Debt management is a facet of business ownership that cannot be avoided; however, ignoring small debt can become a significant barrier to the survival and expansion of the business. Whether you're just starting or you've been in business for years, understanding the different types of debt available and how to manage them effectively is key to maintaining financial health. Business debt is, unfortunately, highly heterogeneous, between short-term, low-rate notes and long-term, high-litigation debt, for example. This blog post describes the different types of debt that small businesses deal with and offers practical tips to handle them properly.
1. Short-Term Debt
Short-run debt is usually defined as loans or lines of credit with a maturity of 1 year. These types of debt are often used to cover immediate expenses, such as inventory purchases, payroll, or unexpected costs. Short-term liabilities are a feature of firms in a constrained cash flow situation or in a position where they will be unable to make loan repayments.
Types of Short-Term Debt include:
a) Lines of Credit (LOC):
Access to a revolving credit line with a limit that can be drawn on as far as necessary by a business. Interest is calculated only on the outstanding balance, which is not tied to cash management.
b) Short-Term Loans:
The repayment term is fixed, usually less than one year. They are usually provided with a higher interest rate because of the relatively short payoff horizon (i.e., Trade Credit: Solutions that allow companies to purchase goods or services and get reimbursed over time (as a broader category of 30-day up to 90-day extensions).
How to Manage Short-Term Debt:
Keep ongoing control over income and expenditure to maintain the liquidity necessary to meet short-term liabilities.
Prioritize high-interest debt: First, pay off the debts with the highest interest rate to avoid accrual of future interest.
Negotiate better terms: Where possible, this is the case when trade credit or short-term loans are also available, then there are strong benefits to being able to provide more favourable arrangements for repayment, for example, a reduction in interest rate.
2. Long-Term Debt
Debt of any amount and any period in which repayment is to be executed within a year is of the nature of a long-term debt. They are primarily used for large investments, like real estate, apparatuses, or expansion of operations. Although it is not to be denied that, over the longer term, debt can finance business growth, debt is siphoning away capital and other resources throughout life and, hence, not easily to be ignored; debt needs to be managed thoughtfully. Types of Long-Term Debt:-
a)Term Loans:
Such loans are granted at a fixed interest rate and within the range of 1 to 10 years and up to 10 years. Corporations use them for expansion, purchase of equipment, and capital investment.
b)Commercial Mortgages: A real property mortgage that is an open-ended real property mortgage is a long-term loan that is a line of credit backed by the firm's right, title, and interest in and/or to subject real property. Commercial mortgages are typically priced at a cheap rate and have a long repayment date.
c)SBA Loans:
Loans with advantageous conditions and long-term and low interest rates are available to small businesses through the U.S. Small Business Administration (SBA). Lending is typically presented at a lower interest rate and with more demanding application criteria.
How to Manage Long-Term Debt:-
Plan for long-term cash flow: But the biggest obstacle is that, as a long-term liability is a debt that has occurred over time, you have to be 100% sure that your business is equipped and able to generate enough cash to keep up with that debt.
Refinance when possible: When you can get a lower interest rate or more favorable terms, refinancing spreads the load throughout the loan.
Avoid over-leveraging: No doubt it is also true that for the sake of business development, debt is there; this debt can be a negative burden; however, if the debt is maximized and increases further, the financial burden will be simply out of control. Predict your capacity to repay before taking out any significant loan.
3. Debt Financing vs. Equity Financing:
In addition to traditional loans, small businesses, in that context, are forced to choose between debt and equity financing. Debt financing is borrowing money with an obligation to repay that money. In contrast, equity finance involves using capital in exchange for access to a specific part of the business and then to a proportion of the business business profit.
Debt Financing:-
a)Ownership retention: Debt financing does preserve full ownership and control of the entity. In line, loan payment servicing can create cash shortfalls.
b)Interest payments: Debt capital bears interest, which grows over time.
Equity Financing:-
a)Ownership dilution: As you need to sell equity, you are giving up a portion of your company ownership by sharing its management with its investors. Yet, you will not accrue any principal or interest.
b)Potential for growth: Investment is capital, expertise, and business connections needed to start and develop a business.
How to Choose Between Debt and Equity Financing:
Assess your financial needs: Access to capital plays an important role when a need for capital is present but needs to be met (otherwise, the loans would remain unpaid) and when it is apparent that capital loans would be repaid. There are things to think about when loaning is not appealing and ownership is not appealing, and equity financing is an option.
Evaluate your growth stage: Youth-based companies have predominantly relied on equity finance to eliminate debt, while corporate companies have used debt finance to keep control (Bawn Cotton, 2020).
4. Credit Cards and Microloans
Microloans, especially for small businesses, are at the corner of credit cards and microloans with smaller credits. Projects of this kind are beneficial when there are short-term operational and financial requirements or emergencies. However, they should be managed with the utmost care to prevent the risk of high-interest entanglements.
Types of Credit-Based Debt:-
a)Business Credit Cards:
These cards offer revolving credit with varying interest rates. Despite the fast and effortless nature of making access to the capital, they are addictive to high or even exponential interest rates if they are not fully repaid every month
b)Microloans:
Micro, short-term ---type loans are predominantly cleared by non-traditional financial institutions and government-sponsored programs. Payments through microloans are, on average, at least penultimate (t=1/p) as an interest rate as credit cards with limited overdraft facilities.
How to Manage Credit-Based Debt:-
Pay off balances promptly: Credit card debt is complicated to overcome due to the rate of compounding. As much as is practical, at the least, attempt to settle the balance in full each month to avoid late charges.
Limit borrowing: Always be careful when buying with business credit cards. Do as much as possible to prevent them from being discriminated against as opportunistic buys or panic buys, and do not carry large balances. -
Research microloan options: Microloans represent an additional option for small enterprises that cannot lend themselves to a banking or similar institution loan. Look for lenders with favorable terms and repayment schedules.
5. Managing Debt Through Effective Strategies:
Every debt credit is sure to be accessible only if it can be controlled efficiently. Here are some general strategies for managing business debt:
Develop a budget: A good budget is one where you are able to commit resources to debt payment, that is, prevent overspending and/or default.
Focus on debt repayment priorities: Always prioritize high-interest debt first. This will help minimize the overall cost of borrowing.
Consider debt consolidation: Perhaps it is feasible to borrow many loans and consolidate them into a single loan with a reduced percentage of interest rate, in which case loan payments will remain uncomplicated and stable. -
Monitor your credit score: A good credit score yields better borrowings. Please take note of your score and attempt to increase it by reducing debt and avoiding late payment fees.
Conclusion
Accurate determination of various business liabilities and the treatment of these liabilities is of tremendous importance to the life span of a business. It does not matter if short-term financing is at stake to fund operation business costs (that is, short-term financing) or for running the business model (that is, long-term financing) the focal point is to develop a strategic plan that is in alignment with the business costs. From a quantitative budget, debt, and financial plan point of view, it is also feasible to satisfy the needs of business debt and take the business to the stage of development and profit.
