Avoid the Bad and Embrace the Good: What You Need to Know About Debt

1Debt is inevitable in business. Some forms of debt are bad whereas others are good for your bottom line. There are even some billionaire mogul business strategies that rely solely on leveraging debt and transferring it from one asset to another. When it’s not managed, debt can cripple a business, so understanding your company’s debt structure positions your organization for expansion, profit and success.

Identify Debt With Good Accounting

You cannot deal with your debt if you cannot find it. The cost of debt can be elusive. While loans are relatively straight forward because your business received a chunk of money and is now paying it back, separating out the principle from the interest is more complicated. And calculating how much money the original cash influx made for you is even more complex.

To truly understand your debt structure, you need a powerful online accounting program, such as Sage One, that keeps your bookkeeping up to date. With Sage One you can create financial statements and see an overview of your business that will be your first and foremost driving document in debt management.

Measure Your Company’s Health With Ratios

There are a dozens of financial ratios that are used to compare a company to industry standards and to indicate the health of the organization. The current ratio is the total assets divided by the total liabilities. This tells you whether or not you have enough assets to cover your overall debt. Anything less than one is a problem. The quick ratio is similar, but it only uses cash and short-term assets to cover the liabilities.

Use ratios to establish your debt structure and overall financial health. If your ratios are good, do not fix what is not broken.

Separate Good Debt From Bad Debt

The ratios should help you identify bad debt situations. Bad debt is anything that does not yield more income than its rate to pay it back. For example, a $100,000 loan at 10 percent annual interest needs to generate at least $10,000 per year to break even.

Once the debt is incurred, the basic rule is to bring the terms down as much as possible. Just like personal credit, you want to switch out high-rate loans and cards with low-rate options.

Manage Your Revenue and Expenses

There are only two columns on an income statement. On one side is revenue and on the other is expenses. To minimize your bad debt, you need to have greater revenue than expenses. It is common for businesses to cut expenses and then stop. Strategically cutting expenses is a good start; however, more importantly, increasing revenue may mean expanding your product lines or entering new markets. According to Entrepreneur magazine, your existing fan base can help you increase your revenue, which in turn increases your fan base.

Be Vigilant

Most business owners are aware before they get into large capital debt. They discuss it in meetings and with family and friends. However, it is the small debt that can get you into trouble. A business line of credit here and a credit card there slowly add up. Create a quality assurance policy for your financial procedures that includes rules for debt acquisition. This prevents unwelcome surprises at the end of your fiscal year.

You must be careful when it comes to debt in your business. While not all debt is bad, you need to make sure that you can make more revenue than your debt is costing you. Understanding and monitoring your business’ finances is the key to successfully managing your debt.

About Mohit Tater

Mohit is the co-founder and editor of Entrepreneurship Life, a place where entrepreneurs, start-ups, and business owners can find wide ranging information, advice, resources, and tools for starting, running, and growing their businesses.

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