Imagine a business that could run without having any debt, paying all bills as soon as they came in and using cash for all other purchases.
This utopia simply isn't attainable for most, so we need to accept that business debt is a fact of life. If managed well, debt can actually work for your business—but bad debt can overtake you and put you out of business.
We all know that debt can be risky, of course, and ways to avoid bad debt may seem obvious. Nonetheless, in my work with owners of small businesses, I often see the following mistakes.
Not maintaining a favorable debt-to-income ratio. This calculation helps a potential lender determine if your company will be able to pay back the borrowed money, based on how leveraged the business already is. Here's how the ratio is determined: the total of a company's current monthly debt payments is divided by the company's monthly gross income. The rule of thumb is that your debt-to-income ratio should never rise above 40 percent, but the maximum ratio varies from lender to lender.
Not thinking long-term when getting a loan. Keep the future in mind when applying for a loan. For example, your payment plan may seem reasonable for the first few months or even years, but did you consider slow times in your business, tax, and other expense increases, or other debts coming due? What about future income?
The best way to avoid running into this problem is to maintain a multi-year forecast budget and analyze it on a regular basis, and anticipate your future needs.
Using credit cards to get out of a crunch. Carrying some credit card debt can be beneficial for your business. It can help you establish good credit and increase your eligibility for future lines of credit. It may make sense for you to make a major, necessary purchase on a credit card if you can't afford to spring for the entire amount at one time.
But try not to use your credit card as a quick fix for times when you can't make a payment or afford other expenses for your business. Accumulating more debt with unsecured credit cards is generally not a good solution for your business's overall health and budget. The added interest may make it difficult to pay back the balance. And missing a payment, or maxing out the card, can damage your business's future borrowing power.
As an alternative, consider cutting back on less-important areas of your budget to find cash you need
Using business funds for personal reasons. Sometimes it can be hard for business owners to separate our money and our business's money in our minds. It's so easy to say, "I'll charge it"—the dinner, the vacation—"to the company card." More times than not, this thought pattern gets your business into trouble. These expenditures, while seemingly harmless, will be a drain on your business's finances since they are not meant to be business expenses and can cause the budget to become unbalanced.
They can also lead to the loss of certain legal protections a corporation would normally give you. By comingling personal and business funds, you are indicating that there is no separation between them. That means your personal possessions (such as your house, car, and so on) could be vulnerable in the event of a lawsuit or bankruptcy.
Sometimes our love for our businesses can get the best of us. Our emotions lead to making impulsive decisions and spending in areas where we could have been saving. Solicit outside advice and other professional help as often as you can when it comes to your business, especially in matters involving money. Seek professional guidance from your attorney, CPA, or other trusted advisor.
Leslie H. Tayne is the founder of Tayne Law Group, P.C., a law firm focusing on consumer debt resolution. She can be reached at email@example.com.
© Citigroup Inc. Citibank, N.A. Member FDIC.