So you've started a business and things are going great. Orders are pouring in, customers love your products, and revenue is on the rise. But then the bills start coming due and you realize you’ve taken on a lot more debt than expected. How did this happen and how do you get out of it? Running a business often means taking on debt, whether through business loans, lines of credit, credit cards, or unpaid bills. It can feel like a tangled web of confusing financial obligations. But don't worry, we're here to help unravel the mystery of business debt and provide some strategies to pay it off. By understanding the different types of debt, how it impacts your business, and the best ways to reduce it, you'll be back in the black in no time.
Differentiating Between Business Debt and Personal Debt
When it comes to debt, it's important to understand the difference between what you owe for your business and what you owe personally.
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Business Debt
Business debt refers to the money your company borrows to fund operations or growth. This could be a business loan, line of credit, or business credit card. The key thing is that the debt is in the name of your business, not you personally. If your company defaults, the lender can pursue legal action against the business but typically not you as the owner.
Business loans often require collateral like equipment, vehicles or property. The business assets secure the loan.
Business lines of credit and credit cards also need to be paid by the business. While you may have personally guaranteed them, the debt isn’t in your own name.
Personal debt
Personal debt, on the other hand, is owed by you as an individual. This includes credit cards, mortgages, auto loans, and personal loans in your own name. If you default on personal debt, the lender can take legal action against you directly to collect.
Keeping business and personal debt separate is critical. Don't use business loans or credit for personal expenses, and don't use personal credit cards or loans for business costs.
Make sure you understand the terms and conditions of any debt before signing on. Know whether you'll be personally liable in case of default. The last thing you want is your business debt becoming your own personal nightmare.
Staying on top of your business's cash flow and financial health is the best way to avoid getting into debt trouble. But if debt does become an issue, keep the lines clearly drawn so you can develop the right solutions and strategies for your business and yourself.
Common Sources and Uses of Business Debt
When running a business, debt is often unavoidable. The two most common types are lines of credit and term loans.
Lines of Credit
A line of credit lets you borrow money up to a pre-set limit and pay interest only on what you use. It's flexible since you can draw on it when needed and pay it back as you're able. Many businesses use lines of credit to manage cash flow.
Term Loans
Term loans provide a lump sum of cash upfront that's paid back over a fixed time period, typically 1 to 25 years. Interest rates are often lower than lines of credit. Businesses frequently use term loans to finance major purchases like equipment, vehicles, or real estate.
To qualify for either type of financing, lenders evaluate your business's ability to repay the debt. They consider things like your revenue, profit margins, credit score, time in business, and personal credit history. The lower the risk, the better terms you can get.
Debt allows your business to grow and thrive. But too much debt can be dangerous. Make sure any new borrowing aligns with your business goals and that you can service the payments. A good rule of thumb is that your total debt payments shouldn't exceed 35-40% of your operating income. Watching your debt levels and using financing strategically will set your business up for success.
Managing and Paying Down Your Business Debt
Managing your business debt effectively is key to the financial health of your company. There are a few strategies to consider:
Make paying off debt a priority. Whether it’s credit cards, loans, or lines of credit, focus on paying off high-interest debts first. Throw as much money as possible at those debts to avoid paying more in interest charges. Even paying just the minimum on low-interest debts and putting extra money toward high-interest debts will help.
Renegotiate with lenders. If your business has a good payment history, you may be able to negotiate lower interest rates with your lenders, especially if rates have dropped since you first borrowed the money. This can save thousands of dollars per year in interest charges. You may also ask about temporarily reducing or suspending payments. Some lenders may work with you if your business is going through a rough patch.
Consider refinancing. If interest rates have dropped substantially since you took on your debt, it may make sense to refinance high-interest debts like mortgages, equipment loans, and lines of credit. Shop around at different banks and credit unions for the best rates. Refinancing can lower your payments and pay off the debts faster.
Make a monthly debt payoff plan. The best way to pay down debt is to make a plan and stick to it. Lay out all your business debts, interest rates, minimum payments, and create a schedule to pay off the highest-rate debts first while maintaining minimums on the rest. As high-interest debts are paid off, roll those payments into the next target debt. Maintaining discipline and consistency is key.
Paying off your business debt may not be easy, but with time and persistence you can free up cash flow and set your company on solid financial footing for the future. Stay focused on your goals and keep chipping away at those balances month by month. Before you know it, you'll be debt-free!
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