How to Manage Debt

Debt isn’t necessarily a dirty word in business. In fact, almost every business can expect to experience some form of it at one point or another. The key is to not let your debt become too overbearing.

“The right amount of debt is the least amount,” says Bill Boothby, chairman of SCORE’s Denver location, www.scoredenver.org. “What people tend to lose sight of in a small business is that cash is king.” SCORE is a nonprofit, volunteer group of seasoned entrepreneurs who provide advice to small-business owners nationwide.

Boothby, who started and sold two multimillion-dollar enterprises and ran international development for a Fortune 500 company, says one principle mainly guided his success in developing all three very different businesses: positive cash flow.

Different industries traditionally have different ratios of debt to equity or debt to net worth. The debt-to-equity ratio expresses the relationship between capital contributed by creditors and capital contributed by owners. A ratio of higher than 1 means a company has more debt than assets; lower than 1 represents the reverse. The higher the ratio, the greater the risk creditors assume.

According to BizStats.com, a site that publishes average ratios for a variety of industries, says that while the automobile rental business, which requires a lot of capital, is heavily leveraged with an average 4.9 debt-to-equity (or new worth) ratio, the semiconductor business is less than 1.1.

For startup companies, the ratio is likely to be 1.5 – and it tends to vary by region and industry. Banks generally want to see an enterprise generating at least 1.25 times the amount of principal and interest payments due on a loan. In other words, in order to obtain financing with annual payments of $100,000, you’ll need to demonstrate that your business will produce $125,000 in unencumbered cash flow.

SCORE provides an excellent, downloadable Excel worksheet for figuring out your assets and liabilities – information that any lender will require. It suggests that you compare key ratios such as debt to net worth to industry averages that are published annually by the Risk Management Association in its Annual Statement Studies, which is available at major libraries or at your local bank.

“Part of managing debt is managing all of your liabilities,” Boothby cautions, not just the obvious ones, like bank loans. Small-business owners sometimes pay too little attention to stealth obligations such as long-term leases with personal guarantees. Boothby advises new businesses to negotiate shorter terms – say two years with a three-year option – in case your dreams fall short of reality. And try to get the landlord to agree to a personal guarantee only for the months that it will take to find another tenant.

“Looking at options that limit your exposure from a financial liability standpoint is essential,” Boothby says. Also, establish a line of credit with a bank, he says, but only draw on it as a last resort. Postpone other liabilities, and stretch out suppliers as long as you can before committing to those monthly payments.

To investigate your options in obtaining loans, check out SCORE’s online financing guide. The handy table includes descriptions of the terms of loans, investment criteria, and typical lenders.

And never lose sight of the big picture.

(No Ratings Yet)

 Loading ...