More often than not, an ambitious start-up businessman would have to take a loan to bring his or her business into fruition. Though having the capital for a business could come from investors or personal savings, oftentimes, it does start from debt. Then again, no matter how big or small your business hopes to be, a debt as part of the capital investment might just be inevitable.
After everything’s been said and done, the big struggle is how to pay them off, especially when you’re just starting in the world of entrepreneurship.
To smooth your way out of this entrepreneurial hurdle, here are 3 tips that you can follow to get out of your business debt smoothly and quickly:
First Things First: Do your homework before taking a loan
Hopefully, before you sign that loan agreement, you did your homework. It’s important to calculate your debt coverage ratio before you apply for a loan. This is important because the debt coverage ratio determines how easily you would be able to pay it back. Debt coverage ratio is also the most famous yardstick used by the lenders to determine the amount, interest rate and the terms of a certain loan.
To calculate your debt coverage ratio, one of the most common methods is to divide net operating income by the interest and principal payments of the debt – or the total debt service:
For example, if you have an annual net operating income of $25,000 and total debt service of $21,000, your debt coverage ratio will be 1.19. Typically, most commercial banks consider a ratio of 1.15 and above to be optimal. If your ratio is 1 or lower, then it is time to look at ways to boost your cash flow.
Your inclination may be to convince a bank to give you a large loan, but play it safe. If a debt coverage ratio suggests that the loan you are seeking seems to be a stretch, there is a good chance you are going to struggle to make your loan payments.
Tip 1: Increase cash flow to pay off debt
For most businesses, paying off debt should be a priority. Of course, to pay your debt, you must gain much more money than you lose; in other words, your cash flow must be increased. The best ways to increase cash flow are to increase productivity, renegotiate terms with vendors, and optimizing inventory turnover (among many other ways).
Increase productivity: Building efficient processes in your business or finding new ways to generate revenue can be sound strategies for increasing cash flow. Increasing employee skills through training or introducing a new technology can be great investments in productivity and increasing profits. New marketing initiatives can also increase the bottom line. Granted, this may increase costs in the short term, but a well-thought-out marketing plan can increase your profits, which in turn, can be used to pay down debt.
Renegotiate terms with vendors: Proper management of accounts payable can significantly increase cash flow and accelerate your ability to pay your debt. Many suppliers offer payment terms of 15, 30, 45 and even 60 days after the delivery of goods and services. Conversely, you may be able to negotiate an early payment discount – early payment discounts can be anywhere from two to ten percent. Finally, periodically, shop for new suppliers that can offer you better pricing. These are all great ways to increase your cash flow.
Optimizing inventory turnover: Stagnant or access inventory can drain your cash reserves. In order to optimize inventory turnover, the best way is to apply for lean manufacturing. Lean manufacturing involves never ending efforts to eliminate or reduce ‘muda’ (Japanese for waste or any activity that consumes resources without adding value) in design, manufacturing, distribution, and customer service processes. Developed by the Toyota executive Taiichi Ohno (1912-90) during post-Second World War reconstruction period in Japan, and popularized by James P. Womack and Daniel T. Jones in their 1996 book “Lean Thinking”.
The main concept is that inventory should be closely monitored and be purchased “just-in-time” for anticipated demand. If possible, work with suppliers that offer consignment inventory or rights of return for unsold goods.
Tip 2: Negotiate for lower interest rates
Did you know that you can actually negotiate for lower interest rates? Yes, you can! One thing that most people neglect is the idea of renegotiating interest rates, especially when the chips are down and they needed to adjust.
The national average credit card annual percentage rate (APR) has fallen to 14.95 percent. While rates are at a historical low, many would consider paying nearly 15% interest on a loan. Ideally, you should pay off your credit card balance every 30 days and avoid interest charges completely.
The problem with many businesses, unfortunately, is with snowballing credit card debt. Clearly, paying down high-interest credit card debt should be a focus for any business, and this can be challenging for some businesses. In these cases, one option would be to consider a balance transfer. The idea behind a balance transfer is to consolidate your credit card debt under one card with a lower interest rate. There are fees associated with balance transfers, so do the math to ensure that the lower finance charges offset the fees.
Actually, the easiest way to get a lower credit card interest rate is to ask for it. If you have a good credit score, and you are a long-term customer who pays on time, then a request for a lower interest rate may just be all that it takes. If you are able to reduce your interest rate by one or two percent, you could end up saving hundreds of dollars a year.
Finally, when things get worse, you can always opt for an IVA. Take the extra mile and contact companies like Stepchange or Creditfix – Individual Voluntary Arrangement or any other IVA-providing companies that can help you get out of debt, as they can make an arrangement for you to pay off your debt in an extended period of time.
An IVA is an agreement with your creditors to pay all or part of your debts. You agree to make regular payments to an insolvency practitioner, who would divide this money between your creditors. An IVA can give you more control of your assets than bankruptcy.
Tip 3: Consolidate your debt
Consolidating debt or loans is one of the fastest ways to lower your interest rates and pay down your debt quickly: instead of paying different loans with varying interest rates, you can consolidate them all into a single low-interest loan. Consolidation Loans combine several student or parent loans into one bigger loan from a single lender, which is then used to pay off the balances on the other loans. They also provide an opportunity for alternative repayment plans, making monthly payments more manageable.
For example, say you have two different loans: one with an annual interest rate of 13 percent and a current balance of $10,000 and the other with an annual interest rate of 12 percent and a current balance of $20,000. Your current monthly payment would be $1200. With debt consolidation, for instance, your interest rate dropped to 9.2 percent. You would be paying $750 per month. This saves you $450 every month. Consult a financial advisor to determine whether debt consolidation is right for you.
In the long run, the decisions you make today can definitely affect both your personal and professional finances. Consider all your financial resources and explore your options fully before you decide to commit to a particular solution.