Financing can help your business grow and help you reach the goals you’ve set for your business. But it’s important to know what kind of debt is helpful and how it can impact your business, especially when you’re trying to climb out from under already existing debt.
Our guide will clarify the difference between good and bad debt and offer strategies to get your business out of debt quickly.
What Is Business Debt?
Debt is money borrowed by one entity from another entity that has to be repaid by a certain date.
Many businesses borrow money to make large investments or purchases they couldn’t make on their own.
Business debt is money a business borrows from a creditor or lender to pay for business expenses. The business agrees to pay the money back, usually with interest.
- Good debt: Contributes to the growth and goals of your business and can increase your business’s future net worth
- Bad debt: Can hamper your business’s ability to progress by negatively impacting its finances and decreasing your business’s future net worth
Keep in mind that every business is different. The right or healthy amount of debt for a business will vary. This is why it’s important to have a debt management plan in place for the business’s loans. It ensures that you’ll get the most benefit out of your debt and that you’re in a position to manage it well.
What Are the Benefits of Good Business Debt?
There isn’t one specific kind of debt that is good or bad. Good debt reflects your business’s goals and financial situation. What might be good debt for one business could be bad debt for another.
Generally, good debt has a lower interest rate and favorable repayment terms. Despite its advantages, you still need to understand how the debt will impact your business and have a plan in place to manage it.
Here are some other benefits of good debt:
- Funds growth: Good debt can be leveraged to help achieve business goals like expanding, project funding or giving your business a more competitive advantage.
- Tax breaks: Business debt interest is tax deductible, which means you may be able to get some money back during tax season.
- Less risky than equity: Good debt can be a less risky or cheaper option than getting funded through equity because shareholders or investors may want a higher rate of return on their investment. Instead of paying dividends to multiple individuals or entities, you may only have to repay one lender or one line of credit.
What Is the Impact of Bad Business Debt?
If good business debt is a thing, so is bad business debt. But there isn’t a specific type of debt that’s bad. Bad debt hinders your business’s ability to progress and hurts its finances because there was no debt management plan in place. This can be especially fatal to small businesses.
The impact of bad debt on business owners can include:
- Collateral repossession: If you got a secured business loan and backed it with property, equipment or inventory and you default on your payments, the lender can repossess the asset.
- Risky investment: If a business already has a lot of debt, a future lender may consider the business a riskier borrower for future loans and/or credit lines. That can make it harder to apply for additional funds.
- Making payments: Businesses that have a lot of debt or debt with high interest rates or debt with strict repayment terms may find it hard to make payments if their income drops.
- Bankruptcy: Your business may get to the point where paying back your debt is impossible. If you can’t negotiate a debt settlement, you may have to file for bankruptcy.
- Closing or dissolving: If your debt negatively impacts your business to the point that it makes no sense to keep it open, you may have to close or dissolve your business. If you close a business with debt, you’ll likely have to resolve any outstanding debt with your lenders or creditors.
When looking at different kinds of debt, try to steer clear of debt that’s tied to high interest rates, has lots of fees or strict repayment terms that may be difficult to meet. And make sure that you’re using the money on assets that won’t depreciate.
How Do You Get Out of Business Debt?
Whether it’s good debt that helped you reach a goal or bad debt that is hindering your growth, getting out of debt can free up more funds for your business. You can take steps to get out of business debt with some planning and debt reduction strategies.
Use these strategies to help find practical solutions for your business:
1. Review your current business debt
An in-depth analysis of your business finances can help you discover what debts you have, your budget and where you can start implementing debt reduction strategies.
Here are some tips for reviewing your budget and debts:
- Work with a professional: Work with a financial advisor and/or your business’s chief financial officer to lay everything out and make sure you have procedures in place for proper data entry and tracking.
- Review often: The in-depth analysis of your finances should become routine. Reviewing your finances and budget every month can help you stay on top of everything.
- Use what you can access: If you don’t have a financial advisor or CFO, consider using financial management software to keep track of your business’s finances. The program may make it easier to see what’s coming in, what’s going out, what debts you have and which debt(s) you should tackle first.
2. Reduce business costs
While reviewing your business finances, you may find some items or operating costs you can cut to reduce your budget. Look for things like subscriptions, vendor contracts or other nonessential expenses. You should also consider the impact of any one-off purchases as you move forward.
If you can’t remove certain expenses, you may be able to lower them. Try to negotiate lower subscription prices or contracts and take advantage of promotional discounts.
