Do you understand the levels of debt you have in your business? Are you aware of the debt options available to you? In this instalment of the 2 minute takeaway series, I unpack debt a little.
Hi. In this two minute takeaway, I want to take a moment to talk about debt, look at what it is and what types of debt that we have out there.
I’m Hillary O’Dwyer, founder of Titian Consulting, your virtual CFO.
So debt is something that we normally introduce into the business to power our business, or to create working capital. So we want to bring in more money cash to do what we’re doing. So the most usual form of debt that most of us have, both professionally and personally, is credit card debt. And it’s also unfortunately the most expensive. So sometimes credit card debt creeps into our lives by stealth because we’re simply just piling expenses on there to keep the business moving forward.
Now, 20% a year interest charge, this is just exorbitantly expensive. So your best bet with your credit card debt is to domino it and replace it with something else if you have to, or just simply get rid of that altogether and start trying to operate within your means, as it were.
Another kind of loan that we can get from funders out there is obviously a bank loan. Now these tend to be much harder to get, although they are at a much cheaper interest rate. So you have to go to the bank, jump through all the hoops, fill out all the reasons as to why you want it. And you also have to be able to prove, generally, that you already have the cash, so you don’t really need it. So you need to have your ATO portals to be clear and have really good reasons as to why you can get it. Now, these can be over three to five years at much lower interest rates. So they can be good option if you can get them.
The ATO tend to offer funding inadvertently as people get to put their debts on a payment plan. So this could be for BAS returns or for income tax returns. So their interest rate is charged, but it often gets reversed as payments are made on time. However, watch out for falling into arrears with these plans, because it means everything including current debt, becomes due all at once if you stuff that up.
Another great way of getting debt onto the balance sheet to fund the business is through finance leases. And these are usually used to purchase equipment or to buy vehicles. So the great thing with these, is that you’re also, you’re acquire the assets as well as bringing in the debt to fund that asset. You end up with a monthly repayment that has a component of interest in it. And at the end of the time, you usually have an asset to go with it if you don’t have an enormous balloon payment.
So when should you take on debt? You might not have a choice. You might just have to simply take it because you need to power forward. When is it too much debt? Well, what you want to make sure is that your longterm debt isn’t bigger than your total assets. Different industries have different ratios for this. You want to try and keep it under 50% would be a rule of thumb there. And this is definitely a metric that is looked at by institutions when they’re assessing your business. So that’s just a few little parts there about debt. I hope you find that useful. I think next time we might have a look at equity.
See you next time.