Most businesses will take on some form of debt – whether a single loan to help cover startup costs or multiple loans and credit cards along the way. Learning to manage this debt is important. When handled correctly, debt can be a great form of investment for business owners. When handled poorly, debt can end up being the downfall of a business. Below are 10 tips for making sure that you healthily use debt.
What you can expect in this article:
1. Explore bank loans for big startup expenses
The biggest loans are typically taken out when first starting a business. These loans are often necessary for covering expensive equipment, marketing and licences.
Banks are still one of the best lenders for these types of loans. Compared to some lenders, banks can offer much larger loans with much lower interest rates. Banks also won’t hassle you to keep borrowing money the way that some private lenders do.
The catch is that these loans aren’t as easy to get approved for as many private lender loans. There will usually be stricter eligibility requirements and you’ll have to wait longer for your application to be processed. Therefore you should apply for these loans well in advance of launching your business.
2. Use a credit card for smaller business borrowing needs
Credit cards are better suited for covering smaller borrowing needs. While you can get some credit cards with high spending limits, most business credit cards have a limit between £1000 and £10,000.
You can buy business credit cards that come with all kinds of rewards and benefits. It’s worth taking the time to compare these, as well as general interest rates.
Credit cards are ideal for covering emergency costs because you don’t have to enter any lengthy application process whenever you borrow money with them. Instead, you can use them like a debit card to quickly deal with any unforeseen urgent costs.
3. Know your monthly budget before taking on new debts
It’s important to keep a clear idea of what each month’s budget is so that you know how much debt you can afford to take on. You need to be earning enough to cover monthly repayments alongside all the other running costs that come with a business.
Many businesses make the mistake of taking on too many debts too early and ending up with a negative cash flow (this cashflow definition page delves more into the importance of maintaining a healthy cash flow). Limit taking on new debt if you already have a slim profit margin.
4. Create detailed business plans when applying for large loans
When applying for large business loans, most lenders will expect a detailed plan as to how you hope to use this loan, as well as evidence that you will be able to cover loan repayments.
It could be worth working with a financial advisor or accountant to draw up a detailed financial plan so that you can increase your chances of being approved. A detailed plan can also help you determine whether a loan is truly justified and whether you can actually pay it back and still make a healthy return.
5. Separate your business and personal finances
When starting a business, it’s always a wise decision to open a separate bank account for your business and to ensure that all business-related debt payments come out of there. This ensures that business debt doesn’t affect your finances.
Changing the legal structure of your business to a limited company is also recommended to reduce the damage your debts could cause. A limited company is seen as a separate entity to you and only funds and items owned by your business can be used to pay off debts owed to your limited company. This means that debt collectors cannot seize personal items to pay off your business debts.
6. Improve your business credit score
Just like a personal credit score, a business credit score determines which loans and credit cards you can access. If you have a good business credit score, you’ll be able to access more borrowing options with lower interest rates. If you have a poor business credit score, you may find that you are limited to a handful of lenders – and that they all charge high-interest fees.
There are a few different ways to improve your business credit score. One way is to simply pay suppliers and lenders on time to show that you are a good debtor. You should also make sure that you never exceed your overdraft limit and that you are consistently making a healthy turnover.
7. Make managing lots of debts easier with consolidation
The more debts you have, the harder it can be to keep track of them. One way to make managing these debts easier is to consolidate them into a single debt. This involves using a single large loan to pay off all of your debts.
There are business loan lenders that offer these consolidation loans. Take the time to compare interest rates and instalment amounts.
8. Alternatively, use the debt snowball method
The debt snowball method is another way to tackle multiple debts. It involves pouring as much money as possible into paying off the smallest debt and then focusing on the next smallest debt before working your way up to the largest debt.
This is a good approach if you want to avoid taking out any more loans whatsoever (even if they are for consolidation purposes).
9. Know when to rent/outsource instead of buying
A lot of business owners overestimate which types of equipment they need to own. There are many types of equipment ranging from vehicles to desks that you can rent out instead. Many rental companies have top-quality equipment and some are even willing to cover the cost of repairs. These are perks you don’t get when buying equipment with a loan.
Renting can be more expensive in the long run of course, and you will not be able to modify the equipment that you are renting. As a result, it may not be suitable for all types of equipment.
10. Don’t overlook grants, investors and crowdfunding
There are many other ways to fund business expenses without borrowing money. Many business owners overlook government and local grants, which exist in many forms and are essentially ‘free money’. You also have the option of seeking funding from investors – this does mean offering shares of your future profits, however, this is still a better alternative than expensive loan repayments. Crowdfunding is also an option which involves raising funds from lots of different people (either via donations or in return for tiny shares). You can explore crowdfunding platforms online.