NFIB

Don't Let the Good Times Get You Into a Debt Crunch
05/ 03/ 2004


The booming U.S. economy still seems to be churning along and this has encouraged companies of all size to take on additional debt for the purpose of increasing inventory, adding equipment, expanding operations, etc. But most business analysts agree that small businesses, in particular, should not let the "good times" go to their heads. It's easy to forecast a rosy future, but if a company's cash flow should go through even a modest temporary downturn, added debt could cause problems. Income streams may rise and fall, but debt payments go on no matter what the financial situation of a company. In today's Workshop, Jeffrey Moses discusses general guidelines to help evaluate and moderate the taking on of additional debt.

The forecasting of future cash flow is difficult for any business but even more so for small companies that may be vulnerable to seasonal business fluctuations, order cancellations, changes in consumer trends, cost-of-supplies variations, etc. In general, short-term forecasting is considerably more accurate than long-term, and should almost always be used as the basis for taking on additional debt.

Working with your business adviser or accountant, carefully evaluate future cash inflow, including both secure revenue (accounts receivable, contracts for sales, etc.) and anticipated revenue. Anticipated revenue should reflect new business based on "real" current expansion. There are numerous ways to mathematically determine a "prudent" percentage of secure and anticipated future revenue to use as the basis for taking on debt. Your business adviser can work with you on this. But such ratios should be rough guidelines only. Banks and other lenders may be willing to lend you substantial sums in a booming economy, but your business (and perhaps you personally) will be responsible for payments.

There are respected business analysts who support the theory that a person should take on debt as personal "motivation." While there may be merit in this philosophy, few experienced business people would agree with it wholeheartedly. Safety first is always the best policy.

This is not to say that debt should be avoided altogether. When planned responsibly and conservatively, taking on debt at key times of expansion can help a company immensely. Even so, work with your adviser to make sure that your company has adequate cash reserves on hand to help make interest and principal payments if your cash flow should take a dip.

Borrowed funds should, as a rule, be used almost exclusively for specific business purposes. These purposes should be determined with great care before the money is borrowed. Avoid the temptation to "re-allocate" your disbursements of cash after the money has been secured (including personal needs). And stick to pre-established time schedules. This will help you avoid spending too rapidly.

Remember, the owners of a small business almost always are personally responsible for payment of company debt. This is usually true even when the business is incorporated. Excess debt in times of cash-flow shortages can become personally stressful, and has caused untold numbers of companies to go out of business. So plan conservatively, looking ahead only at the short term, and make certain that any borrowed funds are used solely as scheduled.

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