CHICAGO — The ability to use debt, and not get used by debt, is an important part of operating most small businesses. This was the topic of a recent webinar hosted by the Service Corps of Retired Executives (SCORE), and presented by Juliana Ramirez, an accounting expert, entrepreneur and small business bookkeeper for more than 20 years.
“Understanding how to handle debt is crucial for maintaining a healthy financial status, ensuring business sustainability and paving the way for growth and success,” Ramirez says. “However, if not managed carefully, it can also lead to financial strain, and limit the potential of a business.”
Debt Management Basics
Debt management is the strategic process of handling outstanding debts, Ramirez says, to ensure they are repaid in a timely, efficient manner.
“You probably have heard that getting in debt is not necessarily a good thing,” she says. “However, in order to make money, we need money, and we need personally to invest it. We may not have that money right off the bat, though, so you may need to acquire money now.”
Debt management can, if managed correctly, help with cash flow stability.
“It helps maintain a healthy cash flow by ensuring that debt repayments are predictable and manageable,” Ramirez says. “This stability is crucial for small businesses, which often operate with tighter cash flow margins.”
With borrowing, however, comes a degree of risk. If the debt isn’t managed properly, or if the terms aren’t in the company’s best interest, business owners can open themselves up for a liability.
“Risk reduction is something that we also need to think about when thinking about managing our debt,” Ramirez says. “By effectively managing debt, small businesses can avoid the risk associated with over-leveraging, such as bankruptcy or financial stress.”
Credit worthiness is also another component of debt management, Ramirez says. If managed properly, borrowing can positively impact a business’s credit rating, and a good credit score can be essential for securing future financing on favorable terms with lower interest rates.
“Debt management is particularly important for when you’re thinking about going to a bank or a lender to let you borrow money and avoiding costly debt traps,” she says. “Businesses can avoid high interest rates and penalties associated with certain types of debt by managing their obligations wisely.”
Types of Business Debt
Part of effectively managing debt is understanding the different types available to small- and mid-sized businesses — the category most dry cleaners fall into. Ramirez offers definitions of the following types of loans:
Term Loans — These are traditional loans where a lump sum is borrowed and repaid with interest over a fixed period. They can be short term (less than a year), medium term (one to three years), or long term (over three years).
SBA Loans — SBA loans are provided by the Small Business Administration. These are loans that are government backed, offering favorable terms like lower interest rates and longer repayment terms, designed to assist small businesses.
Equipment Financing Loans — These are specifically for purchasing business equipment, where the equipment itself serves as collateral.
Business Credit Cards — Similar to personal credit cards, business credit cards offer a revolving line of credit with a set limit, useful for short-term financing and managing day-to-day expenses. They often come with higher interest rates and additional perks, like reward programs.
Lines of Credit — A line of credit is another type of debt that offers access to a predetermined amount of funds that can be drawn upon when needed. It is a flexible option, as the business owner only pays interest on the amount they use. It can be secured or unsecured.
Merchant Cash Advances — Usually, the money comes as an advance and a deposit in the company’s account. Then, the business owner will repay this with the money from sales or income.
Invoice Financing (also known as Factoring or Discounting) — This is selling the company’s outstanding invoices to a third party at a discount in exchange for immediate cash.
Commercial Mortgages — These are used for purchasing or refinancing commercial property. The property usually serves as collateral for the loan.
Microloans — Microloans are smaller loans often provided by nonprofits or government agencies aimed at startups or businesses in under-represented communities.
“Each type of debt has its own set of advantages and disadvantages,” Ramirez says, “and the choice depends on the specific needs and circumstances of the business. It’s important for business owners to understand the terms, interest rates, repayment schedules and potential risks associated with each type of debt to make informed decisions.”
Come Back Thursday for Part 2 of this series, where we’ll examine how debt can affect a business, along with steps to evaluate your company’s current debt.
Have a question or comment? E-mail our editor Dave Davis at [email protected].
