The highest priority in any business is driving sales and increasing overall profitability. The second priority for most businesses is debt management. Companies use different debt types for various situations including purchases, operating expenses, expanding operations, property and other activities. One of the biggest myths in business is that no debt is the ideal financial state. However, the right amount of debt, managed in the right way is the ideal state in a real-world business setting.
The first mistake is waiting until debt threatens the company’s survival. Business debt management services are not solely for the near bankrupt, but should be a part of every business’ tool set. Firms that handle debt management for at-risk companies are even better at debt management for healthy companies looking to improve cash-flow, expand operations or improve the balance sheet and attract investors. Some consulting firms offer specialized financial consulting for expansion capital, lender sourcing, or cash management. In order to consider the different types of services available it helps to understand the basics of business debt.
Types of Debt
To understand how businesses manage their debt, one must first understand what the basic debt types are that most businesses deal with. The three basic forms of debt include short and long-term debt and revolving credit. Short-term debt may include loans made for terms of one year or less and this type of debt is rare among small businesses as smaller firms typically use revolving for their short-term debt needs. The one area were short-term debt can be found in smaller firms is in a letter of credit. A letter of credit is an obligation that is issued by a bank and guarantees payment to a third-party for the business’ purchases or other invoicing.
Letters of credit are used mainly for the purchase of goods from over-seas suppliers. If this practice is conducted often and with the same suppliers, the company can negotiate terms that allow up to 120 days to pay the note. Alternatively, suppliers may accept up to 120 days payment delay to strengthen the business relationship. Delayed payments are the most likely form of short-term credit that a letter of credit takes. The other form of short-term debt that is common among small business is the credit line, which is a form of revolving debt, just like credit cards. Credit lines are a type of revolving debt that permits borrowing to a set limit without a fixed term, meaning no set monthly payments or number of months to pay.
Differences
The difference between credit card debt and a credit line is that credit cards require a minimum monthly payment to maintain credit and a credit line does not. Credit lines are issues by a bank and allow businesses to spend the money at will and pay back the debt at any time. Once the credit line maximum is reached the company must pay back the line and can borrow up to the maximum again. Essentially, long-term debt is any line of credit that has a fixed term lasting more than one year. The most recognized form of long-term debt is the mortgage. Equipment purchases can be made with credit granted with terms of two to six years or longer and they are another form of long-term debt. Of course, vehicles, unless leased, constitute long term debt as well. Typically, most long-term debt will be property or equipment based. Rarely, small businesses will have long-term capital loans, such as a cash loan for business development.
Managing Business Debt
The best practices for managing debt will depend on the size of the business, the type of business done and future development plans. Business debt management services for medium to large businesses is much more complex and depends more on financial management and accounting. Factors to consider are the total debt burden as measured against revenue. A company making $1 million per year could not sustain $100 million in debt, regardless of whether its long- or short-term. The second most important factor is the cost of debt, which is primarily the interest charged. $100,000 in debt may make sense for expansion at a seven percent interest rate, but not at a 15 percent interest rate, depending on expected income growth. Debt management companies, consultants and banks can all be instrumental in a healthy company’s debt practices.
For companies seeking investment a debt management firm can aid in improving the companies balance sheet and cash-flow, making the company more attractive, but a funding consultant is better at finding the right capital source. Full-service general debt management services should be on speed dial at any healthy company to ensure that operations are moving in the right direction and when needs arise, the expertise is available. While it is possible to “do-it-yourself,” in the small business world it is not recommended.
Consider that most large companies maintain a constant relationship with financial consulting firms and debt management specialists in spite of their ability to maintain such experts in-house. While complex, business debt management and business debt management services work very much like the way family budgeting does, once the basics are understood. Small business is challenging and wisdom dictates that every advantage should be used to ensure future growth and health.
