One of the easiest ways for a business to get into financial trouble is to take on too much debt. That's especially true when the economy is stagnant and there aren't enough sales to compensate for the extra debt load. Before the crash, many business owners took on debt to expand in the booming economy. Since then, they've been trying to manage that debt while experiencing decreased sales, and far too many are ending up in bankruptcy. If your debt load is too high and bankruptcy is not an option for you, here's how to try to reduce it.
Determine your debt-to-equity ratio.
You'll first need to calculate your debt-to-equity ratio, which will tell you how much you owe creditors in relation to how much equity you have in the business. You'll need two figures for this. First, add up all of your debt, both short term and long term. Next, you'll need your owner's equity figure, which you can find at the bottom of your balance sheet. Then plug those numbers into this formula:
debt-to-equity ratio = total debt / total equity
So if you have total debt in the amount of $200,000 and your owner's equity is $100,000, your debt to equity ratio is 2. That means for every dollar you own in the company, you owe $2 to creditors. If your debt-to-equity ratio is too high, it means that the profits from your sales may not be sufficient to satisfy all of your debt obligations. Ideal ratios vary by industry, so you'll need to research yours to find your ideal number.
How to lower your debt
The quicker you can lower your debt, the faster your business will thrive. It will allow you to put more of your profits into building your business, rather than only paying off your creditors. Here are some of the ways you can accomplish this.
Talk to your suppliers and creditors.
People who have personal debt may be able to dodge their creditors, but it's a different story for business owners. Chances are, your creditors are the same people who supply you with the raw materials or inventory that you need to run your business. So it makes sense to do what you can to preserve those relationships. Be up front with your suppliers. It's probably not the first time one of their customers has been in a financial bind. Ask them to work with you on a payment plan that extends the terms and gives you extra time to pay.
The same holds true for other types of creditors, such as credit-card issuers and other lenders. They would rather get something from you than see you go out of business and not get anything at all, so they will often work with you and lower your payments temporarily.
Sell what you can do without.
Do you have excess inventory, machinery, or equipment that you can sell? How about real estate or cars and trucks that aren't absolutely necessary? Sell what you can and use the proceeds to reduce your debt.
Tighten your belt.
Cutting your expenses is crucial when you're trying to get rid of debt. Scrutinize all of your day-to-day expenses and determine what you can cut back on. In addition, look at your payroll and figure out if you can cut some hours -- even if you have to fill in for an employee. In short, do whatever you can to reduce your operating expenses, and then use that money to pay down your debt.
Consider a loan or debt consolidation.
One reason excess debt is so difficult is that the accumulation of minimum monthly payments can quickly overload your budget. One tactic is to take out a business loan for the total amount of your debt and only make one payment. If your credit has been hurt by the crunch, alternative lenders are another avenue for much needed loans.
Another option is to engage a debt-consolidation service, which will work with your creditors to consolidate all of your debts into one and then negotiate a payment plan you can afford. Keep in mind that you will take a hit on your credit report, so you'll have to weigh the cost of this option.
If you have a lot of accounts receivables, you can sell them for a percentage of the total owed to you, depending on the age of the invoices. Referred to as factoring, this is a quick way to get a lump sum of cash that can be used to pay down your debt.
One of the major reasons that small businesses go under is because of a lack of cash. And nothing depletes the cash from a business faster than a heavy debt load. Weigh these options and determine which one(s) could help your business pull out from under the burden.
Get more help with your finances using our guide for managing debt.