Debt Management for Business
For businesses, debt is a reality.
Whether it’s from purchasing inventory or equipment, taking out a loan to cover working capital requirements, or simply owing suppliers, debt is an unavoidable part of doing business.
It is important that business never finds itself in a position where the debt is in effect controlling the business outcomes, therefore it must be that the business is managing the debt not the other way round.
This article will discuss different types of business debt, and how cash flow and forecasting can help you understand and manage your debt.
Different Types of Business Debt
Firstly, there are a few different types of debt that businesses might have, and it is important that these differences are understood:
- Short-term debt: This is debt that is typically due within one year. Short-term debt can include things like credit card debt, lines of credit, overdrafts, and the current portion of longer-term debt repayment requirements
- Long-term debt: This is debt that is due after one year. Long-term debt usually includes things like mortgages and loans and equipment debt over a period of greater than 12 months
- Secured debt: This is debt that is backed by collateral, like a loan against equipment or mortgage of property.
- Unsecured debt: This is debt that is not backed by collateral and may include things such as loans from the principals of a family business without security.
Understanding the difference between short term and long-term debt
Short term debt requires a need to commit the current business cash flow to meet the commitments. Whereas long term debt has no demands on short term cash and is for future planning and management.
Therefore, sometimes just getting the funding mix right between short- and long-term debt can ease the pressure on business cash needs.
Cash flow and managing debt
Cash flow budgeting is the process of a business forecasting its likely income and expenses and its debt commitments. Cash flow budgeting is used by a business to better manage its money and to ensure that the business debt is appropriate for what is to come, say in the coming 12 months. This includes ensuring that they have enough money to cover their working capital needs, ongoing expenses, and the current short term-debt repayments.
A proper cash flow budget should identify issues that are likely to occur in the near future and therefore provide time for the business to plan the solutions to those issues. This can include solutions such as:
- negotiating with creditors
- approaching the bank in a timely way to temporarily extend facilities
- identifying a need to more permanently restructure the current / long term debt mix, to possibly ease some of the pressure on current cash.
Conversely poor cash flow management can lead to a profitable business not being able meet its current cash demands.
Forecasting and debt management
Forecasting is vital to debt management and can impact businesses in a number of ways.
By understanding future cash inflows and outflows, businesses can better manage their debt and avoid defaulting on payments. Forecasting cash flow can also help businesses negotiate better or different terms with creditors and lenders.
There are a number of different methods that businesses can use to forecast cash flow. The most common method is to use financial statements from past periods to predict future cash flows.
Another method that businesses can use to forecast cash flow is to create a budget. This involves estimating future income and expenses and then projecting how much cash will be available. This method can be more accurate than using financial statements but can be more difficult to create and maintain.
Debt is a reality for most businesses, but debt doesn’t have to be a problem. It should be the mechanism whereby a business can not only meet its commitments but to be used to grow and prosper.
By understanding the different types of debt and making a budget you can keep your business debt under greater control. This should give peace of mind in the knowledge that your business is appropriately funded to meet its commitments.
If you need support with managing your business debt talk to your Johnsons MME advisor today.