Almost every business at some point through their lifespan will have debt. This could be a problem you find yourself in through bad trading, or unfortunate costs the business incurs. But most businesses find themselves in debt, when they’re just starting out, however, this can be through various loans or commercial finance and doesn’t necessarily mean the business is struggling.
There can be different levels of severity to debt and some debt will affect you long term, whereas other debts will only be a problem for you short term. Some debts aren’t always negative, often businesses will have loan repayments, which still classes as debt, but is part of the bigger plan. This can come in the form of bridging loans, hire purchase, commercial finance or secured loans. But what are the problems debt typically causes?
Trouble with cash flow
Cash flow is essentially the flow of money coming in and out of your business. The more debt you have, the worse your cash flow will be as more of your profit ahs to go out paying liabilities. For start-ups and SMEs, this can’t be helped as the majority of businesses start with and have to pay some level of debt. These are short term debts, and normally don’t cause too many problems, typically you will only find yourself in trouble with these if the business plan doesn’t work and you find yourself struggling early on in your business life.
The damage to your cash flow typically comes when you find yourself with debts you wouldn’t normally have, that have come through unfortunate events. This could be unpaid or late tax bills, broken machinery, or a hike in your outgoings. Long term debt like this, will undoubtedly have a long term effect on your cash flow and could put you in the red.
No opportunity for growth
Put simply, the more debt you have, the less cash you have to invest back into the business. With long term debts, you can often plan around this as any long term debt should be implemented into your cash flow forecast.
For short term debts which need paying quickly, it can put a massive halt on your growth, as repaying those debts becomes a much bigger priority. If growth hasn’t been planned, it’s not too much of an issue, however, if you only have one chance to grow, in the form of a reduced piece of machinery, or hiring a new staff member and a short term debt is halting you, you could miss out on that opportunity.
You have to compromise on stock and production
Depending on what sector you are in and the nature of your business, most businesses need stock and raw material to operate. These are a constant cost, along with the cost of running the production through machinery and staff. This should all be incorporated into your initial cash flow forecast, with a five-year plan in place.
The difficulty comes if you do find yourself in debt, it means every new order of suppliers can be that little bit more difficult as you are having to cover the cost of the debt. Effectively you could find yourself having to go short on stock and production costs, leaving yourself constantly in the process of having to make-up.
Employees can be affected
Employees are often in line to feel the effects if a business is having trouble financially. Although it might not happen straight away, it’s usually not that long before they feel the bite. This can come in a freeze in wages, reduction in hours or even late pay. The worst that employees could see is potentially redundancies. Staff are the cog that keeps a business a going, so debt can have a hugely adverse effect on employees and could end up being the final straw.
Your credit score takes a hit
Just as with personal finances, debt will have a negative effect on your credit rating. Any blots on a credit file can make it much harder to borrow money moving forward. Creditors are likely to take action when it comes to getting what they’re owed, however, defaults, debts and court action typically disappears after six years.
Debt is not good for any business, that is part and parcel of owning a business and any owner should know this. The challenge comes with managing the debt and working out the best way of reducing it without compromising your normal business actions.
There are processes in place to help you manage debts, such as debt management plans or a company voluntary arrangement. These are specifically designed to help your business continue without the worry of debt.