Every business carries a certain amount of debt. Generally speaking, a business may carry a mortgage on the property it owns. It may have a line of credit with its bank in order to purchase the supplies that it needs to produce its product. It may purchase its raw materials using a line of credit with its vendors. Even its accounts receivables are debt, in that they represent time and material expended by the company for which it has not received compensation.
A business owner should consider several issues before deciding to pursue business debt consolidation. Is the amount of debt greater than the projected income? Does the debt ratio jeopardize the covenants of the existing loans? Does the business have enough equity to pursue debt consolidation?
Debt-To-Income Ratio
The first step in determining the debt-to-income ratio for a business is to list all of the debts as monthly figures. Some of these figures are easy to calculate on a monthly basis, such a mortgage payments, payments made on a line of credit, credit card payments, and utilities. For annual expenses, divide the total expense by twelve to determine the monthly amount. Annual expenses include taxes, health care costs, salaries, commissions, bonuses, accounts receivables, attorney’s fees, accountant’s fees, and any other expense that does not occur on a regular, monthly basis.
The second step in determining the debt-to-income ratio for a business is to list all of the income as monthly figures. Depending on the business, this step may be an easy one. For example, a store that sells a commodity can easily track monthly sales figures. For other businesses, this step may require more work. For example, a homebuilder may have several months worth of labor and materials invested in a project prior to receiving payment. Divide the monthly debt by the monthly income to determine the debt-to-income ratio. For example, if a business has a cash outflow of $50,000 per month and an income of $100,000 per month, its debt-to-income ratio is 50%. For a health business, this number should be lower than 30%. A high number indicates that a business may be carrying too much debt.
The third step in determining the debt-to-income ratio for a business is to determine the net value of the business. The net value of a business is the value, positive or negative, of its assets versus its debts. For this figure, a business should engage the services of an outside appraiser. The appraiser will place a current monetary value on all of the property, holdings, equipment, and supplies. This figure represents the value of the business’ assets. Subtract total debt from this figure to determine net value. Total debt includes the remaining balance on any mortgage and the balance owed on any of the equipment. The total amount of each line of credit, whether a financial institution or a vendor holds that line of credit, must be added to the total debt. Even if a line of credit has not been exhausted, its total value is calculated into the debt. A line of credit represents cash that the business can access, and it is therefore a liability. Subtract the total amount of debt from the value of the business’ assets to determine net value. For a healthy business, this figure should be a positive number. For a troubled business, the net value may be a negative number.
The business should evaluate its debt-to-income ratio and its net value in order to determine the viability of pursuing a business debt consolidation.
The Business Debt Consolidation Process
If a business is receiving debt collection notices on a regular basis, debt consolidation can help. Debt consolidation allows a business to pay its creditors on a more reasonable plan. A business can then use its extra cash flow to increase its marketing, increase its productivity, decrease its overhead, or for any number of other activities that will bolster the health of the business. If a business is receiving foreclosure notices, debt consolidation can protect the business’ assets. The business owner then has the option of growing his business or selling it for its maximum value.
Debt consolidation works by reducing the total cash outflow from a business. It is accomplished by working with the creditors to determine a feasible payment plan. Creditors who are willing to accept less than the amount owed are paid faster than creditors who will not negotiate the total balance. In this manner, the company’s debt load is reduced quickly and efficiently.
Creditors are not required to participate in a debt consolidation. However, most creditors find it in their best interest to do so. Creditors with whom the business needs to continue to interact benefit because the success of the company enhances the success of their companies. Creditors with whom the business is not longer involved benefit from participation in the debt consolidation in that they will receive a structured payment. These benefits are especially appealing when the business is facing bankruptcy. Creditors may receive no payment should the business declare bankruptcy.
