We all know that consumer debt has been a “dirty word” in the past two years, but what about business debt? Business debt, if you manage it correctly, allows you to actually protect and grow your business. I spoke with Larry Frank, a business coach and regional developer with the Richmond, Va.–based Advicoach, about the right way to approach business debt. He says that just as consumer debt isn’t a four-letter word if you use it wisely, business debt is also not a dirty word. In fact, he says, there’s a real need for it in small business management.
Good reasons for taking on business debt include improving or protecting cash flow; financing an expansion; upgrading or replacing equipment; and building a credit history. But one of the best (and most common) reasons for taking on debt is purchase inventory. Depending on the type of business you own, you may to need to do this on a seasonal basis (many stores stockpile inventory for Christmas, for instance) or throughout the year (depending on how high your turnover is).
The trick to using debt to finance inventory purchases, however, is this: You need to pay the debt off as soon as you receive your accounts receivable. In other words, inventory debt is cyclical short-term debt, not long-term debt. And here’s another word of warning: If you’ve got access to credit, it can be tempting to stockpile inventory. After all, prices might go up in the future, or your access to credit may go down; so isn’t it best to buy when you can? Generally speaking, no. If you’ve got too much inventory, you’re likely to be renting out unnecessary space (or dealing with overstocked shelves and cabinets); paying higher insurance premiums; risking the possibility that the inventory could become spoiled or outdated. Too much inventory is like money sitting on the shelves, money that you could have invested elsewhere.
Of course, if you’re going to take on extra debt, you have to have a clear plan for paying for it. Make sure you understand the terms of your payment plan; are the payments fixed over the term of the loan or will they go down as your balance decreases? What are the penalties for late payments or a total default? And will you be personally liable for the loan or debt if your business is unable to make its payments? “Acquiring debt without a business plan is dangerous,” Frank says. “Failing to plan is essentially planning to fail.”
One other issue to keep in mind: just as consumer debt is harder to find these days, so too is business debt. “Banks are tightening up on their credit, which means that even credit-worthy companies may have a hard time getting what they need,” Frank says. “It may take longer than you expect to get debt, even if you have sound reasons for doing so.”