Debt is a natural part of a business鈥檚 finances, and a valuable tool to enable the establishment or growth of the company and to weather seasonal fluctuations in revenue and expenses. However, this debt needs to be managed carefully in order for it to remain beneficial rather than a danger to the health of the company. Small businesses in particular can benefit greatly from loans, but can also have the most difficulty recovering if debt gets out of hand. This is why effective corporate debt management techniques are valuable tools to have.
Types of Debt
There are two broad categories of corporate debt: short-term and long-term. Short-term debt involves loans or lines of credit that are used to cover immediate expenses that the business may not have the cash on hand to cover, such as supply purchases or maintenance bills. Long-term debt involves larger sums for capital purchases such as equipment or property.
Long-term debt comes in several forms, such as leases, mortgages, and commercial loans. Short-term loans may come from a bank, but they may also take the form of trade credit from other businesses. Trade credit can help a business manage cashflow by deferring payment for goods and services, but invoices can pile up if not properly tracked and managed. Business credit cards are another source of debt that offer convenience and flexibility, but carry high interest rates if the balance is not paid off regularly.
Corporate Debt Management Techniques
It is easier to manage corporate debt from a strong financial position than from an overextended one, but effective corporate debt management techniques can help get a company back on track from a difficult situation. There are many tactics to help control and discharge debt, and they tend to work best in combination with each other.
1. Take Stock of Existing Debt
The first step in corporate debt management is making a complete list of all debts and determining what priority each one is. Which liabilities have the worst penalties for late payment? The highest interest rates? Can any be discharged quickly? Would it benefit your relationship with a supplier or other creditor to settle something quickly?
When drafting a list of debts, include information such as:
- Creditor name
- Original amount borrowed
- Outstanding balance
- Interest rate
- Monthly payment amount
Collecting this information in one place makes it easier to get a full picture of the company鈥檚 debts and to determine which are the most urgent or the most expensive to maintain.
2. Create a Debt Repayment Strategy
Selecting a debt repayment strategy can provide focus and structure to corporate debt management. Two common strategies are the debt avalanche method and the debt snowball method. The debt avalanche strategy involves paying off the loan with the highest interest rate first, clearing the most expensive loan to reduce the amount of interest the company is paying.
Conversely, the snowball strategy involves paying off the smallest loan first, making extra payments on that one while making minimum payments on all the others. When the first loan is settled, the total amount that was originally allocated to it can be rolled into the payments being made on the next smallest. As more loans are paid off, the total amount being put into the prioritized debt grows, and momentum accelerates.
Different strategies will appeal to different businesses. If the debt with the highest interest rate is a large one, following the avalanche method may make progress feel slow, as it will be a long time until the first one is eliminated, though it may still be the most cost-efficient. The snowball method provides more concrete and immediate signs of progress, as smaller debts will be eliminated faster.
3. Review the Budget
It鈥檚 important to evaluate the company鈥檚 current budget and determine whether it needs adjustments. Maybe the business has grown beyond the old budget and it no longer accurately reflects current revenue streams and expenses. Maybe the budget could be trimmed down to allow more funds to be put towards clearing debts. Regardless, it鈥檚 important to have an accurate picture of available funds, as well as a cash flow forecast to help ensure there is enough cash on hand to pay bills when they come due.
4. Increase Revenue
While this may be easier said than done, there are many ways to improve profitability without making dramatic business changes. This is an opportunity to evaluate revenue sources and identify areas where the company may be losing money or missing opportunities. Reviewing the profitability of products and services can identify offerings that aren鈥檛 earning many sales, pricing that needs adjustment, customers that need more attention or prospects that are costing too much to convert. Sometimes small changes can make a significant impact on revenue.
5. Improve Cash Flow
Sometimes a business鈥檚 profitability may be strong on paper, but cash isn鈥檛 available when it鈥檚 needed to pay bills and cover other expenses. Improving management of accounts payable and receivable can help address this: sending invoices in a timely manner helps bring in payments sooner, as does offering discounts for customers that pay quickly. It鈥檚 also important to follow up on overdue accounts, and automated payment reminders can make this faster and easier. Online payment options can also make the payment process smoother and encourage customers to pay more quickly.
It’s important to take advantage of payment terms as a customer as well. If the company has cash available, paying early to take advantage of discounts can free up funds for other uses. If cash is currently tight, paying closer to the deadline gives the business time to find the necessary funds.
Inventory management is also important: carrying too much inventory at a time not only ties up funds in unsold products or unused supplies, but also results in higher warehousing costs. However, keeping too little inventory on hand can cost a company sales if it doesn鈥檛 have products available when customers come looking for them.
6. Negotiate with Creditors
Negotiation can be an effective corporate debt management technique. Many lenders and suppliers are willing to renegotiate payment terms if asked. Clear communication when a business is unable to make payments on time can build trust, especially if the business in question demonstrates that they are committed to paying the debt. When opening the conversation, come prepared with financial statements and a plan for repayment that will work with current and future cash flows. Longer payment terms or lower interest rates, for example, can help a business pay its debts without causing the creditor significant losses. Often a creditor will prefer a later payment over no payment at all.
7. Restructure or Refinance
Corporate debt restructuring involves changing the conditions of a debt contract, such as lowering the interest rate or extending the loan term. Refinancing involves securing a new loan with better terms to settle an existing loan. If interest rates are more favorable currently than when the loan was first taken out, restructuring or refinancing can result in a loan that is less costly to pay off.
8. Consolidate
Consolidation can provide similar benefits by exchanging multiple smaller loans with varying interest rates and terms for one new loan. This simplifies things by giving the company just one recurring, consistent debt payment and also provides the opportunity to secure a lower interest rate and a longer repayment term. This process may come with additional fees and the current interest rates may be less favorable than those on existing loans, so it鈥檚 important to evaluate the options to determine which one will provide the greatest financial benefit.
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