I hear from a lot of entrepreneurs who are having problems and don't understand why. If you look hard enough, there's always a logical reason for whatever has happened, but it can be difficult to pinpoint when you're dealing with a variety of issues at the same time. It's especially tough if you've had to take on debt from multiple lenders to finance your growth, and they are all charging different interest rates.
That was more or less the situation Kate and Jason McCrea found themselves in several months ago, when Kate first came to see me. She realized something was wrong at their company, McCrea's Candies, but she wasn't sure what it was.
The McCreas started the business in 2010. They sell caramels that Jason, who has a background in chemistry and an interest in food, developed the recipe for. His ambition was to make the best caramels in the world. Customers loved them. As word got around, sales began to take off. The company grew 30 percent or more annually for several years in a row.
With all those orders coming in, the McCreas needed cash to pay for supplies to make, package, and ship their product. When it was clear their own savings and loans from friends and family would not be enough, they raised more by signing up for zero-interest credit cards. The deal with these cards is you can spend up to your credit limit and the money is interest-free for a given period of time, usually about a year. But if it isn't paid off by the end of that period, you owe interest on the outstanding balance at whatever rate the credit card company charges. That rate can range from 14 to 25 percent.
The McCreas would have preferred to retire the entire balance when each card's zero-interest period ended, but they couldn't always afford to. In that case, they would pay the minimum plus a small amount more. They were juggling several cards in this fashion, but they didn't worry as long as revenue and cash flow kept increasing. When sales leveled off in 2018, however, they grew concerned.
To assess how serious the situation really was, I first had to determine whether the business was viable--that is, if it didn't have all the debt and if the McCreas didn't take too much out in salary and perks, could the company sustain itself on its own internally generated cash flow? I asked Jason and Kate to add up what they were paying monthly on their loans and to estimate how much they were compensating themselves, including any personal spending--say, for a car or for health insurance--charged to the business. When we looked at an income statement without those expenses, it was clear the company could be very profitable.
So, how to reduce the credit card debt? I could see the McCreas had the wrong strategy. They were certainly right to pay the monthly minimum due on each card, but the credit card companies couldn't care less about the extra amount they paid over that. I told them to stick to the minimum on all but one of the cards--specifically, the one with the highest interest rate. Given their excellent payment record to date, the issuer would likely be willing to give them a lower rate if they asked for it. Then they could take all the above-the-minimum money they'd been spending on cards and use it to pay down the one with the highest interest as fast as possible. Once that one was paid off, they could focus on the card with the next highest interest rate and do the same--and so on until they retired all of their credit card debt.
Kate and Jason have now started the process. Meanwhile, we will look for other ways to improve their company's profit margins. I'll let you know what happens in a future column.