a banker might extend a line of credit that’s used up but needs repayment at high interest rates. Excessive debt means any positive cash flow is consumed by debt repayments. Failure to pay creditors, employees, suppliers and overheads can have devastating consequences.
For businesses carrying too much debt, we encourage leaders to take early and decisive action. Each business is different… but here are some options.
Improve the Inflow and Outflow of Cash
On the one hand, this means connecting with customers to sell more and get paid faster, even if that means offering discounts. Any increase in revenue (inflow) is highly desirable and means the business probably has good fundamentals. This can also mean renegotiating payment terms with suppliers through discounts and/or deferred payments. Anything to stem the outflow of cash is welcome.
Communicate with Creditors
No one likes surprises, including creditors. Early notice of a delayed payment can help creditors look for solutions to improve their chances of collecting their cash. With enough information, they may be willing to reduce interest rates, increase your credit line or restructure repayment terms. On the other hand, failure to communicate with your lenders will probably make matters worse.
Consolidate your business loans into one payment
Dealing with a single creditor rather than many may reduce monthly costs, and possibly allow you to get a lower interest rate, all without negatively affecting your credit score.
Consider Fundraising
For businesses with strong underlying fundamentals, a capital raise can overcome an adverse cash situation. This comes at a cost, including selling valuable equity and being exposed to a new shareholder(s) who will exert influence on the business. Still, angel investors, crowdfunding and accelerators can provide critical support to a vulnerable, cash-strapped business.
Cost Reduction
It sounds obvious, but a business with debt, negative cash flow and no external sources of capital will need to take drastic action. It’s just a matter of time before creditors come calling. In this case, reducing costs like rent, human resources, marketing and procurement may allow creditors to be paid while keeping operations running. These are not easy decisions, but they may be necessary.
Conclusions
The obvious lesson here is to avoid debt unless the borrowings are sure to generate a positive return. If things go wrong, consider these ideas to bring the business back to health. And remember, many businesses have been through very tough periods but have clawed their way back. That’s part of building successful businesses!
This is general information only. Contact us today for an obligation free chat about your business needs.