3. Create a repayment strategy
Once you’ve outlined your current debts and budget, it’s time to create a repayment strategy. Focus on paying off any bad debt unless you’ve identified a specific debt that makes more sense to tackle first.
This is where working with a professional can be very helpful. They can help you create a repayment plan for your business. If you can’t work with a professional, develop a detailed assessment of your financial situation (aka a business debt schedule) by listing out all your debts and their details, like the lender name, the debt amount, the repayment terms, etc.
Here are some ways to repay debt faster:
- Extra or larger monthly payments: To pay your debt off sooner, make payments that are larger than your minimum monthly payment or make multiple payments during the same month. If you were able to free up some extra cash by reducing business costs, consider putting that money toward extra or larger debt payments.
- Snowball method: Pinpoint your smallest debt and pay it off as quickly as you can. Once it’s paid off, roll the amount you were putting toward that old payment on top of the monthly payment for your next smallest debt to pay it even off faster. Keep moving on to your next smallest debt until you’re debt-free.
- Avalanche method: Laser in on your debt with the highest interest rate and pay it off as quickly as you can. Once it’s paid off, roll the amount you paid on the first debt on top of the monthly payment for your debt with the next highest interest rate, and so on. This method should help you save time and money because you’re focusing on your highest-interest debts first.
- Consolidate or restructure: You may be able to consolidate multiple debts into a single loan or restructure your debt to lower your interest rate and make your payments more affordable (more on these options later). If your debt is easier to manage and you pay less in interest, you may be able to pay it off faster.
4. Communicate with lenders
It’s important to reach out to your lenders and creditors if you’re having difficulty paying your debts. You may be able to renegotiate your repayment plans or other loan terms (like the interest rates).
5. Consider refinancing expensive business debt
You may want to refinance debt that is draining your earnings and hurting your business goals. When you refinance, you apply for a new loan to pay off your old loan. You may get a lower interest rate or a longer repayment period with a loan refinance.
When you refinance a loan, you go through the loan process all over again, which means any fees that come with getting a loan will have to be paid. To qualify for the loan, your credit score and debt-to-income (DTI) ratio will have to meet your lender’s requirements.
Refinancing is different from debt consolidation and restructuring. We’ll touch on each option later on. It’s important to know how they work, how they differ and how they may help you.
6. Increase your income
When you have more income, you have more money to pay off debt. Find ways to increase the money flowing into your business. Just remember that more income also means paying more in taxes.
Here are some tips to increase your business income:
- Upsell by encouraging customers to upgrade their order(s)
- Create customer loyalty programs
- Optimize inventory
- Add more services or products to your offerings
- Collaborate with other businesses to capture new customers
- Increase your prices
7. Temporarily pay with cash (if you can)
Explore making payments with cash temporarily to avoid piling on more interest-generating debt. And save your receipts! It’s important to keep track of all the expenses you pay with cash so when it comes time to do your taxes, there is proof that the expenses were made.
Consider paying cash for:
- Office supplies
- Unexpected small expenses
- Gas for the company car
- Nonessential expenses
Using cash for business expenses (no matter how small) shouldn’t be a long-term strategy and isn’t a mandatory step to getting out of debt. But it may help!
What’s the Difference Between Refinancing Debt and Consolidating Debt?
Understanding the difference between refinancing, consolidating and restructuring your debt can help you decide which option is best for you.
- Refinancing: When you refinance, you take an existing debt and negotiate new terms – like your monthly payment, your interest rate or your repayment period – with a lender or creditor. You refinance loans by swapping out your existing loan for a new loan. If you’re refinancing credit card debt, you can do that with balance transfers to new, low-interest cards.
- Consolidation: Consolidation combines your existing debt into one new debt (usually a loan). Your new loan may have a lower monthly payment, a reduced interest rate and a new repayment schedule that makes paying off your debt more manageable. You can even consolidate multiple credit card debts into a single business loan.
- Restructuring: When a debt is restructured, your monthly payments are lowered by adjusting the interest rates or the debt repayment period. Debt restructuring usually happens when you’re finding it difficult to repay your debt, and you need to negotiate a new amount to pay back. It’s similar to refinancing, but with refinancing, you get a new loan (or credit card). With restructuring, you modify an existing debt.
Destroy Business Debt
Whether you decide to apply all the debt reduction strategies we’ve outlined or just a few, make sure you understand how each strategy will impact your business.
If you can, work with a financial professional to help you analyze your business’s finances and come up with a strategy you can afford and manage.