When you run your own business, debt is a part of life. You typically need some debt to get your business up and running, and you’ll likely need some kind of funding at certain points to expand and invest in new endeavors. Taking out credit is normal and okay – as long as you practice wise debt management.
It’s best to be organized from the start to stay on top of things like loan payments. Every small business owner should also have a strategy for spending and new lines of credit. Sometimes, however, unexpected circumstances occur, and you’ll need to take steps to manage and repay your debt.
We’re sharing four crucial steps to managing your debt in this post. We’ll also touch on alternative options for when your business is stuck in a tough financial situation, including debt management plans.
1. Organize & Review Your Debt Information
Before making any changes, assess your current business debt. This not only means organizing your debt details but also understanding both current (due within the next 12 months) and long-term (due beyond 12 months) liabilities. Review any existing and new debt agreements to ensure you know your responsibilities. Consult with a trusted advisor if you’re uncertain about something or it sounds too good to be true.
As you review your open debts, prioritize them by urgency. For example, you should worry about paying your employees and remaining current with your landlord before your office supplies vendor.
Create a spreadsheet and organize the information for each individual debt by:
Monthly payment amount
Payment method (e.g., check or ACH)
Reason for debt
Credit type (e.g., loan, business credit card, or personal credit card)
Why payables and employees? Employers should look at both as “debt” because they are still accounts and people you have to pay! Most importantly, if you don’t pay your people, they won’t come to work, and you won’t have a team to keep your business running.
2. Watch Your Spending & Boost Your Income
Next, consider what you can do to reduce your spending and increase your revenue. Whether you’re a new business trying to get off the ground or your organization is struggling financially, you may need to make adjustments.
Cut back on expenses. What is unnecessary? What can you and your team do without? This may mean fewer team lunches, canceling unused software or apps, or even reducing/eliminating physical workplaces (after all, we’re in a new era of remote work!).
Review all vendor contracts. Are you paying for things your team no longer needs? Have prices gone up? Don’t be afraid to shop for other options or negotiate costs. When signing a new contract, make sure you understand the contracts (i.e., vendor’s commitments, payment schedules, late fees, etc.).
Adjust pricing. You may need to raise your product or service prices to keep up with market trends and become more profitable. Or maybe it makes sense to lower your prices to sell more.
Find ways to increase revenue. What new revenue streams can you implement? Are there new products or services you can offer? Perhaps cost-effective options that complement your current offerings. Or maybe you can extend your business hours to cater to more customers.
Invest in a sound accounting system. Automate your invoicing to ensure timely payments from clients with easy payment options and reminders. Plus, more convenient payment methods mean you can shorten your payment due dates. An efficient accounting system will also show you outstanding balances so you can ensure customers are paying on time.
3. Practice Proactive Communication
Be proactive in communication with your creditors if a challenge or obstacle arises that could impact your ability to make a payment. When you reach out to them early enough, your lenders may be more willing to work with you by:
Lowering your interest rates
Temporarily modifying your repayment requirements
Helping you consolidate your debts into a new loan with better terms
This is another reason having a solid accounting system is critical to your organization. When you do, you’ll have clear insight into your company’s financial health and debt situation.
4. Consider Other Debt Management Options
Speaking of debt consolidation, let’s look at other ways you can manage your small business debt.
Debt consolidation involves opening a new loan, ideally with better terms, and using the funds from that loan to pay off the previous debts. You would then need to repay the new loan.
If you opt for debt consolidation, you must understand the terms. It’s only worthwhile if the new loan has a significantly lower interest rate than your existing debts – which requires good to excellent credit. Also, beware of origination fees required by some banks. You should look into several options and try to avoid these.
Debt Management Plans
You may also consider a debt management plan, a strategy offered by credit counseling agencies that allows you to make a single monthly payment on all of your personal unsecured debts (e.g., credit cards and personal loans) covered by the plan. It may be a good option if you have some personal debts you used for your business. The goal is to simplify the process and help you repay your debts in a shorter amount of time.
A debt management plan is not:
A debt settlement that allows you to pay less than you owe
Available for secured debts (e.g., mortgages, auto loans, or others secured with collateral)
How does it work?
The credit counseling agency will help you set up a voluntary agreement between you and your creditors. You make a monthly payment to the agency, and they send the funds directly to your applicable creditors. One-hundred percent of the amount you pay goes toward your accounts.
A debt management plan can help you rebuild your credit by fully paying off your debt. Plus, it allows you to save up for future goals thanks to lower monthly payments.
What else does the credit counseling agency do?
Also known as consumer credit counseling agencies, these are often nonprofits that guide you in paying off your debts. They also provide financial education and counseling by trained and certified finance professionals. A good agency will help you do things like setting up a budget.
They typically charge modest fees for their services, which should be explained in a written agreement. Your credit counseling agency will even help you negotiate debts with your creditors, getting them to waive late fees and lower their interest rates.
To declare bankruptcy, you would need to file through the U.S. Bankruptcy Court. Bankruptcy releases honest debtors in unfortunate situations from paying certain debts, allowing them to start anew.
If you are considering filing for bankruptcy, you will be required to participate in a credit counseling session first. The credit counselor will determine if bankruptcy is the best option for your financial situation. Learn more about avoiding business bankruptcy.
Avoid Debt Settlement
Debt settlement involves settling your debt for less than what you currently owe and requires you to pay the settlement amount in full. There are two types of debt settlement, and both are ill-advised:
DIY: You avoid fees of a professional debt settlement company by negotiating directly with your creditor, and they agree to consider your account paid for less than what you owe.
Professional: You pay a debt settlement firm to negotiate a settlement with your creditor. If they settle, the firm then pays your creditor either with a) a lump sum (one large payment); or b) multiple payments over a period of time (i.e., term settlement).
Both options pose major problems, including:
Credit score damage
Possible lawsuits from your creditors: During the process, you intentionally do not pay your loans, so they become delinquent.
High costs: Debt settlement firms charge between 15-20% of your enrolled debt. Plus, forgiven debt over $600 is considered taxable income.
Complications: If you have multiple debts, your firm may not be able to settle with all of your lenders. This causes more complications and costs.
Overall, debt settlement has been proven ineffective with meager success rates. The process takes three to four years on average, and many people end up paying more than 78% of their original balance due, according to a study by the American Fair Credit Council. It’s simply not worth the risks and costs.
Do you need small business debt management guidance? Check & Balance will be happy to answer your additional questions and point you to reputable resources. Schedule a free consultation or call us at 603-505-2368 to find out how we can help you!