Dr. Richard Stephens Certified Public Accountant (CPA) and Certified Financial Consultant (CFC), gives you tips on when not to borrow money.
It is quite common for a small business or individual to take on debt to finance its expansion or maintain cash flow. Yet borrowing money is not a good idea for every small business and its financial issues. Below are some instances when it may not pay for your business to take on a loan.
When you cannot afford the debt Many businesses pursue loans without having a clear idea of whether they can afford to take on the debt. Ask yourself: what is the purpose of the debt and what will be its impact on the company’s finances? In other words, can you afford the debt and can you make the monthly payments? In order to clearly answer this question, you may need to sit down with your CPA or financial consultant to run various projections. In general, a loan should be able to provide sufficient cash flow to allow your business to make regular payments that can be budgeted for. Otherwise, the loan can quickly become a drag on cash flow and hurt your ability to run your company profitably.
When you are looking to pay down other debts Taking on debt to cover other debt payments is a self perpetuating way to get your business into deeper financial problems. It not only adds to cash flow pressure, but can also put the life of your business at risk. In fact, many financial institutions will prevent you from using a loan to pay off creditors. On the other hand, refinancing debt to consolidate several loans into one can be an effective way to decrease your overall interest rate and spread the loan over a longer period of time.
When you need help covering fixed expenses Fixed expenses are those business costs that do not change with the volume of the business, such as rent, utilities, insurance payments, etc. A business generally should be able to pay these out of cash flow. Variable expenses such as manufacturing costs, inventory, or advertising are generally better targets for debt financing, since these investments are more likely to help boost your business cash flow.
((graphic with this) When you are making certain capital equipment purchases If your business needs new equipment such as computers, phone systems or other capital gear but doesn’t have cash on hand, leasing may be a better option than taking out a loan. Although your business will not own the equipment it leases, it can avoid taking on debt or tying up lines of credit that can be used for other areas of business.
