Traditionally, small business owners have been conditioned to be quite sceptical of debt. At best, they see it as a necessary evil and a means to an end when additional capital is urgently required. At worst, they believe it’s a sign of failure and something that needs to be avoided at all costs.
However, the challenges of the last couple of years have left many small businesses with no choice but to borrow money. For them, debt has become an uncomfortable reality, and a necessity to simply keep the lights on and doors open. It’s also become the source of significant stress, anxiety, and – often – shame.
But it really doesn’t need to be. When managed effectively, debt can open up opportunities a business wouldn’t otherwise have access to. Here we explore what good debt looks like and share our tips for keeping your debt under control.
Good debt v Bad debt
One of the keys to unlocking the power of debt is understanding that not all debt is created equal. Some debt will allow you to take your business to the next level, upgrading your tools and increasing your productivity. Other debt will weigh you down, adding to your ongoing expenses and inhibiting your ability to grow.
The latter usually comes from treating debt as a stop-gap solution and using it to cover short-term cashflow shortfalls. While borrowing money can be an effective way to smooth out income irregularities, this generally only works for seasonal businesses. And even then, it still has long-term impacts, eating into the business’ profitability and potentially limiting peak season operations.
It’s also possible for good debt to turn bad if not managed correctly. For example, if you take out a loan to buy business assets, but overcapitalise, at least part of the debt will be an unnecessary expense. Similarly, if you struggle to make repayments and accrue additional fees and charges, this could negatively impact your overall profitability.
With that in mind, before committing to a debt, you should carefully consider the value it will provide your business. If you believe it will produce more income than it will cost, both in the short and long term, it may be worthwhile. But if you feel it’s more likely to be just an ongoing expense, you should probably look at other options.
Tips for better managing your debt
Regardless of the reason for a debt, there are a few simple things you can do to minimise any potential negative impacts. Specifically, we recommend you:
- Prioritise paying down bad debt: As a general rule, the longer you hold a debt, the more it will cost you (in fees, interest, etc.). Conversely, the quicker you get it off your books, the smaller the impact it has on finances. As such, you should aim to clear your debts as quickly as you comfortably can – starting with the most expensive ones.
- Regularly renegotiate debt terms: Refinancing your loans can help you pay them off quicker – particularly, when you take advantage of interest-free and reduced interest period offers. Many lenders provide these terms, which in turn allow you to focus on paying down the loan’s principal. Also, if you have multiple debts, you could save money by consolidating them into one preferably lower interest rate loan.
- Don’t rely on debt: Once you have debt, it’s easy to fall into a negative debt cycle. This is where you use debt to pay off debt, or constantly move from one debt to the next. To avoid this, make sure you’re only taking on good debt and keep a close eye on your debt-to-equity ratio.
- Adjust your prices to reflect your costs: Many small businesses resist raising their prices for fear of losing customers and, by extension, impacting their profits. But over time, the cost of doing business will increase in line with inflation, effectively eating away at your profits. As such, it’s only reasonable to increase your prices to protect your planned profit margin.
Want more information?
If you want to learn more about good debt and how it could help you build your business, contact MT Corporate Advisory. Our team are experts in growth planning, and are always happy to offer advice on cashflow management, and business strategy. We can also work with you to develop a tailored plan to optimise your operations, and boost your profitability.