Part of being an effective leader of your small business is to be able to make sense of the numbers and to know that cash is king! Understanding debt is important because your business must be able to understand how to properly utilize debt as a tool that can help your business expand and grow.
As an entrepreneur, you will face two different types of debt to utilize as you you’re your business: personal debt and business debt. The reason for this is because often you are the first creditor for your business until your business grows to the point where it can get credit in its name.
In simple terms, debt is money owed from one person to another and it is not necessarily a bad thing. Debt can be a powerful tool to help a business grow. When properly utilized, debt can help a business benefit from leveraging the bank’s money in order to buy assets that will generate a profit. Unlike consumer debt which rarely allows a person to generate revenue, business debt can be a valuable tool because it allows a business to leverage other people’s money for the purpose of expanding. Some common uses of debt for your small business are to help fund operating costs or to purchase equipment or inventory.
Before getting debt, it is important for a small business owner to evaluate the true reason for why the debt is needed. If a business is having cash flow issues then obtaining new debt should be done only after a well thought out plan as to how the debt will improve the health of the business. Don’t make the mistake if your small business is having cash flow issues of taking on more debt that may not really fix the underlying financial situation. In this scenario, the business may be better suited to focusing on other ways to generate more revenue rather than on getting further into debt. On the other hand, the use of debt can be advantageous if the business is able to use the debt as a means to allow it to generate more revenue – such as by purchasing more inventory.
One way that a business can evaluate how effectively it is using debt is to calculate its debt ratio. The debt ratio is defined as the ratio of total – long-term and short-term – debt to total assets, expressed as a decimal or percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt. The lower the debt ratio, the less leveraged the business is. Comparing your business’ debt ratio to those of your industry is one way of gauging where you stand among your peers.
Some ways that we can help an entrepreneur with business debt issues is by helping you to understand your financials and your ratios. Additionally, we can assist in restructuring business debts in the event that the current terms become unmanageable.